UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-11848
REINSURANCE GROUP OF AMERICA, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MISSOURI 43-1627032
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
1370 TIMBERLAKE MANOR PARKWAY
CHESTERFIELD, MISSOURI 63017
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(636) 736-7439
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
--- ---
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN
ACCELERATED FILER, OR A NON-ACCELERATED FILER.
LARGE ACCELERATED FILER X ACCELERATED FILER NON-ACCELERATED FILER
--- --- ---
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN
RULE 12B-2 OF THE EXCHANGE ACT). YES NO X
--- ---
COMMON STOCK OUTSTANDING ($.01 PAR VALUE) AS OF APRIL 30, 2006: 61,181,349
SHARES.
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
TABLE OF CONTENTS
ITEM PAGE
---- ----
PART I - FINANCIAL INFORMATION
1 Financial Statements
Condensed Consolidated Balance Sheets (Unaudited)
March 31, 2006 and December 31, 2005 3
Condensed Consolidated Statements of Income (Unaudited)
Three months ended March 31, 2006 and 2005 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three months ended March 31, 2006 and 2005 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
3 Quantitative and Qualitative Disclosures About Market Risk 29
4 Controls and Procedures 29
PART II - OTHER INFORMATION
1 Legal Proceedings 29
1A Risk Factors 30
2 Unregistered Sales of Equity Securities and Use of Proceeds 30
6 Exhibits 30
Signatures 31
Index to Exhibits 32
2
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
March 31, December 31,
2006 2005
----------- ------------
(Dollars in thousands)
ASSETS
Fixed maturity securities: $ 6,781,908 $ 6,874,243
Available-for-sale at fair value (amortized cost of $6,417,481 and
$6,331,225 at March 31, 2006 and December 31, 2005, respectively)
Mortgage loans on real estate 669,368 648,067
Policy loans 973,625 987,442
Funds withheld at interest 3,612,193 3,459,943
Short-term investments 44,548 126,296
Other invested assets 195,580 235,464
----------- -----------
Total investments 12,277,222 12,331,455
Cash and cash equivalents 430,740 128,692
Accrued investment income 78,560 62,498
Premiums receivable and other reinsurance balances 594,981 573,145
Reinsurance ceded receivables 534,523 541,944
Deferred policy acquisition costs 2,549,553 2,465,630
Other assets 98,350 90,502
----------- -----------
Total assets $16,563,929 $16,193,866
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Future policy benefits $ 4,784,424 $ 4,693,454
Interest sensitive contract liabilities 5,674,554 5,503,528
Other policy claims and benefits 1,544,500 1,529,298
Other reinsurance balances 231,532 212,422
Deferred income taxes 630,515 652,024
Other liabilities 255,265 117,101
Short-term debt 100,000 125,610
Long-term debt 699,683 674,392
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely junior subordinated debentures of the Company 158,589 158,553
----------- -----------
Total liabilities 14,079,062 13,666,382
Commitments and contingent liabilities (See Note 5)
Stockholders' Equity:
Preferred stock (par value $.01 per share; 10,000,000 shares authorized; no
shares issued or outstanding) -- --
Common stock (par value $.01 per share; 140,000,000 shares authorized;
63,128,273 shares issued at March 31, 2006 and December 31, 2005) 631 631
Warrants 66,915 66,915
Additional paid-in-capital 1,059,967 1,053,814
Retained earnings 1,111,785 1,048,215
Accumulated other comprehensive income:
Accumulated currency translation adjustment, net of income taxes 83,090 85,127
Unrealized appreciation of securities, net of income taxes 247,185 361,815
----------- -----------
Total stockholders' equity before treasury stock 2,569,573 2,616,517
Less treasury shares held of 1,948,936 and 2,052,316 at cost at
March 31, 2006 and December 31, 2005, respectively (84,706) (89,033)
----------- -----------
Total stockholders' equity 2,484,867 2,527,484
----------- -----------
Total liabilities and stockholders' equity $16,563,929 $16,193,866
=========== ===========
See accompanying notes to condensed consolidated financial statements
(unaudited).
3
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three months ended March 31,
----------------------------
2006 2005
---------- ----------
(Dollars in thousands,
except per share data)
REVENUES:
Net premiums $ 992,442 $ 901,820
Investment income, net of related expenses 186,941 157,053
Investment related gains, net 632 3,979
Change in value of embedded derivatives 4,552 22,561
Other revenues 14,530 10,803
---------- ----------
Total revenues 1,199,097 1,096,216
BENEFITS AND EXPENSES:
Claims and other policy benefits 811,513 738,053
Interest credited 61,529 55,053
Policy acquisition costs and other insurance expenses 151,804 143,976
Change in deferred acquisition costs associated with
change in value of embedded derivatives 2,757 15,708
Other operating expenses 46,527 33,006
Interest expense 16,767 9,885
---------- ----------
Total benefits and expenses 1,090,897 995,681
Income from continuing operations before
income taxes 108,200 100,535
Provision for income taxes 37,620 33,271
---------- ----------
Income from continuing operations 70,580 67,264
Discontinued operations:
Loss from discontinued accident and health
operations, net of income taxes (1,510) (707)
---------- ----------
Net income $ 69,070 $ 66,557
========== ==========
BASIC EARNINGS PER SHARE:
Income from continuing operations $ 1.15 $ 1.08
Discontinued operations (0.02) (0.02)
---------- ----------
Net income $ 1.13 $ 1.06
========== ==========
DILUTED EARNINGS PER SHARE:
Income from continuing operations $ 1.13 $ 1.05
Discontinued operations (0.03) (0.01)
---------- ----------
Net income $ 1.10 $ 1.04
========== ==========
DIVIDENDS DECLARED PER SHARE $ 0.09 $ 0.09
========== ==========
See accompanying notes to condensed consolidated financial statements
(unaudited).
4
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three months ended
March 31,
----------------------
2006 2005
--------- ---------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 69,070 $ 66,557
Adjustments to reconcile net income to net cash provided by
operating activities:
Change in:
Accrued investment income (16,109) (18,160)
Premiums receivable and other reinsurance balances (19,127) (20,258)
Deferred policy acquisition costs (79,007) (60,503)
Reinsurance ceded balances 7,421 (7,740)
Future policy benefits, other policy claims and
benefits, and other reinsurance balances 137,557 229,280
Deferred income taxes 37,173 39,772
Other assets and other liabilities, net 19,157 (39,828)
Amortization of net investment discounts and other (11,888) (5,256)
Investment related gains, net (632) (3,982)
Other, net 8,435 1,148
--------- ---------
Net cash provided by operating activities 152,050 181,030
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of fixed maturity securities - available for sale 505,016 376,380
Maturities of fixed maturity securities - available for sale 25,200 18,983
Purchases of fixed maturity securities - available for sale (610,412) (563,294)
Cash invested in mortgage loans on real estate (34,364) (9,555)
Cash invested in funds withheld at interest (9,103) (28,546)
Principal payments on mortgage loans on real estate 12,874 5,142
Principal payments on policy loans 13,822 --
Change in short-term investments and other invested assets 117,960 (9,879)
--------- ---------
Net cash provided by (used in) investing activities 20,993 (210,769)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends to stockholders (5,500) (5,627)
Purchases of treasury stock (194) --
Exercise of stock options 2,871 4,339
Net increase in securitized lending activities 108,400 28,454
Excess deposits (payments) on universal life and other
investment type policies and contracts 24,429 (12,918)
--------- ---------
Net cash provided by financing activities 130,006 14,248
Effect of exchange rate changes (1,001) (1,582)
--------- ---------
Change in cash and cash equivalents 302,048 (17,073)
Cash and cash equivalents, beginning of period 128,692 152,095
--------- ---------
Cash and cash equivalents, end of period $ 430,740 $ 135,022
========= =========
Supplementary information:
Cash paid for interest $ 4,568 $ 4,192
Cash paid for income taxes, net of refunds $ (21,724) $ 52,894
See accompanying notes to condensed consolidated financial statements
(unaudited).
5
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Reinsurance Group of America, Incorporated ("RGA") and its subsidiaries
(collectively, the "Company") have been prepared in conformity with accounting
principles generally accepted in the United States of America for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included. Operating results for the
three-month period ended March 31, 2006 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2006. These
unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2005 Annual Report on Form 10-K ("2005 Annual Report")
filed with the Securities and Exchange Commission on February 27, 2006.
The accompanying unaudited condensed consolidated financial statements include
the accounts of Reinsurance Group of America, Incorporated and its subsidiaries.
All material intercompany accounts and transactions have been eliminated. The
Company has reclassified the presentation of certain prior-period information,
including all segment information, to conform to the 2006 presentation.
2. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share on income from continuing operations (in thousands, except per share
information):
THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2006 2005
--------- ---------
Earnings:
Income from continuing operations (numerator
for basic and diluted calculations) $70,580 $67,264
Shares:
Weighted average outstanding shares (denominator
for basic calculation) 61,138 62,553
Equivalent shares from outstanding stock options 1,479 1,301
------- -------
Denominator for diluted calculation 62,617 63,854
Earnings per share:
Basic $ 1.15 $ 1.08
Diluted $ 1.13 $ 1.05
------- -------
The calculation of common equivalent shares does not include the impact of
options or warrants having a strike or conversion price that exceeds the average
stock price for the earnings period, as the result would be antidilutive. The
calculation of common equivalent shares also excludes the impact of outstanding
performance contingent shares, as the conditions necessary for their issuance
have not been satisfied as of the end of the reporting period. For the three
month period ended March 31, 2006, approximately 0.6 million stock options and
0.4 million performance contingent shares were excluded from the calculation.
