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 SEPTEMBER 30, 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) 736-7000
(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 OCTOBER 31, 2006: 61,374,951
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) September 30, 2006
and December 31, 2005 3
Condensed Consolidated Statements of Income (Unaudited) Three and
nine months ended September 30, 2006 and 2005 4
Condensed Consolidated Statements of Cash Flows (Unaudited) Nine
months ended September 30, 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 13
3 Quantitative and Qualitative Disclosures About Market Risk 35
4 Controls and Procedures 35
PART II - OTHER INFORMATION
1 Legal Proceedings 35
1A Risk Factors 35
2 Unregistered Sales of Equity Securities and Use of Proceeds 36
6 Exhibits 36
Signatures 37
Index to Exhibits 38
2
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2006 2005
------------- ------------
(Dollars in thousands)
ASSETS
Fixed maturity securities:
Available-for-sale at fair value (amortized cost of
$7,740,919 and $6,331,225 at September 30, 2006
and December 31, 2005, respectively) $ 8,290,196 $ 6,874,243
Mortgage loans on real estate 669,929 648,067
Policy loans 964,284 987,442
Funds withheld at interest 3,912,715 3,459,943
Short-term investments 49,332 126,296
Other invested assets 220,259 235,464
----------- -----------
Total investments 14,106,715 12,331,455
Cash and cash equivalents 244,584 128,692
Accrued investment income 102,810 62,498
Premiums receivable and other reinsurance balances 632,164 573,145
Reinsurance ceded receivables 551,833 541,944
Deferred policy acquisition costs 2,720,872 2,465,630
Other assets 119,269 90,502
----------- -----------
Total assets $18,478,247 $16,193,866
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Future policy benefits $ 5,172,689 $ 4,693,454
Interest sensitive contract liabilities 5,954,196 5,503,528
Other policy claims and benefits 1,685,678 1,529,298
Other reinsurance balances 130,948 212,422
Deferred income taxes 763,236 652,024
Other liabilities 284,778 117,101
Short-term debt 28,085 125,610
Long-term debt 674,666 674,392
Collateral finance facility 850,265 --
Company-obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely junior
subordinated debentures of the Company 158,663 158,553
----------- -----------
Total liabilities 15,703,204 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
September 30, 2006 and December 31, 2005) 631 631
Warrants 66,915 66,915
Additional paid-in-capital 1,065,306 1,053,814
Retained earnings 1,238,434 1,048,215
Accumulated other comprehensive income:
Accumulated currency translation adjustment, net
of income taxes 116,344 85,127
Unrealized appreciation of securities, net of
income taxes 363,996 361,815
----------- -----------
Total stockholders' equity before treasury stock 2,851,626 2,616,517
Less treasury shares held of 1,761,365 and 2,052,316
at cost at September 30, 2006 and December 31,
2005, respectively (76,583) (89,033)
----------- -----------
Total stockholders' equity 2,775,043 2,527,484
----------- -----------
Total liabilities and stockholders' equity $18,478,247 $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 Nine months ended
September 30, September 30,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
REVENUES:
Net premiums $1,076,191 $ 973,532 $3,145,236 $2,806,706
Investment income, net of related expenses 183,357 166,456 538,903 469,793
Investment related gains (losses), net (125) 2,659 (4,807) 19,588
Change in value of embedded derivatives 4,272 3,536 (2,251) 6,180
Other revenues 18,788 12,234 47,035 43,698
---------- ---------- ---------- ----------
Total revenues 1,282,483 1,158,417 3,724,116 3,345,965
BENEFITS AND EXPENSES:
Claims and other policy benefits 846,908 774,336 2,532,952 2,340,319
Interest credited 43,582 59,919 149,843 153,587
Policy acquisition costs and other insurance expenses 188,731 158,698 513,235 460,529
Change in deferred acquisition costs associated with
change in value of embedded derivatives 2,886 3,858 (2,339) 5,962
Other operating expenses 54,568 37,992 146,925 109,030
Interest expense 15,103 10,052 46,884 29,832
Collateral finance facility expense 13,136 -- 13,413 --
---------- ---------- ---------- ----------
Total benefits and expenses 1,164,914 1,044,855 3,400,913 3,099,259
Income from continuing operations before
income taxes 117,569 113,562 323,203 246,706
Provision for income taxes 41,995 40,043 113,260 80,763
---------- ---------- ---------- ----------
Income from continuing operations 75,574 73,519 209,943 165,943
Discontinued operations:
Loss from discontinued accident and health
operations, net of income taxes (1,539) (5,890) (3,207) (9,940)
---------- ---------- ---------- ----------
Net income $ 74,035 $ 67,629 $ 206,736 $ 156,003
========== ========== ========== ==========
BASIC EARNINGS PER SHARE:
Income from continuing operations $ 1.23 $ 1.17 $ 3.43 $ 2.65