For the three months ended March 31, 2005, approximately 0.3 million stock
options and 0.3 million performance contingent shares were excluded from the
calculation.
6
3. COMPREHENSIVE INCOME
The following schedule reflects the change in accumulated other comprehensive
income (dollars in thousands):
THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2006 2005
--------- ---------
Net income $ 69,070 $ 66,557
Accumulated other comprehensive
income (loss), net of income tax:
Unrealized gains (losses), net of reclassification
adjustment for gains (losses) included in net income (114,630) (33,850)
Foreign currency items (2,037) (8,399)
--------- --------
Comprehensive income (loss) $ (47,597) $ 24,308
========= ========
4. SEGMENT INFORMATION
The accounting policies of the segments are the same as those described in the
Summary of Significant Accounting Policies in Note 2 of the 2005 Annual Report.
The Company measures segment performance primarily based on profit or loss from
operations before income taxes. There are no intersegment reinsurance
transactions and the Company does not have any material long-lived assets other
than internally developed software. As of March 31, 2006, the carrying value of
internally developed software was approximately $16.4 million. Investment income
is allocated to the segments based upon average assets and related capital
levels deemed appropriate to support the segment business volumes.
Effective January 1, 2006 the Company changed its method of allocating capital
to its segments from a method based upon regulatory capital requirements to one
based on underlying economic capital levels. The economic capital model is 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. This is in contrast to the standardized regulatory
risk based capital formula, which is not as refined in its risk calculations
with respect to each of the Company's businesses. As a result of the economic
capital allocation process, a portion of investment income and investment
related gains (losses) is 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. The prior period segment
results have been adjusted to conform to the new allocation methodology.
Information related to total revenues, income (loss) from continuing operations
before income taxes, and total assets of the Company for each reportable segment
are summarized below (dollars in thousands).
INCOME (LOSS) FROM CONTINUING
TOTAL REVENUES OPERATIONS BEFORE INCOME TAXES
THREE MONTHS ENDED MARCH 31, THREE MONTHS ENDED MARCH 31,
---------------------------- ------------------------------
2006 2005 2006 2005
---------- ---------- -------- --------
U.S. $ 765,552 $ 721,362 $ 80,336 $ 68,496
Canada 119,508 96,962 8,431 15,662
Europe & South Africa 148,668 144,001 14,797 14,513
Asia Pacific 147,634 122,714 6,614 2,910
Corporate and Other 17,735 11,177 (1,978) (1,046)
---------- ---------- -------- --------
Total $1,199,097 $1,096,216 $108,200 $100,535
========== ========== ======== ========
7
TOTAL ASSETS
--------------------------
MARCH 31, DECEMBER 31,
2006 2005
----------- ------------
U.S. $11,243,109 $11,049,424
Canada 1,987,277 1,954,612
Europe & South Africa 999,437 956,453
Asia Pacific 894,580 873,230
Corporate and Other 1,439,526 1,360,147
----------- -----------
Total $16,563,929 $16,193,866
=========== ===========
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has commitments to fund investments in limited partnerships in the
amount of $29.4 million at March 31, 2006. The Company anticipates that the
majority of these amounts will be invested over the next five years, however,
contractually these commitments could become due at the request of the
counterparties. Investments in limited partnerships are carried at cost and are
included in other invested assets in the condensed consolidated balance sheets.
The Company is currently a party to three arbitrations that involve its
discontinued accident and health business, including personal accident business
(which includes London market excess of loss business) and workers' compensation
carve-out business. The Company is also party to one pending and one threatened
arbitration related to its life reinsurance business. In addition, the Company
has been joined in a suit filed against one of its ceding companies alleging
wrongful denial of a life insurance claim. As of March 31, 2006, the parties
involved in these actions have raised claims, or established reserves that may
result in claims, in the amount of $32.0 million, which is $27.6 million in
excess of the amounts held in reserve by the Company. The Company generally has
little information regarding any reserves established by the 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. See Note 20, "Discontinued Operations" in the
Company's 2005 Annual Report for more information. Additionally, from time to
time, the Company is subject to litigation related to employment-related matters
in the normal course of its business. While it is difficult to predict or
determine the ultimate outcome of the pending litigation or arbitrations or
provide useful 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 condensed 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.
The Company has obtained letters of credit, issued by banks, in favor of various
affiliated and unaffiliated insurance companies from which the Company assumes
business. These letters of credit represent guarantees of performance under the
reinsurance agreements and allow ceding companies to take statutory reserve
credits. At March 31, 2006 and December 31, 2005, there were approximately $15.4
million and $17.4 million, respectively, of outstanding bank letters of credit
in favor of third parties. Additionally, the Company utilizes letters of credit
to secure reserve credits when it retrocedes business to its offshore
subsidiaries, including RGA Americas Reinsurance Company, Ltd., RGA Reinsurance
Company (Barbados) Ltd. and RGA Worldwide Reinsurance Company, Ltd. The Company
cedes business to its offshore affiliates to help reduce the amount of
regulatory capital required in certain jurisdictions such as the U.S. and the
United Kingdom. The capital required to support the business in the offshore
affiliates reflects more realistic expectations than the original jurisdiction
of the business, where capital requirements are often considered to be quite
conservative. As of March 31, 2006 and December 31, 2005, $395.5 million and
$439.8 million, respectively, in letters of credit from various banks were
outstanding between the various subsidiaries of the Company. Applicable letter
of credit fees and fees payable for the credit facility depend upon the
Company's senior unsecured long-term debt rating. Fees associated with the
Company's other letters of
8
credit are not fixed for periods in excess of one year and are based on the
Company's ratings and the general availability of these instruments in the
marketplace.
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 $239.6 million and $256.2 million as of
March 31, 2006 and December 31, 2005, respectively, and are reflected on the
Company's condensed consolidated balance sheets in future policy benefits.
Potential guaranteed amounts of future payments will vary depending on
production levels and underwriting results. Guarantees related to trust
preferred securities and credit facilities provide additional security to third
party banks should a subsidiary fail to make principal and/or interest payments
when due. As of March 31, 2006, RGA's exposure related to these guarantees was
$183.7 million.
In addition, the Company indemnifies its directors and officers as provided in
its charters and by-laws. Since this indemnity generally is not subject to
limitation with respect to duration or amount, the Company does not believe that
it is possible to determine the maximum potential amount due under this
indemnity in the future.
6. EMPLOYEE BENEFIT PLANS
The components of net periodic benefit costs were as follows (dollars in
thousands):
Three months ended March 31,
---------------------------------
Pension Benefits Other Benefits
---------------- --------------
2006 2005 2006 2005
----- ----- ---- ----
(in thousands)
DETERMINATION OF NET PERIODIC BENEFIT COST:
Service cost $ 614 $ 548 $179 $103
Interest cost 477 382 156 99
Expected rate of return on plan assets (347) (300) -- --
Amortization of prior service cost 9 9 -- --
Amortization of prior actuarial loss 106 40 66 17
----- ----- ---- ----
Net periodic benefit cost $ 859 $ 679 $401 $219
===== ===== ==== ====
The Company made no pension contributions during the first quarter of 2006 and
expects to make second quarter 2006 contributions of $4.6 million.
7. FINANCING ACTIVITIES
On March 3, 2006, RGA Australian Holdings PTY, Limited ("Australian Holdings"),
a wholly-owned subsidiary of the Company, entered into a five-year credit
agreement with a capacity of Australian $50.0 million (approximately $35.8
million). Interest on borrowings is based on Australian Bank Bill short term
rates plus a base rate margin. The base rate margin and fees payable for the
credit facility depend upon the Company's senior unsecured long-term debt
rating. Australian Holdings immediately borrowed Australian $35.0 million under
the facility, using the funds to repay the outstanding debt under a similar
credit facility, which expired in March 2006. As of March 31, 2006, the Company
had Australian $35.0 million (approximately $25.1 million) outstanding under
this new facility at an average interest rate of 6.20%. The credit agreement is
unsecured but contains affirmative, negative and financial covenants customary
for financings of this type.
8. EQUITY BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(r), "Share-Based Payment" ("SFAS 123(r)"). SFAS 123(r)
requires that the cost of all share-based transactions be recorded in the
financial statements. The Company has been recording compensation cost for all
equity-based grants or awards after January 1, 2003 consistent with the
requirement of SFAS No. 123, as amended by SFAS 148. Equity compensation
9
expense was $5.9 million and $1.7 million in the first quarter of 2006 and 2005,
respectively. The adoption of SFAS 123(r) increased compensation expense
recorded in the first quarter of 2006 by approximately $1.7 million, primarily
related to unvested options from the 2002 grants, which were previously reported
under Accounting Principles Board Opinion No. 25, and the acceleration of
compensation expense for certain retirement eligible employees. Compensation
cost associated with grants issued to retirement eligible employees prior to
January 1, 2006 continues to be recognized over the nominal vesting period. In
the first quarter of 2006, the company granted 336,725 incentive stock options
at $47.47 weighted average per share and 144,097 performance contingent units
("PCUs") to employees. Additionally, non-employee directors were awarded a total
of 4,800 shares of common stock. The remainder of the increase in compensation
expense related to an increase in estimated shares required to settle PCUs
granted in 2004 and the incremental expense from stock options and PCUs granted
during the first quarter of 2006. As of March 31, 2006, the total compensation
cost of non-vested awards not yet recognized in the financial statements was
$28.1 million with various recognition periods over the next five years. The
effect of applying the provisions of SFAS 123(r) on a pro forma basis to the
comparable 2005 period did not have material effect on net income or earnings
per share.
9. NEW ACCOUNTING STANDARDS
Effective January 1, 2006, the Company prospectively adopted SFAS No. 155,
"Accounting for Certain Hybrid Instruments" ("SFAS 155"). SFAS 155 amends SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133") and SFAS 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities". SFAS 155 allows financial instruments that
have embedded derivatives to be accounted for as a whole, eliminating the need
to bifurcate the derivative from its host, if the holder elects to account for
the whole instrument on a fair value basis. In addition, among other changes,
SFAS 155 (i) clarifies which interest-only strips and principal-only strips are
not subject to the requirements of SFAS 133; (ii) establishes a requirement to
evaluate interests in securitized financial assets to identify interests that
are freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation; (iii) clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives; and (iv) eliminates the prohibition on a qualifying special-purpose
entity ("QSPE") from holding a derivative financial instrument that pertains to
a beneficial interest other than another derivative financial interest. The
adoption of SFAS 155 did not have a material impact on the Company's condensed
consolidated financial statements.
In June 2005, the FASB cleared SFAS 133 Implementation Issue No. B38, "Embedded
Derivatives: Evaluation of Net Settlement with Respect to the Settlement of a
Debt Instrument through Exercise of an Embedded Put Option or Call Option"
("Issue B38") and SFAS 133 Implementation Issue No. B39, "Embedded Derivatives:
Application of Paragraph 13(b) to Call Options That Are Exercisable Only by the
Debtor" ("Issue B39"). Issue B38 clarified that the potential settlement of a
debtor's obligation to a creditor occurring upon exercise of a put or call
option meets the net settlement criteria of SFAS No. 133. Issue B39 clarified
that an embedded call option, in which the underlying is an interest rate or
interest rate index, that can accelerate the settlement of a debt host financial
instrument should not be bifurcated and fair valued if the right to accelerate
the settlement can be exercised only by the debtor (issuer/borrower) and the
investor will recover substantially all of its initial net investment. Issues
B38 and B39, which must be adopted as of the first day of the first fiscal
quarter beginning after December 15, 2005. Issues B38 and B39 were adopted by
the Company during the first quarter of 2006 and did not have a material effect
on the Company's condensed consolidated financial statements.
In May 2005, the Financial Accounting Standards Board ("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 accounted for as a change in
accounting estimate rather than a change in accounting principle. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. SFAS 154 was adopted by the Company during
the first quarter of 2006 and did not have a material effect on the Company's
condensed consolidated financial statements.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company's primary business is 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 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 2005 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 many years, claims
become less predictable over shorter periods and are subject to significant
fluctuation from quarter to quarter and year to year. Effective July 1, 2003,
the Company increased the maximum amount of coverage that it retains per life
from $4 million to $6 million. This increase does not affect business written
prior to July 1, 2003. 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 increase in the Company's
retention limit from $4 million to $6 million reduces the amount of premiums it
pays to retrocessionaires, but increases the maximum impact a single death claim
can have on its results and therefore may result in additional volatility to its
results from operations. The Company believes its sources of liquidity are
sufficient to cover the potential increase in 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, Asia Pacific and Europe & South Africa 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, Asia Pacific
and Europe & South Africa 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, Argentine business in run-off and the
provision for income taxes. The Company's discontinued accident and health
operations are not reflected in its results from continuing operations.
Effective January 1, 2006 the Company changed its method of allocating capital
to its segments from a method based upon regulatory capital requirements to one
based on underlying economic capital levels. The economic capital model is 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. This is in contrast to the standardized regulatory
risk based capital formula, which is not as refined in its risk calculations
with respect to each of the Company's businesses. As a result of the economic
capital allocation process, a portion of investment income and investment
related gains (losses) is 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. The prior period segment
results have been adjusted to conform to the new allocation methodology.
RESULTS OF OPERATIONS
Consolidated income from continuing operations before income taxes increased
$7.7 million, or 7.6% for the first quarter of 2006 compared to the first
quarter of 2005, primarily due to good results in the U.S. and Europe & South
Africa segments offset in part by poor results due to adverse mortality
experience in Canada. Consolidated net premiums increased $90.6 million, or
10.0% during the first quarter of 2006.
Consolidated investment income, net of related expenses, increased $29.9
million, or 19.0%, during the first quarter of 2006, primarily due to a larger
invested asset base. Invested assets as of March 31, 2006 totaled $12.3 billion,
a
11
13.4% increase over March 31, 2005. While the Company's invested asset base has
grown significantly since March 31, 2005, the average yield earned on
investments excluding funds withheld increased only slightly from 5.75% during
the first quarter of 2005 to 5.78% for the first quarter of 2006. 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 and changes in the mix of the underlying investments. Investment
income and a portion of investment related gains (losses) are allocated to the
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 34.8% for the first quarter
of 2006, compared to 33.1% for the prior-year period. The prior-year period
effective tax rate included the realization of a tax receivable against which
the Company had initially established a valuation reserve.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are described in Note 2 in the 2005 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
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.
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.
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. Deferred policy
acquisition costs 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. 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.
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 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
12
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 vary significantly by
ceding company and business segment, but averages around 3.0 months on a
consolidated basis. 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.
The Company primarily invests in fixed maturity securities, and monitors these
fixed maturity securities to determine potential impairments in value. With the
Company's external investment managers, it 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.
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.
The Company is currently a party to various litigation and arbitrations. While
it is difficult to predict or determine the ultimate outcome of the pending
litigation or arbitrations or even to provide useful ranges of potential losses,
it is the opinion of management, after consultation with counsel, that the
outcomes of such litigation and arbitrations, 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 a
particular quarter or year. See Note 20, "Discontinued Operations" of the 2005
Annual Report for more information.
Further discussion and analysis of the three month results for 2006 compared to
2005 are presented by segment. Certain prior-year amounts have been reclassified
to conform to the current-year presentation. Additionally, segment results for
the prior-year have been reclassified to conform to the economic capital process
mentioned above. References to income before income taxes exclude the effects of
discontinued operations.
13
U.S. OPERATIONS
U.S. operations consist of two major sub-segments: Traditional and
Non-Traditional. The Traditional sub-segment primarily specializes in
mortality-risk reinsurance. The Non-Traditional category consists of
Asset-Intensive and Financial Reinsurance.
FOR THE THREE MONTHS ENDED MARCH 31, 2006 (IN THOUSANDS)
NON-TRADITIONAL
----------------------- TOTAL
ASSET- FINANCIAL U.S.
TRADITIONAL INTENSIVE REINSURANCE OPERATIONS
----------- --------- ----------- ----------
REVENUES:
Net premiums $611,837 $ 1,474 $ -- $613,311
Investment income, net of related expenses 71,042 70,897 (3) 141,936
Investment related losses, net (1,229) (3,333) -- (4,562)
Change in value of embedded derivatives -- 4,552 -- 4,552
Other revenues (320) 3,289 7,346 10,315
-------- ------- ------ --------
Total revenues 681,330 76,879 7,343 765,552
BENEFITS AND EXPENSES:
Claims and other policy benefits 508,146 (869) 1 507,278
Interest credited 11,487 49,537 -- 61,024
Policy acquisition costs and other insurance expenses 82,172 16,395 2,334 100,901
Change in deferred acquisition costs associated with change
in value of embedded derivatives -- 2,757 -- 2,757
Other operating expenses 10,126 1,776 1,354 13,256
-------- ------- ------ --------
Total benefits and expenses 611,931 69,596 3,689 685,216
Income before income taxes $ 69,399 $ 7,283 $3,654 $ 80,336
======== ======= ====== ========
FOR THE THREE MONTHS ENDED MARCH 31, 2005 (IN THOUSANDS)
NON-TRADITIONAL
-----------------------
ASSET- FINANCIAL TOTAL
TRADITIONAL INTENSIVE REINSURANCE U.S.
----------- --------- ----------- ----------
REVENUES:
Net premiums $566,794 $ 1,224 $ -- $568,018
Investment income, net of related expenses 63,325 56,654 70 120,049
Investment related gains (losses), net (1,031) 3,516 (2) 2,483
Change in value of embedded derivatives -- 22,561 -- 22,561
Other revenues 566 1,047 6,638 8,251
-------- ------- ------ --------
Total revenues 629,654 85,002 6,706 721,362
BENEFITS AND EXPENSES:
Claims and other policy benefits 483,262 (1,684) 2 481,580
Interest credited 14,007 40,251 -- 54,258
Policy acquisition costs and other insurance expenses 73,638 13,687 1,961 89,286
Change in deferred acquisition costs associated with change
in value of embedded derivatives -- 15,708 -- 15,708
Other operating expenses 9,259 1,338 1,437 12,034
-------- ------- ------ --------
Total benefits and expenses 580,166 69,300 3,400 652,866
Income (loss) before income taxes $ 49,488 $15,702 $3,306 $ 68,496
======== ======= ====== ========
14
Income before income taxes for the U.S. operations segment totaled $80.3 million
for the first quarter of 2006 compared to $68.5 million for the same period
prior year. This increase in income can be primarily attributed to growth in
total business in force and improved mortality experience over the first quarter
of 2005.
Traditional Reinsurance
The U.S. Traditional sub-segment provides life reinsurance to domestic clients
for a variety of life products through yearly renewable term, coinsurance and
modified coinsurance agreements. These reinsurance arrangements may be either
facultative or automatic agreements. During the first quarter of 2006, this
sub-segment added $47.9 billion of new business compared to $36.0 billion during
the same period in 2005. Management believes industry consolidation and the
established practice of reinsuring mortality risks should continue to provide
opportunities for growth.
Income before income taxes for U.S. Traditional reinsurance increased 40.2% for
the quarter over the same prior-year period. Claims and other policy benefits,
as a percentage of net premiums (loss ratios), were 83.1% for the first quarter
of 2006 compared to 85.3% for the first three months of 2005. In addition,
stronger premiums and higher investment income reflect the increase in total
business in force.