Discontinued operations (0.02) (0.09) (0.05) (0.16)
---------- ---------- ---------- ----------
Net income $ 1.21 $ 1.08 $ 3.38 $ 2.49
========== ========== ========== ==========
DILUTED EARNINGS PER SHARE:
Income from continuing operations $ 1.20 $ 1.15 $ 3.34 $ 2.60
Discontinued operations (0.03) (0.09) (0.05) (0.15)
---------- ---------- ---------- ----------
Net income $ 1.17 $ 1.06 $ 3.29 $ 2.45
========== ========== ========== ==========
DIVIDENDS DECLARED PER SHARE $ 0.09 $ 0.09 $ 0.27 $ 0.27
========== ========== ========== ==========
See accompanying notes to condensed consolidated financial statements
(unaudited).
4
REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended
September 30,
-------------------------
2006 2005
----------- -----------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 206,736 $ 156,003
Adjustments to reconcile net income to net cash provided by
operating activities:
Change in:
Accrued investment income (40,120) (38,872)
Premiums receivable and other reinsurance balances (37,955) (14,789)
Deferred policy acquisition costs (197,550) (259,075)
Reinsurance ceded balances (9,889) (76,343)
Future policy benefits, other policy claims and benefits, and
other reinsurance balances 455,242 538,515
Deferred income taxes 97,806 23,129
Other assets and other liabilities, net 48,957 (13,867)
Amortization of net investment discounts and other (40,525) (29,560)
Investment related losses (gains), net 4,807 (19,597)
Other, net 2,991 5,633
----------- -----------
Net cash provided by operating activities 490,500 271,177
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of fixed maturity securities - available for sale 1,216,753 1,176,186
Maturities of fixed maturity securities - available for sale 78,042 41,346
Purchases of fixed maturity securities - available for sale (2,604,214) (1,483,955)
Cash invested in mortgage loans on real estate (73,567) (47,280)
Cash invested in policy loans (8,581) (8,294)
Cash invested in funds withheld at interest (43,871) (65,211)
Principal payments on mortgage loans on real estate 51,543 22,093
Principal payments on policy loans 31,739 31,582
Change in short-term investments and other invested assets 96,421 (29,087)
----------- -----------
Net cash used in investing activities (1,255,735) (362,620)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends to stockholders (16,517) (16,899)
Principal payments on debt (100,000) --
Exercise of stock options, net 7,582 4,977
Net proceeds from collateral finance facility 837,500 --
Net increase in securitized lending activities 88,618 89,713
Excess deposits on universal life and other
investment type policies and contracts 64,755 6,087
----------- -----------
Net cash provided by financing activities 881,938 83,878
Effect of exchange rate changes (811) (2,458)
----------- -----------
Change in cash and cash equivalents 115,892 (10,023)
Cash and cash equivalents, beginning of period 128,692 152,095
----------- -----------
Cash and cash equivalents, end of period $ 244,584 $ 142,072
=========== ===========
Supplementary information:
Cash paid for interest $ 51,805 $ 30,292
Cash paid (received) for income taxes, net of refunds $ (12,980) $ 78,368
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
nine-month period ended September 30, 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2006 2005 2006 2005
------- ------- -------- --------
Earnings:
Income from continuing operations (numerator
for basic and diluted calculations) $75,574 $73,519 $209,943 $165,943
Shares:
Weighted average outstanding shares
(denominator for basic calculation) 61,290 62,640 61,205 62,607
Equivalent shares from outstanding stock
options and warrants 1,815 1,013 1,606 1,149
------- ------- -------- --------
Denominator for diluted calculation 63,105 63,653 62,811 63,756
Earnings per share:
Basic $ 1.23 $ 1.17 $ 3.43 $ 2.65
Diluted $ 1.20 $ 1.15 $ 3.34 $ 2.60
======= ======= ======== ========
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 and
nine month periods ended September 30, 2006, 0.4 million performance contingent
shares were excluded from the calculation. For the three and nine months ended
September 30, 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 NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Net income $ 74,035 $ 67,629 $206,736 $156,003
Accumulated other comprehensive income
(expense), net of income tax:
Unrealized gains (losses), net of
reclassification adjustment for
gains (losses) included in net income 233,060 (43,834) 2,181 100,921
Foreign currency translation (1,502) 25,541 31,217 (2,757)
-------- -------- -------- --------
Comprehensive income $305,593 $ 49,336 $240,134 $254,167
======== ======== ======== ========
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 consolidated
financial statements accompanying 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. 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 the Company'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).