Net premiums for U.S. Traditional reinsurance increased 7.9% for the first
quarter of 2006. This increase in net premiums was driven by the growth of total
U.S. business in force, which totaled just over $1.1 trillion as of March 31,
2006, a 9.4% increase over the amount in force on March 31, 2005.
Investment income and realized investment 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. During the first quarter of
2006, investment income in the sub-segment totaled $71.0 million, a 12.2%
increase over the same prior-year period. This increase can be primarily
attributed to growth in the invested asset base.
Mortality experience for the first three months of 2006 was in line with
management's expectations, however, as previously mentioned, improved over prior
year. Death claims are reasonably predictable over a period of many years, but
are less predictable over shorter periods and are subject to significant
fluctuation.
Interest credited relates to amounts credited on cash value products, which have
a significant mortality component. The amount of interest credited fluctuates in
step with changes in deposit levels, cash surrender values and investment
performance. Income before income taxes is affected by the spread between the
investment income and the interest credited on the underlying products. Interest
credited expense for the first quarter of 2006 totaled $11.5 million, compared
to $14.0 million for the same period in 2005. The decrease is primarily the
result of lower investment income earned on the assets supporting this business
resulting in lower interest credited.
Policy acquisition costs and other insurance expenses, as a percentage of net
premiums, were 13.4% for the first quarter of 2006 compared to 13.0% for the
first quarter of 2005. Overall, while these ratios are expected to remain in a
certain range, they may fluctuate from period to period due to varying allowance
levels within coinsurance-type arrangements. In addition, the amortization
pattern of previously capitalized amounts, which are subject to the form of the
reinsurance agreement and the underlying insurance policies, may vary. Also, the
mix of first year coinsurance business versus yearly renewable term business can
cause the percentage to fluctuate from period to period.
Other operating expenses, as a percentage of net premiums, were 1.7% for the
first quarter, which is reasonably consistent with the 1.6% reported in same
prior-year period. The expense ratio can fluctuate slightly from period to
period, however, the size and maturity of the U.S. operations segment indicates
it should remain relatively constant over the long term.
Asset-Intensive Reinsurance
The U.S. Asset-Intensive sub-segment assumes investment risk within underlying
annuities and corporate-owned life insurance policies. Most of these agreements
are coinsurance, coinsurance with funds withheld or modified coinsurance of
non-mortality risks whereby the Company recognizes profits or losses primarily
from the spread between the investment income earned and the interest credited
on the underlying deposit liabilities.
15
In accordance with the provisions 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" ("Issue
B36"), the Company recorded a change in value of embedded derivatives of $4.6
million within revenues and $2.8 million of related deferred acquisition costs.
Comparable figures for 2005 were $22.6 million and $15.7 million, respectively.
The Asset-Intensive sub-segment reported income before income taxes of $7.3
million for the first quarter of 2006, a 53.6% decrease from the prior-year
period. This decrease in income can be primarily attributed to investment
related gains and losses which decreased from a net gain of $3.5 million in 2005
to a loss of $3.3 million in 2006. Strong investment spreads partially offset
these losses. In addition, Issue B36 resulted in $5.1 million less of income in
2006 than 2005.
Total revenues decreased $8.1 million or 9.6% from 2005 to 2006. This is
primarily the result of an $18.0 million decrease in the change in fair value of
embedded derivatives quarter over quarter. In 2005, the fair value of the
embedded derivative increased due to the tightening of credit spreads along with
a significant increase in short-term rate yields. The spreads in the first
quarter of 2006 also tightened, but not to the same extent. In addition, this
sub-segment reported a $6.8 million decrease in investment related gains and
losses over prior quarter. These decreases were partially offset by the increase
in investment income associated with a larger asset base.
The average invested asset base supporting this segment grew from $3.7 billion
in the first quarter of 2005 to $4.1 billion for the first quarter of 2006. The
growth in the asset base is primarily driven by new business written on one
existing annuity treaty. Invested assets outstanding as of March 31, 2006 were
$4.1 billion, of which $2.6 billion were funds withheld at interest. Of the $2.6
billion of total funds withheld balance as of March 31 2006, 88.0% of the
balance is associated with one client.
Total benefits and expenses, which are comprised primarily of interest credited
and policy acquisition costs, increased less than 1.0% from the first quarter of
2005. The large decrease in deferred acquisition expenses relating to Issue B36
was essentially offset by increases in both interest credited and policy
acquisition costs. The rise in interest credited correlates with the increase in
investment income, both of which are driven by the growth in the average asset
base.
Financial Reinsurance
The U.S. Financial Reinsurance sub-segment income consists primarily of net fees
earned on financial reinsurance transactions. The majority of the financial
reinsurance risks assumed by the Company are retroceded to other insurance
companies. The fees earned from the assumption of the financial reinsurance
contracts are reflected in other revenues, and the fees paid to
retrocessionaires are reflected in policy acquisition costs and other insurance
expenses. Fees are also earned on brokered business in which the Company does
not participate in the assumption of the financial reinsurance. This income is
reflected in other revenues.
Income before income taxes increased 10.5%, during the first quarter of 2006
compared to the same period in 2005. The increase in income primarily relates to
several new transactions that occurred in late 2005.
At March 31, 2006, the amount of reinsurance provided, as measured by pre-tax
statutory surplus, was $1.8 billion. The pre-tax statutory surplus includes all
business assumed or brokered by the Company. Fees earned from this business can
vary significantly depending on the size of the transactions and the timing of
their completion and therefore can fluctuate from period to period.
CANADA OPERATIONS
The Company conducts reinsurance business in Canada through RGA Life Reinsurance
Company of Canada ("RGA Canada"), a wholly-owned subsidiary. RGA Canada assists
clients with capital management activity and mortality risk management, and is
primarily engaged in traditional individual life reinsurance, as well as group
reinsurance and non-guaranteed critical illness products.
16
2006 2005
-------- -------
FOR THE THREE MONTHS ENDED MARCH 31, (IN THOUSANDS)
REVENUES:
Net premiums $ 94,402 $73,756
Investment income, net of related expenses 25,305 22,537
Investment related gains (losses), net (199) 635
Other revenues -- 34
-------- -------
Total revenues 119,508 96,962
BENEFITS AND EXPENSES:
Claims and other policy benefits 89,079 68,645
Interest credited 205 357
Policy acquisition costs and other insurance
expenses 17,820 8,838
Other operating expenses 3,973 3,460
-------- -------
Total benefits and expenses 111,077 81,300
Income before income taxes $ 8,431 $15,662
======== =======
Income before income taxes decreased by $7.2 million or 46.2% in the first
quarter of 2006. The decrease in 2006 was primarily the result of less favorable
mortality experience in the current period as well as a decrease in investment
related gains of $0.8 million.
Net premiums increased by $20.6 million, or 28.0% in the first quarter of 2006
from the prior-year quarter. The increase is primarily due to new business from
new and existing treaties. Approximately $7.4 million of the premium increase
represents the effect of two inforce creditor treaties which were executed in
late 2005. In addition, a stronger Canadian dollar resulted in an increase in
net premiums of $5.5 million in the first quarter in 2006 as compared to 2005.
Premium levels are significantly influenced by large transactions, mix of
business and reporting practices of ceding companies and therefore can fluctuate
from period to period.
Net investment income increased $2.8 million or 12.3% in the first quarter of
2006 compared to the first quarter of 2005. Investment income represents an
allocation to the segments based upon average assets and related capital levels
deemed appropriate to support business volumes. The increase in investment
income was mainly the result of an increase in the allocated asset base due to
growth in the underlying business volume and a stronger Canadian dollar, which
resulted in an increase of $0.9 million.
For the first quarter of 2006, the loss ratio for this segment was 94.4%
compared to 93.1% in 2005. Excluding creditor business, the loss ratio for this
segment was 102.4% first quarter of 2006 compared to 94.4% in the comparable
prior-year period. The higher loss ratio in 2006 is primarily due to unfavorable
mortality experience compared to the prior year as well as the strengthening of
the Canadian dollar. Historically, the loss ratio increased primarily as the
result of several large permanent level premium in-force blocks assumed in 1998
and 1997. These blocks are mature blocks of permanent level premium business in
which mortality as a percentage of net premiums is expected to be higher than
the 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 mortality costs to fund claims in the later years when
premiums, by 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 74.4% during 2006 compared to 71.3% in
2005. Death claims are reasonably predictable over a period of many years, but
are less predictable over shorter periods and are subject to significant
fluctuation.
Policy acquisition costs and other insurance expenses as a percentage of net
premiums totaled 18.9% in the first quarter of 2006 and 12.0% in 2005. Excluding
the impact of the stronger Canadian dollar and creditor business, policy
acquisition costs and other insurance expenses as a percentage of net premiums
totaled 15.2% in 2006 compared to 11.0% in 2005. Overall, while these ratios are
expected to remain in a certain range, they may fluctuate from period to period
due to varying allowance levels. In addition, the amortization pattern of
previously capitalized amounts, which are subject to the form of the reinsurance
agreement and the underlying insurance
17
policies may vary. Also, the mix of first year coinsurance business versus
yearly renewable term business can cause the percentage to fluctuate from period
to period.
Other operating expenses increased $0.5 million or 14.8% in 2006. A stronger
Canadian dollar resulted in an increase of $0.2 million. Other operating
expenses as a percentage of net premiums totaled 4.2% in 2006 compared to 4.7%
in 2005.