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
TOTAL REVENUES
U.S $ 791,050 $ 752,365 $2,338,989 $2,142,356
Canada 131,861 112,161 377,599 310,035
Europe & South Africa 150,094 140,401 448,349 419,765
Asia Pacific 186,783 141,465 511,580 416,702
Corporate & Other 22,695 12,025 47,599 57,107
---------- ---------- ---------- ----------
Total $1,282,483 $1,158,417 $3,724,116 $3,345,965
========== ========== ========== ==========
7
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES
U.S. $ 84,802 $ 85,791 $236,073 $181,549
Canada 13,462 11,690 32,967 38,149
Europe & South Africa 8,813 15,727 40,879 23,396
Asia Pacific 20,378 1,416 34,717 15,702
Corporate & Other (9,886) (1,062) (21,433) (12,090)
-------- -------- -------- --------
Total $117,569 $113,562 $323,203 $246,706
======== ======== ======== ========
TOTAL ASSETS
----------------------------
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
U.S. $11,836,388 $11,049,424
Canada 2,127,758 1,954,612
Europe & South Africa 1,134,008 956,453
Asia Pacific 922,276 873,230
Corporate and Other 2,457,817 1,360,147
----------- -----------
Total $18,478,247 $16,193,866
=========== ===========
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has commitments to fund investments in limited partnerships in the
amount of $37.5 million at September 30, 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 less any
other-than-temporary impairment and are included in other invested assets in the
condensed consolidated balance sheets.
Subsequent to September 30, 2006 the Company settled a pending arbitration and a
suit filed against one of its ceding companies in which it was joined. These
settlements were for amounts which were substantially reserved by the Company.
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 a threatened arbitration
related to its life reinsurance business. As of October 31, 2006, the parties
involved in these actions have raised claims, or established reserves that may
result in claims, in the amount of $27.7 million, which is $23.8 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 consolidated financial statements accompanying the 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. The Company cannot 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
8
under the reinsurance agreements and allow ceding companies to take statutory
reserve credits. At September 30, 2006 and December 31, 2005, there were
approximately $14.6 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 September 30, 2006 and December 31, 2005, $438.0 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 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 office lease obligations, 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 $275.0 million and $256.2 million as of
September 30, 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
parties should a subsidiary fail to make principal and/or interest payments when
due. As of September 30, 2006, RGA's exposure related to these guarantees was
$184.8 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):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
2006 2005 2006 2005
----- ----- ------- ------
NET PERIODIC PENSION BENEFIT COST:
Service cost $ 518 $ 513 $ 1,555 $1,536
Interest cost 425 397 1,273 1,191
Expected return on plan assets (379) (289) (1,137) (867)
Amortization of prior service cost 7 7 22 22
Amortization of prior actuarial loss 91 88 275 265
----- ----- ------- ------
Net periodic pension benefit cost $ 662 $ 716 $ 1,988 $2,147
===== ===== ======= ======
NET PERIODIC OTHER BENEFITS COST:
Service cost $ 156 $ 208 $ 515 $ 413
Interest cost 163 185 474 383
Expected return on plan assets -- -- -- --
Amortization of prior service cost -- -- -- --
Amortization of prior actuarial loss 77 118 209 153
----- ----- ------- ------
Net periodic other benefits cost $ 396 $ 511 $ 1,198 $ 949
===== ===== ======= ======
9
The Company made $3.8 million in pension contributions during the second quarter
of 2006 and expects this to be the only contribution for the year.
7. COLLATERAL FINANCE FACILITY
On June 28, 2006, RGA's subsidiary, Timberlake Financial, L.L.C. ("Timberlake
Financial"), issued $850.0 million of Series A Floating Rate Insured Notes due
June 2036 in a private placement. The notes were issued to fund the collateral
requirements for statutory reserves required by the U.S. valuation of Life
Policies Model Regulation (commonly referred to as Regulation XXX) on specified
term life insurance policies reinsured by RGA Reinsurance Company. Proceeds from
the notes, along with a $112.7 million direct investment by the Company, have
been deposited into a series of trust accounts that collateralize the notes and
are not available to satisfy the general obligations of the Company. Interest on
the notes will accrue at an annual rate of 1-month LIBOR plus a base rate
margin, payable monthly. The payment of interest and principal on the notes is
insured through a financial guaranty insurance policy with a third party. The
notes represent senior, secured indebtedness of Timberlake Financial with no
recourse to RGA or its other subsidiaries. Timberlake Financial will rely
primarily upon the receipt of interest and principal payments on a surplus note
and dividend payments from its wholly-owned subsidiary, Timberlake Reinsurance
Company II ("Timberlake Re"), a South Carolina captive insurance company, to
make payments of interest and principal on the notes. The ability of Timberlake
Re to make interest and principal payments on the surplus note and dividend
payments to Timberlake Financial is contingent upon South Carolina regulatory
approval and the performance of specified term life insurance policies with
guaranteed level premiums retroceded by RGA's subsidiary, RGA Reinsurance
Company, to Timberlake Re.
In accordance with Financial Accounting Standards Board ("FASB") Interpretation
No. 46(r), "Consolidation of Variable Interest Entities - An Interpretation of
ARB No. 51," Timberlake Financial is considered to be a variable interest entity
and the Company is deemed to hold the primary beneficial interest. As a result,
Timberlake Financial has been consolidated in the Company's condensed financial
statements. The Company's condensed consolidated balance sheets include the
assets of Timberlake Financial recorded as fixed maturity investments and other
invested assets, which consists of restricted cash and cash equivalents, with
the liability for the notes recorded as collateral finance facility. The
Company's condensed consolidated statements of income include the investment
return of Timberlake Financial as investment income and the cost of the facility
is reflected in collateral finance facility expense.
8. EQUITY BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standard ("SFAS") 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 expense
was $4.5 million and $1.7 million in the third quarter of 2006 and 2005,
respectively, and $15.2 million and $5.2 million in the first nine months 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 September 30,
2006, the total compensation cost of non-vested awards not yet recognized in the
financial statements was $19.3 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.
10
9. NEW ACCOUNTING STANDARDS
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108
provides guidance on how prior year misstatements should be considered when
quantifying misstatements in current year financial statements for purposes of
assessing materiality. SAB 108 requires that a registrant assess the materiality
of a current period misstatement by determining how the current period's balance
sheet would be affected in correcting a misstatement without considering the
year(s) in which the misstatement originated and how the current period's income
statement is misstated, including the reversing effect of prior year
misstatements. SAB 108 is effective for fiscal years ending after November 15,
2006. The cumulative effect of applying SAB 108 may be recorded by adjusting
current year beginning balances of the affected assets and liabilities with a
corresponding adjustment to the current year opening balance in retained
earnings if certain criteria are met. The Company is currently evaluating the
impact of SAB 108 and does not expect that the pronouncement will have a
material impact on the Company's condensed consolidated financial statements.