EUROPE & SOUTH AFRICA OPERATIONS
The Europe & South Africa segment has operations in India, Mexico, Spain, South
Africa and the United Kingdom. The segment provides life reinsurance for a
variety of products through yearly renewable term and coinsurance agreements,
and reinsurance of accelerated critical illness coverage, which pays on the
earlier of death or diagnosis of a pre-defined critical illness. Reinsurance
agreements may be either facultative or automatic agreements covering primarily
individual risks and in some markets, group risks.
2006 2005
-------- --------
FOR THE THREE MONTHS ENDED MARCH 31, (IN THOUSANDS)
REVENUES:
Net premiums $145,151 $141,358
Investment income, net of related expenses 3,392 2,528
Investment related gains, net 34 14
Other revenues 91 101
-------- --------
Total revenues 148,668 144,001
BENEFITS AND EXPENSES:
Claims and other policy benefits 105,646 96,332
Interest credited 190 363
Policy acquisition costs and other insurance expenses 19,257 27,133
Other operating expenses 8,778 5,660
-------- --------
Total benefits and expenses 133,871 129,488
Income before income taxes $ 14,797 $ 14,513
-------- --------
Income before income taxes was $14.8 million during the first quarter of 2006 as
compared to $14.5 million during the first quarter of 2005. This increase was
primarily the result of the growth in premiums and investment income offset
partially by an increase in other operating expenses and adverse foreign
currency fluctuations of $1.2 million.
Net premiums increased $3.8 million, or 2.7%, during the first quarter of 2006
compared to the same period last year. This increase was primarily the result of
new business from both existing and new treaties. Several foreign currencies,
particularly the British pound, the euro, and the South African rand weakened
against the U.S. dollar and adversely affected net premiums by approximately
$9.7 million for the current quarter. Also, a portion of the net premiums were
due to reinsurance of accelerated critical illness, primarily in the UK. Net
premiums associated with critical illness coverage totaled $49.2 million in the
first quarter of 2006 compared to $50.9 million in the first quarter of 2005.
Premium levels are significantly influenced by large transactions and reporting
practices of ceding companies and therefore can fluctuate from period to period.
Investment income increased $0.9 million for the first quarter of 2006 compared
to the same period in 2005. This increase was primarily due to an increase in
allocated investment income. Investment income and realized investment 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.
Loss ratios were 72.8% and 68.1% for the first three months of 2006 and 2005,
respectively. Death claims are reasonably predictable over a period of many
years, but are less predictable over shorter periods and are subject to
significant fluctuation.
18
Policy acquisition costs and other insurance expenses as a percentage of net
premiums were 13.3% in the first quarter of 2006 compared to 19.2% in the first
quarter of 2005. These percentages fluctuate due to timing of client company
reporting, variations in the mixture of business being reinsured and the
relative maturity of the business. In addition, as the segment grows, renewal
premiums, which have lower allowances than first-year premiums, represent a
greater percentage of the total net premiums. Accordingly, the change in the
mixture of business during the current quarter caused the loss ratio to slightly
increase and caused the policy acquisition costs and other insurance expenses as
a percentage of net premiums to slightly decrease.
Other operating expenses for the quarter increased to 6.0% of net premiums in
2006 from 4.0% in 2005. This increase was due to higher costs associated with
maintaining and supporting the increase in business over the past several years.
The Company believes that sustained growth in net premiums should lessen the
burden of start-up expenses and expansion costs over time.
ASIA PACIFIC OPERATIONS
The Asia Pacific segment has operations in Australia, Hong Kong, Japan,
Malaysia, Singapore, New Zealand, South Korea, Taiwan and mainland China. The
principal types of reinsurance for this segment include life, critical care and
illness, disability income, superannuation, and financial reinsurance.
Superannuation is the Australian government mandated compulsory retirement
savings program. Superannuation funds accumulate retirement funds for employees,
and in addition, offer life and disability insurance coverage. Reinsurance
agreements may be either facultative or automatic agreements covering primarily
individual risks and in some markets, group risks.
2006 2005
-------- --------
FOR THE THREE MONTHS ENDED MARCH 31, (IN THOUSANDS)
REVENUES:
Net premiums $139,213 $118,208
Investment income, net of related expenses 6,496 4,740
Investment related gains (losses), net 15 (47)
Other revenues 1,910 (187)
-------- --------
Total revenues 147,634 122,714
BENEFITS AND EXPENSES:
Claims and other policy benefits 110,356 90,660
Policy acquisition costs and other insurance expenses 22,005 24,470
Other operating expenses 8,659 4,674
-------- --------
Total benefits and expenses 141,020 119,804
Income before income taxes $ 6,614 $ 2,910
======== ========
Income before income taxes increased $3.7 million during the first quarter of
2006 as compared to the same period in 2005. The increase in income before
income taxes was primarily the result of strong premium growth, and favorable
results in certain significant markets, primarily Australia and Japan. The
favorable results in Australia and Japan were partially offset by poor mortality
results in Korea. Strong growth in Asia Pacific business volume correlated
directly with an increase in investment income of $1.8 million from 2005 to
2006. A $2.1 million increase in other revenues for the segment also contributed
to the increase in income before income taxes for the first quarter of 2006, as
compared to the same quarter in 2005. The increase in income before income taxes
was partially offset by adverse foreign currency exchange fluctuations totaling
approximately $0.6 million.
Net premiums grew $21.0 million, or 17.8%, during the current quarter as
compared to the same period in 2005. This premium growth was primarily the
result of continued increases in the volume of business in Australia, Japan and
Korea. Due to continued growth in its group business, premiums in Australia
increased by $8.2 million in the first quarter of 2006 as compared to the first
quarter of 2005. Premium levels are significantly influenced by large
transactions and reporting practices of ceding companies and therefore can
fluctuate from period to period.
A portion of the premiums for the segment during the first quarter of each year
presented is due to reinsurance of
19
critical illness as a stand alone benefit, or as an accelerated benefit on a
life insurance policy. This coverage provides a benefit in the event of a death
from, or the diagnosis of, a defined critical illness. Reinsurance of critical
illness in the Asia Pacific operations is offered primarily in Australia and
Korea. Premiums earned from this coverage totaled $11.7 million during the first
quarter of 2006, and $15.9 million during the first quarter of 2005.
Foreign currencies in certain significant markets, particularly the Australian
dollar and the Japanese Yen, began to weaken against the U.S. dollar during the
first quarter of 2006. The overall effect of changes in local Asia Pacific
segment currencies was a decrease of approximately $5.8 million in the first
quarter 2006 net premiums compared to 2005.
Net investment income increased $1.8 million in the current quarter compared to
the prior-year quarter. This increase was primarily due to growth in the
invested assets in Australia, 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.
Other revenues increased by $2.1 million for the first quarter of 2006, as
compared to the same period in 2005. The primary source of other revenues during
the first quarter of 2006 was fees from three financial reinsurance treaties in
the Japan market. Other revenue in the first quarter of 2005 includes the
effects of the recapture of a significant client treaty in Hong Kong.
Loss ratios were 79.3% and 76.7% for the first quarter of 2006 and 2005,
respectively. The current quarter loss ratio was higher than the comparable
prior-year period primarily due to adverse mortality experience in Korea and to
a lesser extent in New Zealand. Loss ratios will fluctuate due to timing of
client company reporting, variations in the mixture of business being reinsured
and the relative maturity of the business. Death claims are reasonably
predictable over a period of many years, but are less predictable over shorter
periods and are subject to significant fluctuation.
Policy acquisition costs and other insurance expenses as a percentage of net
premiums were 15.8% during the first quarter of 2006, and 20.7% for the first
quarter of 2005. The ratio of policy acquisition costs and other insurance
expenses as a percentage of net premiums will generally decline as the business
matures, however, the percentage does fluctuate periodically due to timing of
client company reporting and variations in the mixture of business being
reinsured. The decline in the policy acquisition ratio between the first quarter
of 2006 and the first quarter of 2005 is caused in part by a maturation of
significant blocks of business in Korea. Allowances for renewal premium are
generally lower than first year premium allowances. The comparison of the policy
acquisition ratio between the first quarter of 2006 and the first quarter of
2005 is also affected by the amortization of a DAC balance of approximately $3.0
million associated with the recapture of a significant treaty in Hong Kong in
the first quarter of 2005.
Other operating expenses increased to 6.2% of net premiums in the current
quarter, from 4.0% in the comparable prior-year period. The timing of premium
flows and the level of costs associated with the entrance into and development
of new markets in the growing Asia Pacific segment may cause other operating
expenses as a percentage of net premiums to fluctuate over periods of time.
CORPORATE AND OTHER OPERATIONS
Corporate and Other revenues include investment income from invested assets not
allocated to support segment operations and undeployed proceeds from the
Company's capital raising efforts, in addition to unallocated realized capital
gains or losses. General corporate expenses consist of the offset to capital
charges allocated to the operating segments within the policy acquisition costs
and other insurance expenses line item, unallocated overhead and executive
costs, and interest expense related to debt and the $225.0 million of 5.75%
Company-obligated mandatorily redeemable trust preferred securities.
Additionally, the Corporate and Other Operations includes results from RGA
Technology Partners, Inc., a wholly-owned subsidiary that develops and markets
technology solutions for the insurance industry, the Company's Argentine
privatized pension business, which is currently in run-off, and an insignificant
amount of direct insurance operations in Argentina.