In September 2006, the FASB issued SFAS 158, "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements
No. 87, 88, 106, and 132(r)" ("SFAS 158"). The pronouncement revises financial
reporting standards for defined benefit pension and other postretirement plans
by requiring the (i) recognition in its statement of financial position of the
funded status of defined benefit plans measured as the difference between the
fair value of plan assets and the benefit obligation, which shall be the
projected benefit obligation for pension plans and the accumulated
postretirement benefit obligation for other postretirement plans; (ii)
recognition as an adjustment to the ending balance of accumulated other
comprehensive income (loss), net of income taxes, those amounts of actuarial
gains and losses, prior service costs and credits, and transition obligations
that have not yet been included in net periodic benefit costs as of the end of
the year of adoption; (iii) measurement of benefit plan assets and obligations
as of the date of the statement of financial position; and (iv) disclosure of
additional information about the effects on the employer's statement of
financial position. SFAS 158 is effective for fiscal years ending after December
15, 2006 with the exception of the requirement to measure plan assets and
benefit obligations as of the date of the employer's statement of financial
position, which is effective for fiscal years after December 15, 2008. The
recognition provisions of SFAS 158 are to be applied as of the end of the year
of adoption which, for the Company, will be based on balances as of December 31,
2006. The Company is currently evaluating the effect of SFAS 158 on the
Company's condensed consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in GAAP and requires enhanced disclosures about fair value
measurements. SFAS 157 does not require any new fair value measurements. The
pronouncement is effective for fiscal years beginning after November 15, 2006.
The guidance in SFAS 157 will be applied prospectively with the exception of:
(i) block discounts of financial instruments; (ii) certain financial and hybrid
instruments measured at initial recognition under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"); which are to be
applied retrospectively as of the beginning of initial adoption (a limited form
of retrospective application). The Company is currently evaluating the impact of
SFAS 157 and does not expect that the pronouncement will have a material impact
on the Company's condensed consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation ("FIN") No. 48, "Accounting
for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109"
("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, treatment of interest and penalties, and
disclosure of such positions. FIN 48 will be applied prospectively and will be
effective for fiscal years beginning after December 31, 2006. The Company is
currently evaluating the effect, if any, of FIN 48 on the Company's condensed
consolidated financial statements.
Effective January 1, 2006, the Company prospectively adopted SFAS No. 155,
"Accounting for Certain Hybrid Instruments" ("SFAS 155"). SFAS 155 amends SFAS
No. 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
11
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 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 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 was adopted by the Company
during the first quarter of 2006 and will apply the provisions of SFAS 154 when
applicable.
12
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. The maximum amount of
coverage the Company retains per life is $6 million. Claims in excess of this
retention amount are retroceded to retrocessionaires; however, the Company
remains fully liable to the ceding company for the entire amount of risk it
assumes. The Company believes its sources of liquidity are sufficient to cover
potential claims payments on both a short-term and long-term basis.
The Company measures performance based on income or loss from continuing
operations before income taxes for each of its five segments. The Company's
U.S., Canada, 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
$4.0 million, or 3.5%, and $76.5 million, or 31.0%, for the third quarter and
first nine months of 2006, respectively. The third quarter increase was
primarily due to increased premiums and improved mortality experience in the
Asia Pacific segment, partially offset by slightly adverse mortality experience
in the Canada segment relative to prior year. The prior-year quarter also
reflected favorable mortality in the U.S. segment. The nine month increase was
primarily due to the favorable third quarter Asia Pacific segment results and
improved mortality results in the U.S. and Europe & South Africa segments, which
experienced high claim levels in the comparable prior-year period. The nine
month increase was offset in part by adverse mortality experience in Canada,
particularly during the first six months of 2006. Consolidated net premiums
increased $102.7 million, or 10.5%, and $338.5 million, or 12.1%, for the third
quarter and first nine months of 2006, respectively, due to growth in life
reinsurance in force.
13
Consolidated investment income, net of related expenses, increased $16.9
million, or 10.2%, and $69.1 million, or 14.7%, in the third quarter and first
nine months of 2006, respectively, primarily due to a larger invested asset
base. Invested assets as of September 30, 2006 totaled $14.1 billion, a 21.5%
increase over September 30, 2005. A significant portion of the increase in
invested assets is related to the Company's investment of the net proceeds from
its collateral finance facility in June 2006 and the issuance of Junior
Subordinated Debentures in December 2005. While the Company's invested asset
base has grown significantly since September 30, 2005, the average yield earned
on investments, excluding funds withheld, decreased from 5.89% in the third
quarter of 2005 to 5.79% for the third 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 35.7% for the third quarter
and 35.0% for the first nine months of 2006, compared to 35.3% and 32.7% for the
comparable prior-year periods. The lower rates in the prior year periods was due
to the utilization of tax loss carryforwards, for which no prior financial
statement tax benefit had been taken.