20
2006 2005
------- -------
FOR THE THREE MONTHS ENDED MARCH 31, (IN THOUSANDS)
REVENUES:
Net premiums $ 365 $ 480
Investment income, net of related expenses 9,812 7,199
Investment related gains, net 5,344 894
Other revenues 2,214 2,604
------- -------
Total revenues 17,735 11,177
BENEFITS AND EXPENSES:
Claims and other policy benefits (846) 836
Interest credited 110 75
Policy acquisition costs and other insurance expenses (8,179) (5,751)
Other operating expenses 11,861 7,178
Interest expense 16,767 9,885
------- -------
Total benefits and expenses 19,713 12,223
Loss before income taxes $(1,978) $(1,046)
======= =======
Loss before income taxes increased $0.9 million during the first quarter of 2006
from $1.1 million during the same period in 2005. This increase was primarily
due to increased interest expense and operating expenses largely offset by an
increase in investment income and investment related gains. The increase in
interest expense is due to the issuance of $400 million in Junior Subordinated
Debentures in the fourth quarter of 2005. The increase in operating expenses is
largely due to additional expense related to equity based compensation plans.
Investment income and investment related gains are the result of an allocation
to other segments based upon average assets and related capital levels deemed
appropriate to support their business volumes.
DISCONTINUED OPERATIONS
The discontinued accident and health division reported a loss, net of taxes, of
$1.5 million for the first quarter of 2006 compared to a loss, net of taxes, of
$0.7 million for the first quarter of 2005. As of March 31, 2006, amounts in
dispute or subject to audit exceed the Company's reserves by approximately $23.5
million. 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, 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.
LIQUIDITY AND CAPITAL RESOURCES
The Holding Company
RGA is a holding company whose primary uses of liquidity include, but are not
limited to, the immediate capital needs of its operating companies associated
with the Company's primary businesses, dividends paid by RGA to its
shareholders, interest payments on its indebtedness, and repurchases of RGA
common stock under a plan approved by the board of directors. The primary
sources of RGA's liquidity include proceeds from its capital raising efforts,
interest income on undeployed corporate investments, interest income received on
surplus notes with two operating subsidiaries, and dividends from operating
subsidiaries. As the Company continues its expansion efforts, RGA will continue
to be dependent on these sources of liquidity.
The Company believes that it has sufficient liquidity to fund its cash needs
under various scenarios that include the potential risk of the early recapture
of a reinsurance treaty by the ceding company and significantly higher than
expected death claims. Historically, the Company has generated positive net cash
flows from operations. However,
21
in the event of significant unanticipated cash requirements beyond normal
liquidity, the Company has multiple liquidity alternatives available based on
market conditions and the amount and timing of the liquidity need. These options
include borrowings under committed credit facilities, secured borrowings, the
ability to issue long-term debt, capital securities or common equity and, if
necessary, the sale of invested assets.
Cash Flows
The Company's net cash flows provided by operating activities for the three
months ended March 31, 2006 and 2005 were $152.1 million and $181.0 million,
respectively. Cash flows from operating activities are affected by the timing of
premiums received, claims paid, and working capital changes. The $29.0 million
net decrease in operating cash flows during the first quarter of 2006 compared
to the same period in 2005 was primarily a result of cash outflows related to
claims, acquisition costs, income taxes and other operating expenses increasing
more than cash inflows related to premiums and investment income. Cash from
premiums and investment income increased $103.7 million and $31.9 million,
respectively, and was offset by higher operating cash outlays of $164.6 million
during the current quarter. The Company believes the short-term cash
requirements of its business operations will be sufficiently met by the positive
cash flows generated. Additionally, the Company believes it maintains a high
quality fixed maturity portfolio with positive liquidity characteristics. These
securities are available for sale and could be sold if necessary to meet the
Company's short and long-term obligations.
Net cash provided by investing activities was $21.0 million in the first quarter
of 2006 and net cash used in investing activities was $210.8 million in the
first quarter of 2005. This change, in particular, the sales and purchases of
fixed maturity securities, are primarily related to the management of the
Company's investment portfolios and the investment of excess cash generated by
operating and financing activities. The majority of the cash generated by the
change in short-term investments and other invested assets was used to repay the
Company's $100 million Senior Notes in April 2006.
Net cash provided by financing activities was $130.0 million and $14.2 million
in the first quarter of 2006 and 2005, respectively. This change was largely due
to an increase in securitized lending activities, which had a balance of $108.4
million at March 31, 2006.
Debt and Preferred Securities
As of March 31, 2006, the Company had $799.7 million in outstanding borrowings
under its debt agreements and was in compliance with all covenants under those
agreements.
The Company maintains three revolving credit facilities. The Company's largest
credit facility that expires in September 2010, is a syndicated credit facility
with an overall capacity of $600.0 million. The overall capacity available for
issuance of letters of credit is reduced by any cash borrowings made by the
Company against this credit facility. The Company may borrow up to $300.0
million of cash under the facility. As of March 31, 2006 the Company's
outstanding cash balance was $50.0 million under this credit facility, with an
average interest rate of 5.16%. The Company's other credit facilities consist of
a (pound)15.0 million credit facility that expires in May 2007 and an Australian
$50.0 million credit facility that expires in March 2011. The Company's foreign
denominated credit facilities had a combined outstanding balance of $51.1
million as of March 31, 2006.
The average interest rate on all long-term debt outstanding, excluding the
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely junior subordinated debentures of the Company ("Trust
Preferred Securities"), was 6.64%. Interest is expensed on the face amount, or
$225 million, of the Trust Preferred Securities at a rate of 5.75%.
Asset / Liability Management
The Company actively manages its assets using an approach that is intended to
balance quality, diversification, asset/liability matching, liquidity and
investment return. The goals of the investment process are to optimize
after-tax, risk-adjusted investment income and after-tax, risk-adjusted total
return while managing the assets and liabilities on a cash flow and duration
basis.
The Company has established target asset portfolios for each major insurance
product, which represent the investment strategies intended to profitably fund
its liabilities within acceptable risk parameters. These strategies include
objectives for effective duration, yield curve sensitivity and convexity,
liquidity, asset sector concentration and credit quality.
22
The Company's liquidity position (cash and cash equivalents and short-term
investments) was $475.3 million and $255.0 million at March 31, 2006 and
December 31, 2005, respectively. Approximately $100 million of the cash and cash
equivalents at March 31, 2006 was used to repay the maturity of Senior Notes in
April 2006. Liquidity needs are determined from valuation analyses conducted by
operational units and are driven by product portfolios. Annual evaluations of
demand liabilities and short-term liquid assets are designed to adjust specific
portfolios, as well as their durations and maturities, in response to
anticipated liquidity needs.
The Company occasionally enters into sales of investment securities under
agreements to repurchase the same securities to help manage its short-term
liquidity requirements. These transactions are reported as collateralized
financings and the repurchase obligation is a component of other liabilities.
There were $108.4 million of these agreements outstanding at March 31, 2006 and
there were no agreements outstanding at December 31, 2005.
Future Liquidity and Capital Needs
Based on the historic cash flows and the current financial results of the
Company, subject to any dividend limitations which may be imposed by various
insurance regulations, management believes RGA's cash flows from operating
activities, together with undeployed proceeds from its capital raising efforts,
including interest and investment income on those proceeds, interest income
received on surplus notes with two operating subsidiaries, and its ability to
raise funds in the capital markets, will be sufficient to enable RGA to make
dividend payments to its shareholders, to make interest payments on its senior
indebtedness and junior subordinated notes, to repurchase RGA common stock under
the plan approved by the board of directors, and to meet its other liquidity
obligations.
A general economic downturn or a downturn in the equity and other capital
markets could adversely affect the market for many annuity and life insurance
products. Because the Company obtains substantially all of its revenues through
reinsurance arrangements that cover a portfolio of life insurance products, as
well as annuities, its business would be harmed if the market for annuities or
life insurance were adversely affected.
INVESTMENTS
The Company had total cash and invested assets of $12.7 billion and $11.0
billion at March 31, 2006 and 2005, respectively. All investments made by RGA
and its subsidiaries conform to the qualitative and quantitative limits
prescribed by the applicable jurisdiction's insurance laws and regulations. In
addition, the Boards of Directors of the various operating companies
periodically review the investment portfolios of their respective subsidiaries.
RGA's Board of Directors also receives reports on material investment
portfolios. The Company's investment strategy is to maintain a predominantly
investment-grade, fixed maturity portfolio, to provide adequate liquidity for
expected reinsurance obligations, and to maximize total return through prudent
asset management. The Company's earned yield on invested assets, excluding funds
withheld, was 5.78% during the first quarter of 2006, compared with 5.75% for
the first quarter of 2005. See "Note 5 - INVESTMENTS" in the Notes to
Consolidated Financial Statements of the 2005 Annual Report for additional
information regarding the Company's investments.
The Company's fixed maturity securities are invested primarily in commercial and
industrial bonds, public utilities, U.S. and Canadian government securities, as
well as mortgage- and asset-backed securities. As of March 31, 2006,
approximately 96.9% of the Company's consolidated investment portfolio of fixed
maturity securities was investment grade. Important factors in the selection of
investments include diversification, quality, yield, total rate of return
potential and call protection. The relative importance of these factors is
determined by market conditions and the underlying product or portfolio
characteristics. Cash equivalents are invested in high-grade money market
instruments. The largest asset class in which fixed maturities were invested was
in corporate securities, including commercial, industrial, finance and utility
bonds, which represented approximately 57.9% of fixed maturity securities as of
March 31, 2006 and had an average Standard and Poor's ("S&P") rating of "A-".
Within the fixed maturity security portfolio, the Company holds approximately
$120.9 million in asset-backed securities at March 31, 2006, which include
credit card and automobile receivables, home equity loans, manufactured housing
bonds and collateralized bond obligations. The Company's asset-backed securities
are diversified by issuer and contain both floating and fixed rate securities.
In addition to the risks associated with floating rate securities, principal
risks in holding asset-backed securities are structural, credit and capital
market risks. Structural risks include the securities' priority in the issuer's
capital structure, the adequacy of and ability to realize proceeds from
collateral, and the potential for prepayments. Credit risks include consumer or
corporate credits such as credit card holders, equipment lessees, and corporate
obligors. Capital market risks include general level of interest rates and the
liquidity for these securities in the marketplace.