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.
14
The Company periodically reviews actual historical experience and relative
anticipated experience compared to the assumptions used to establish aggregate
policy reserves. Further, the Company establishes premium deficiency reserves if
actual and anticipated experience indicates that existing aggregate policy
reserves, together with the present value of future gross premiums, are not
sufficient to cover the present value of future benefits, settlement and
maintenance costs and to recover unamortized acquisition costs. The premium
deficiency reserve is established through a charge to income, as well as a
reduction to unamortized acquisition costs and, to the extent there are no
unamortized acquisition costs, an increase to future policy benefits. Because of
the many assumptions and estimates used in establishing reserves and the
long-term nature of the Company's reinsurance contracts, the reserving process,
while based on actuarial science, is inherently uncertain. If the Company's
assumptions, particularly on mortality, are inaccurate, its reserves may be
inadequate to pay claims and there could be a material adverse effect on its
results of operations and financial condition.
Other policy claims and benefits include claims payable for incurred but not
reported losses, which are determined using case-basis estimates and lag studies
of past experience. These estimates are periodically reviewed and any
adjustments to such estimates, if necessary, are reflected in current
operations. The time lag from the date of the claim or death to the date when
the ceding company reports the claim to the Company can 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
consolidated financial statements accompanying the 2005 Annual Report for more
information.
Further discussion and analysis of the results for 2006 compared to 2005 are
presented by segment. Certain prior-year period amounts have been reclassified
to conform to the current-year presentation. Additionally, segment results for
the prior-year period have been reclassified to conform to the economic capital
process mentioned above. References to income before income taxes exclude the
effects of discontinued operations.
15
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 sub-segment consists of
Asset-Intensive and Financial Reinsurance.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 (IN THOUSANDS)
NON-TRADITIONAL
----------------------- TOTAL
ASSET- FINANCIAL U.S.
TRADITIONAL INTENSIVE REINSURANCE OPERATIONS
----------- --------- ----------- ----------
REVENUES:
Net premiums $646,529 $ 1,559 $ -- $648,088
Investment income, net of related expenses 76,900 48,473 (7) 125,366
Investment related gains (losses), net 200 (1,998) 4 (1,794)
Change in value of embedded derivatives -- 4,272 -- 4,272
Other revenues 271 7,263 7,584 15,118
-------- ------- ------ --------
Total revenues 723,900 59,569 7,581 791,050
BENEFITS AND EXPENSES:
Claims and other policy benefits 514,259 1,069 3 515,331
Interest credited 12,337 30,824 -- 43,161
Policy acquisition costs and other insurance
expenses 109,213 17,644 2,392 129,249
Change in deferred acquisition costs associated
with change in value of embedded derivatives -- 2,886 -- 2,886
Other operating expenses 12,334 1,869 1,418 15,621
-------- ------- ------ --------
Total benefits and expenses 648,143 54,292 3,813 706,248
Income before income taxes $ 75,757 $ 5,277 $3,768 $ 84,802
======== ======= ====== ========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 (IN THOUSANDS)
NON-TRADITIONAL
----------------------- TOTAL
ASSET- FINANCIAL U.S.
TRADITIONAL INTENSIVE REINSURANCE OPERATIONS
----------- --------- ----------- ----------
REVENUES:
Net premiums $610,242 $ 1,147 $ -- $611,389
Investment income, net of related expenses 69,011 59,776 157 128,944
Investment related gains (losses), net (861) 405 (3) (459)
Change in value of embedded derivatives -- 3,536 -- 3,536
Other revenues 185 2,116 6,654 8,955
-------- ------- ------ --------
Total revenues 678,577 66,980 6,808 752,365
BENEFITS AND EXPENSES:
Claims and other policy benefits 484,493 860 3 485,356
Interest credited 13,553 45,828 -- 59,381
Policy acquisition costs and other insurance
expenses 90,696 12,559 2,105 105,360
Change in deferred acquisition costs associated
with change in value of embedded derivatives -- 3,858 -- 3,858
Other operating expenses 10,159 1,173 1,287 12,619
-------- ------- ------ --------
Total benefits and expenses 598,901 64,278 3,395 666,574
Income before income taxes $ 79,676 $ 2,702 $3,413 $ 85,791
======== ======= ====== ========
16
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 (IN THOUSANDS)
NON-TRADITIONAL
----------------------- TOTAL
ASSET- FINANCIAL U.S.
TRADITIONAL INTENSIVE REINSURANCE OPERATIONS
----------- --------- ----------- ----------
REVENUES:
Net premiums $1,920,667 $ 4,638 $ -- $1,925,305
Investment income, net of related expenses 222,599 167,794 (162) 390,231
Investment related gains (losses), net (3,535) (7,842) 4 (11,373)
Change in value of embedded derivatives -- (2,251) -- (2,251)
Other revenues 227 14,460 22,390 37,077
---------- -------- ------- ----------
Total revenues 2,139,958 176,799 22,232 2,338,989
BENEFITS AND EXPENSES:
Claims and other policy benefits 1,568,045 927 4 1,568,976
Interest credited 35,620 112,291 -- 147,911
Policy acquisition costs and other insurance
expenses 292,614 48,578 7,052 348,244
Change in deferred acquisition costs associated
with change in value of embedded derivatives -- (2,339) -- (2,339)
Other operating expenses 31,192 5,058 3,874 40,124
---------- -------- ------- ----------
Total benefits and expenses 1,927,471 164,515 10,930 2,102,916
Income before income taxes $ 212,487 $ 12,284 $11,302 $ 236,073
========== ======== ======= ==========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 (IN THOUSANDS)
NON-TRADITIONAL
----------------------- TOTAL
ASSET- FINANCIAL U.S.
TRADITIONAL INTENSIVE REINSURANCE OPERATIONS
----------- --------- ----------- ----------
REVENUES:
Net premiums $1,751,731 $ 3,488 $ -- $1,755,219
Investment income, net of related expenses 198,508 157,471 319 356,298
Investment related gains (losses), net (4,525) 2,039 (10) (2,496)
Change in value of embedded derivatives -- 6,180 -- 6,180
Other revenues 896 5,960 20,299 27,155
---------- -------- ------- ----------
Total revenues 1,946,610 175,138 20,608 2,142,356
BENEFITS AND EXPENSES:
Claims and other policy benefits 1,464,774 4,109 5 1,468,888
Interest credited 41,863 109,809 -- 151,672
Policy acquisition costs and other insurance
expenses 252,151 38,683 6,179 297,013
Change in deferred acquisition costs associated
with change in value of embedded derivatives -- 5,962 -- 5,962
Other operating expenses 29,456 3,747 4,069 37,272
---------- -------- ------- ----------
Total benefits and expenses 1,788,244 162,310 10,253 1,960,807
Income before income taxes $ 158,366 $ 12,828 $10,355 $ 181,549
========== ======== ======= ==========
Income before income taxes for the U.S. operations segment totaled $84.8 million
and $236.1 million for the third quarter and first nine months of 2006,
respectively, compared to $85.8 million and $181.5 million for the same periods
in the prior year. This increase in income for the first nine months can be
primarily attributed to growth in total business in force and improved mortality
experience in 2006.
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 third quarter and first nine
months of 2006, this sub-segment added $43.1 billion and $132.7 billion of new
business, respectively, compared to $56.7 billion and $140.9 billion
17
in the same periods 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 decreased 4.9% from
the third quarter of 2005, but increased 34.2% for the first nine months of the
year. Improved mortality experience in 2006 was the primary contributor to the
overall growth in net income for the first nine months of 2006. Stronger
premiums and higher investment income also contributed to the total increase in
net income for the year.
Net premiums for U.S. Traditional reinsurance totaled $646.5 and $1,920.7 for
the third quarter and first nine months of 2006. Comparable prior-year amounts
were $610.2 and $1,751.7, respectively. The 9.6% increase in year to date net
premiums was driven primarily by the growth of total U.S. business in force,
which totaled just over $1.1 trillion as of September 30, 2006, an 7.7% increase
over the amount in force as of September 30, 2005.
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. During the third quarter of
2006, investment income in the segment totaled $76.9 million, an 11.4% increase
over same prior-year period. Year to date 2006, investment income grew 12.1%
over the first nine months of 2005. This increase can be primarily attributed to
growth in the invested asset base.