23
The Company monitors its fixed maturity securities to determine impairments in
value and evaluates factors such as financial condition of the issuer, payment
performance, the length of time and the extent to which the market value has
been below amortized cost, compliance with covenants, general market conditions
and industry sector, current intent and ability to hold securities and various
other subjective factors. Based on management's judgment, securities determined
to have an other-than-temporary impairment in value are written down to fair
value. The Company did not record other-than-temporary write-downs on fixed
maturity securities for the three months ending March 31, 2006 or the three
months ending March 31, 2005. During the three months ended March 31, 2006, the
Company sold fixed maturity securities with a fair value of $284.8 million,
which were below amortized cost, at a loss of $8.8 million.
The following table presents the total gross unrealized losses for 868 fixed
maturity securities and equity securities as of March 31, 2006, where the
estimated fair value had declined and remained below amortized cost by the
indicated amount (in thousands):
AT MARCH 31, 2006
-----------------------
Gross
Unrealized
Losses % of Total
---------- ----------
Less than 20% $114,680 100%
20% or more for less than six months -- --
20% or more for six months or greater -- --
-------- ---
Total $114,680 100%
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.
24
The following tables present the estimated fair values and gross unrealized
losses for the 868 fixed maturity securities and equity securities that have
estimated fair values below amortized cost as of March 31, 2006. These
investments are presented by class and grade of security, as well as the length
of time the related market value has remained below amortized cost.
AS OF MARCH 31, 2006
EQUAL TO OR GREATER THAN
--------------------------------------------------------------------------
LESS THAN 12 MONTHS 12 MONTHS TOTAL
----------------------- ---------------------- -----------------------
Estimated Gross Estimated Gross Estimated Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
---------- ---------- --------- ---------- ---------- ----------
(in thousands)
INVESTMENT GRADE SECURITIES:
COMMERCIAL AND INDUSTRIAL $ 955,098 $ 35,029 $ 62,297 $ 3,495 $1,017,395 $ 38,524
PUBLIC UTILITIES 354,309 11,980 3,063 151 357,372 12,131
ASSET-BACKED SECURITIES 75,438 1,893 9,209 141 84,647 2,034
CANADIAN AND CANADIAN PROVINCIAL GOVERNMENTS 100,091 2,057 1,637 49 101,728 2,106
MORTGAGE-BACKED SECURITIES 1,142,796 29,438 122,421 4,359 1,265,217 33,797
FINANCE 665,688 14,798 61,948 2,690 727,636 17,488
U.S. GOVERNMENT AND AGENCIES 48,946 396 675 30 49,621 426
STATE AND POLITICAL SUBDIVISIONS 40,703 1,451 -- -- 40,703 1,451
FOREIGN GOVERNMENTS 96,324 755 4,314 10 100,638 765
---------- -------- -------- ------- ---------- --------
INVESTMENT GRADE SECURITIES 3,479,393 97,797 265,564 10,925 3,744,957 108,722
---------- -------- -------- ------- ---------- --------
NON-INVESTMENT GRADE SECURITIES:
COMMERCIAL AND INDUSTRIAL 71,425 1,662 1,963 81 73,388 1,743
FINANCE 6,947 311 1,895 146 8,842 457
ASSET-BACKED SECURITIES -- -- -- -- -- --
PUBLIC UTILITIES 27,256 474 -- -- 27,256 474
---------- -------- -------- ------- ---------- --------
NON-INVESTMENT GRADE SECURITIES 105,628 2,447 3,858 227 109,486 2,674
---------- -------- -------- ------- ---------- --------
TOTAL FIXED MATURITY SECURITIES $3,585,021 $100,244 $269,422 $11,152 $3,854,443 $111,396
========== ======== ======== ======= ========== ========
EQUITY SECURITIES $ 62,614 $ 1,790 $ 28,295 $ 1,494 $ 90,909 $ 3,284
========== ======== ======== ======= ========== ========
The Company believes that the analysis of each security whose price has been
below market for twelve months or longer indicates that the financial strength,
liquidity, leverage, future outlook and/or recent management actions support the
view that the security was not other-than-temporarily impaired as of March 31,
2006. The unrealized losses did not exceed 17.5% on an individual security basis
and are primarily a result of rising interest rates, changes in credit spreads
and the long-dated maturities of the securities. Additionally, each security
whose price has been below market for twelve months or longer is investment
grade.
The Company's mortgage loan portfolio consists principally of investments in
U.S.-based commercial offices and retail locations. The mortgage loan portfolio
is diversified by geographic region and property type. All mortgage loans are
performing and no valuation allowance has been established as of March 31, 2006.
Policy loans present no credit risk because the amount of the loan cannot exceed
the obligation due the ceding company upon the death of the insured or surrender
of the underlying policy. The provisions of the treaties in force
25
and the underlying policies determine the policy loan interest rates. Because
policy loans represent premature distributions of policy liabilities, they have
the effect of reducing future disintermediation risk. In addition, the Company
earns a spread between the interest rate earned on policy loans and the interest
rate credited to corresponding liabilities.
Funds withheld at interest comprised approximately 28.4% and 27.8% of the
Company's cash and invested assets as of March 31, 2006 and December 31, 2005,
respectively. For agreements written on a modified coinsurance basis and certain
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 condensed
consolidated balance sheet. 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 to the Company from the ceding company. Interest accrues to
these assets at rates defined by the treaty terms. The Company is subject to the
investment performance on the withheld assets, although it does not directly
control them. These assets are primarily fixed maturity investment securities
and pose risks similar to the fixed maturity securities the Company owns. To
mitigate this risk, the Company helps set the investment guidelines followed by
the ceding company and monitors compliance. Ceding companies with funds withheld
at interest had a minimum A.M. Best rating of "A-".
Other invested assets represented approximately 1.5% and 1.9% of the Company's
cash and invested assets as of March 31, 2006 and December 31, 2005,
respectively. Other invested assets include common stock, preferred stocks and
limited partnership interests. The Company recorded an other-than-temporary
writedown of $3.1 million and $1.3 million on its investments in limited
partnerships due to losses in the underlying holdings during the first quarter
of 2006 and 2005, respectively.
CONTRACTUAL OBLIGATIONS
The following table displays the Company's contractual obligations that have
materially changed since December 31, 2005 (in millions):
PAYMENT DUE BY PERIOD
--------------------------------------------------------------
Less than
Contractual Obligations: Total 1 Year 1 - 3 Years 4 - 5 Years After 5 Years
------------------------ ------ --------- ----------- ----------- -------------
Short-term debt, including interest $103.6 $103.6 $-- $-- $--
Mortgage purchase commitments 10.8 10.8 -- -- --
The Company's insurance liabilities, including future policy benefits and
interest-sensitive contract liabilities, represent future obligations, where the
timing of payment is unknown because the payment depends on an insurable event,
such as the death of an insured, or policyholder behavior, such as the surrender
or lapse of a policy. These future obligations are established based primarily
on actuarial principles and are reflected on the Company's condensed
consolidated balance sheet, but have been excluded from the table above due to
the uncertain timing of payment.
26
MORTALITY RISK MANAGEMENT
In the normal course of business, the Company seeks to limit its exposure to
loss on any single insured and to recover a portion of benefits paid by ceding
reinsurance to other insurance enterprises or reinsurers under excess coverage
and coinsurance contracts. In the U.S., the Company retains a maximum of $6.0
million of coverage per individual life. In certain limited situations, due to
the acquisition of in-force blocks of business, the Company has retained more
than $6.0 million per individual policy. In total, there are 36 such cases of
over-retained policies, for amounts averaging $2.6 million over the Company's
normal retention limit. The largest amount over retained on any one life is
$13.1 million. For other countries, particularly those with higher risk factors
or smaller books of business, the Company systematically reduces its retention.
The Company has a number of retrocession arrangements whereby certain business
in force is retroceded on an automatic or facultative basis.
Generally, RGA's insurance subsidiaries retrocede amounts in excess of their
retention to RGA Reinsurance Company ("RGA Reinsurance"), RGA Reinsurance
Company (Barbados) Ltd., or RGA Americas Reinsurance Company, Ltd. Retrocessions
are arranged through the Company's retrocession pools for amounts in excess of
its retention. The Company also retrocedes most of its financial reinsurance
business to other insurance companies to alleviate the strain on statutory
surplus created by this business. For a majority of the retrocessionaires that
are not rated, letters of credit or trust assets have been given as additional
security in favor of RGA Reinsurance. In addition, the Company performs annual
financial and in force reviews of its retrocessionaires to evaluate financial
stability and performance.
The Company has never experienced a material default in connection with
retrocession arrangements, nor has it experienced any material difficulty in
collecting claims recoverable from retrocessionaires; however, no assurance can
be given as to the future performance of such retrocessionaires or as to the
recoverability of any such claims.
The Company maintains a catastrophe insurance program ("Program") that renews on
August 13th of each year. The current Program began August 13, 2005, and covers
events involving 10 or more insured deaths from a single occurrence. The Company
retains the first $25 million in claims, the Program covers the next $50 million
in claims, and the Company retains all claims in excess of $75 million. The
Program covers only losses under U.S. guaranteed issue (corporate owned life
insurance, bank owned life insurance, etc.) reinsurance programs and includes
losses due to acts of terrorism, but excludes losses due to nuclear, chemical
and/or biological events. The Program is insured by several insurance companies
and Lloyd's Syndicates, with no single entity providing more than $10 million of
coverage.
COUNTERPARTY RISK
In the normal course of business, the Company seeks to limit its exposure to
reinsurance contracts by ceding a portion of the reinsurance to other insurance
companies or reinsurers. Should a counterparty not be able to fulfill its
obligation to the Company under a reinsurance agreement, the impact could be
material to the Company's financial condition and results of operations.
MARKET RISK
Market risk is the risk of loss that may occur when fluctuations in interest and
currency exchange rates and equity and commodity prices change the value of a
financial instrument. Both derivative and nonderivative financial instruments
have market risk so the Company's risk management extends beyond derivatives to
encompass all financial instruments held that are sensitive to market risk. The
Company is primarily exposed to interest rate risk and foreign currency risk.
Interest rate risk arises from many of the Company's primary activities, as the
Company invests substantial funds in interest-sensitive assets and also has
certain interest-sensitive contract liabilities. The Company manages interest
rate risk and credit risk to maximize the return on the Company's capital
effectively and to preserve the value created by its business operations. As
such, certain management monitoring processes are designed to minimize the
impact of sudden and sustained changes in interest rates on fair value, cash
flows, and net interest income.
The Company is subject to foreign currency translation, transaction, and net
income exposure. The Company generally does not hedge the foreign currency
translation 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 equity.
The Company generally does not hedge the foreign currency
27
exposure of its subsidiaries transacting business in currencies other than their
functional currency (transaction exposure).
There has been no significant change in the Company's quantitative or
qualitative aspects of market risk during the quarter ended March 31, 2006 from
that disclosed in the 2005 Annual Report.
NEW ACCOUNTING STANDARDS
Effective January 1, 2006, the Company prospectively adopted SFAS No. 155,
"Accounting for Certain Hybrid Instruments" ("SFAS 155"). SFAS 155 amends SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133") and SFAS 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities." SFAS 155 allows financial instruments that
have embedded derivatives to be accounted for as a whole, eliminating the need
to bifurcate the derivative from its host, if the holder elects to account for
the whole instrument on a fair value basis. In addition, among other changes,
SFAS 155 (i) clarifies which interest-only strips and principal-only strips are
not subject to the requirements of SFAS 133; (ii) establishes a requirement to
evaluate interests in securitized financial assets to identify interests that
are freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation; (iii) clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives; and (iv) eliminates the prohibition on a qualifying special-purpose
entity ("QSPE") from holding a derivative financial instrument that pertains to
a beneficial interest other than another derivative financial interest. The
adoption of SFAS 155 did not have a material impact on the Company's condensed
consolidated financial statements.
In June 2005, the FASB cleared SFAS 133 Implementation Issue No. B38, "Embedded
Derivatives: Evaluation of Net Settlement with Respect to the Settlement of a
Debt Instrument through Exercise of an Embedded Put Option or Call Option"
("Issue B38") and SFAS 133 Implementation Issue No. B39, "Embedded Derivatives:
Application of Paragraph 13(b) to Call Options That Are Exercisable Only by the
Debtor" ("Issue B39"). Issue B38 clarified that the potential settlement of a
debtor's obligation to a creditor occurring upon exercise of a put or call
option meets the net settlement criteria of SFAS No. 133. Issue B39 clarified
that an embedded call option, in which the underlying is an interest rate or
interest rate index, that can accelerate the settlement of a debt host financial
instrument should not be bifurcated and fair valued if the right to accelerate
the settlement can be exercised only by the debtor (issuer/borrower) and the
investor will recover substantially all of its initial net investment. Issues
B38 and B39, which must be adopted as of the first day of the first fiscal
quarter beginning after December 15, 2005. Issues B38 and B39 were adopted by
the Company during the first quarter of 2006 and did not have a material effect
on the Company's condensed consolidated financial statements.
In May 2005, the FASB issued SFAS 154. The statement requires retrospective
application to prior periods' financial statements for correction 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 accounted for as a change in
accounting estimate rather than a change in accounting principle. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. SFAS 154 was adopted by the Company during
the first quarter of 2006 and did not have a material effect on the Company's
condensed consolidated financial statements.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 including,
among others, statements relating to projections of the strategies, earnings,
revenues, income or loss, ratios, future financial performance, and growth
potential of the Company. The words "intend," "expect," "project," "estimate,"
"predict," "anticipate," "should," "believe," and other similar expressions also
are intended to identify forward-looking statements. Forward-looking statements
are inherently subject to risks and uncertainties, some of which cannot be
predicted or quantified. Future events and actual results, performance, and
achievements could differ materially from those set forth in, contemplated by,
or underlying the forward-looking statements.
Numerous important factors could cause actual results and events to differ
materially from those expressed or implied by forward-looking statements
including, without limitation, (1) adverse changes in mortality, morbidity or
claims experience, (2) changes in the Company's financial strength and credit
ratings or those of MetLife, Inc. ("MetLife"), the beneficial owner of a
majority of the Company's common shares, or its subsidiaries, and the effect
28
of such changes on the Company's future results of operations and financial
condition, (3) inadequate risk analysis and underwriting, (4) general economic
conditions or a prolonged economic downturn affecting the demand for insurance
and reinsurance in the Company's current and planned markets, (5) the
availability and cost of collateral necessary for regulatory reserves and
capital, (6) market or economic conditions that adversely affect the Company's
ability to make timely sales of investment securities, (7) risks inherent in the
Company's risk management and investment strategy, including changes in
investment portfolio yields due to interest rate or credit quality changes, (8)
fluctuations in U.S. or foreign currency exchange rates, interest rates, or
securities and real estate markets, (9) adverse litigation or arbitration
results, (10) the adequacy of reserves, resources and accurate information
relating to settlements, awards and terminated and discontinued lines of
business, (11) the stability of and actions by governments and economies in the
markets in which the Company operates, (12) competitive factors and competitors'
responses to the Company's initiatives, (13) the success of the Company's
clients, (14) successful execution of the Company's entry into new markets, (15)
successful development and introduction of new products and distribution
opportunities, (16) the Company's ability to successfully integrate and operate
reinsurance business that the Company acquires, (17) regulatory action that may
be taken by state Departments of Insurance with respect to the Company, MetLife,
or its subsidiaries, (18) the Company's dependence on third parties, including
those insurance companies and reinsurers to which the Company cedes some
reinsurance, third-party investment managers and others, (19) the threat of
natural disasters, catastrophes, terrorist attacks, epidemics or pandemics
anywhere in the world where the Company or its clients do business, (20) changes
in laws, regulations, and accounting standards applicable to the Company, its
subsidiaries, or its business, (21) the effect of the Company's status as an
insurance holding company and regulatory restrictions on its ability to pay
principal of and interest on its debt obligations, and (22) other risks and
uncertainties described in this document and in the Company's other filings with
the Securities and Exchange Commission ("SEC").
Forward-looking statements should be evaluated together with the many risks and
uncertainties that affect the Company's business, including those mentioned in
this document and the cautionary statements described in the periodic reports
the Company files with the SEC. These forward-looking statements speak only as
of the date on which they are made. The Company does not undertake any
obligations to update these forward-looking statements, even though the
Company's situation may change in the future. The Company qualifies all of its
forward-looking statements by these cautionary statements. For a discussion of
these risks and uncertainties that could cause actual results to differ
materially from those contained in the forward-looking statements, you are
advised to see Item 1A Risk Factors of the 2005 Annual Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk" which is included herein.
ITEM 4. CONTROLS AND PROCEDURES
The Chief Executive Officer and the Chief Financial Officer have evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures as defined in Exchange Act Rule 13a-15(e) as of the end of the
period covered by this report. Based on that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that these disclosure controls
and procedures were effective.
There was no change in the Company's internal control over financial reporting
as defined in Exchange Act Rule 13a-15(f) during the quarter ended March 31,
2006, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently a party to three arbitrations that involve its
discontinued accident and health business, including personal accident business
(which includes London market excess of loss business) and workers' compensation
carve-out business. The Company is also party to one pending and one threatened
arbitration related to its life reinsurance business. In addition, the Company
has been joined in a suit filed against one of its ceding companies alleging
wrongful denial of a life insurance claim. As of March 31, 2006, the parties
involved in these actions have raised claims, or established reserves that may
result in claims, in the amount of $32.0 million, which is $27.6 million in
excess of the amounts held in reserve by the Company. The Company generally has
little
29
information regarding any reserves established by the 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. See Note 20, "Discontinued Operations" in the
Company's 2005 Annual Report for more information. Additionally, from time to
time, the Company is subject to litigation related 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.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously disclosed
in the Company's 2005 Annual Report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Under a Board of Directors approved plan, the Company may purchase at its
discretion up to $50 million of its common stock on the open market. As of March
31, 2006, the Company had purchased 225,500 shares of treasury stock under this
program at an aggregate price of $6.6 million. All purchases were made during
2002. The Company generally uses treasury shares to support the future exercise
of options granted under its stock option plans.
ITEM 6. EXHIBITS
See index to exhibits.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Reinsurance Group of America,
Incorporated
By: /s/ A. Greig Woodring
------------------------------------
A. Greig Woodring
President & Chief Executive Officer
(Principal Executive Officer)
May 5, 2006
By: /s/ Jack B. Lay
------------------------------------
Jack B. Lay
Executive Vice President & Chief
Financial Officer
(Principal Financial and Accounting
Officer)
May 5, 2006
31
INDEX TO EXHIBITS
Exhibit
Number Description
------- -----------
3.1 Restated Articles of Incorporation, incorporated by reference to
Exhibit 3.1 of Current Report on Form 8-K filed June 30, 2004.
3.2 Bylaws of RGA, as amended, incorporated by reference to Exhibit 3.2 of
Quarterly Report on Form 10-Q filed August 6, 2004.
31.1 Certification of Chief Executive Officer pursuant to section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.
32