Mortality experience for the third quarter of 2006 was in line with
expectations, however, year over year, it improved significantly mainly due to
the unfavorable experience in the second quarter of 2005. Claims and other
policy benefits, as a percentage of net premiums (loss ratios), were 79.5% for
the third quarter and 81.6% for the first nine months of 2006. The loss ratios
for the comparative prior periods were 79.4% and 83.6%, 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.
Interest credited relates to amounts credited on cash value products, which have
a significant mortality component. The amount of interest credited fluctuates
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 third quarter and first nine months of 2006 totaled
$12.3 million and $35.6 million, respectively, compared to $13.6 million and
$41.9 million for the same periods in 2005. The decrease is primarily the result
of one treaty in which the credited loan rate decreased from 5.7% in 2005 to
4.6% in 2006.
Policy acquisition costs and other insurance expenses, as a percentage of net
premiums, were 16.9% for the third quarter of 2006 and 15.2% for the first nine
months of 2006. Comparable ratios for the third quarter and first nine months of
2005 were 14.9% and 14.4% respectively. 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. Additionally, 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 1.9% for the
third quarter of 2006 and 1.6% year to date, compared to 1.7% reported for the
quarter and year to date in 2005. 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.
In accordance with the provisions of Statement of Financial Accounting Standard
("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
18
Obligor under Those Instruments" ("Issue B36"), the Company recorded a change in
value of embedded derivatives of $4.3 million and $(2.3) million within revenues
for the third quarter and first nine months of 2006, respectively, and $2.9
million and $(2.3) million of related deferred acquisition costs. Significant
fluctuations may occur as the fair value of the embedded derivatives is tied
primarily to the movements in credit spreads. These fluctuations have no impact
on cash flows or interest spreads on the underlying treaties. Therefore, Company
management believes it is helpful to distinguish between the effects of Issue
B36 and the primary factors that drive profitability of the underlying treaties,
namely investment income, fee income, and interest credited. Additionally, over
the expected life of the underlying treaties, management expects the cumulative
effect of Issue B36 to be immaterial.
The Asset-Intensive sub-segment reported income before income taxes of $5.3
million for the third quarter of 2006 and $12.3 million year to date. Compared
to prior year, income before income taxes increased $2.6 million in the third
quarter, but decreased $0.5 million in the first nine months of 2006. Issue B36
increased income before income taxes by $1.7 million during the comparable
quarters and decreased income before income taxes by $0.1 million during the
comparable nine month periods. The remaining $0.9 million increase in income
before income taxes in the comparable quarters is associated with growth in the
investment asset base and improved spreads earned on those assets, partially
offset by additional investment related losses. The remaining $0.4 million
decrease in income before income taxes for the year-to-year comparison is the
result of an increase in investment losses of $9.9 million in 2006, mostly
offset by an increase in income generated from the growth in the invested asset
base and improved spreads earned on those assets.
Total revenues decreased $7.4 million for the third quarter of 2006, but
increased $1.7 million for the first nine months of 2006. Issue B36 related
revenues increased $0.7 million for the third quarter of 2006, but decreased
$8.4 million during the first nine months of 2006. The primary driver for the
remaining decrease in total revenues quarter over quarter of $8.1 million was a
decrease in investment income of $11.3 million, partially offset by an increase
in other revenues of $5.1 million. The decrease in investment income relates
primary to the change in market value of call options on various equity indexes
associated with a funds withheld portfolio. The call options are used to hedge
the equity-index based crediting rates on the underlying equity index annuities
associated with the treaty. This decrease in investment income is offset by a
decrease in interest credited expense, with minimal impact on income before
income taxes. Year to date, investment income is up $10.3 million and other
income increased $8.5 million. These increases were partially offset by
investment related losses of $7.8 million in 2006 compared to $2.0 million of
investment related gains in the prior year. These losses were mainly the result
of an increased rate environment which allowed the Company to sell bonds at low
book yields and reinvest in higher book yielding securities, which should result
in higher future investment income. The growth in investment income is driven by
a higher asset base due to new business on existing treaties. The increase in
other income is due to increased surrender charges and mortality and expense
fees on a new variable annuity deal.
The average invested asset base supporting this sub-segment grew from $3.9
billion in the third quarter of 2005 to $4.3 billion for the third 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 September 30,
2006 were $4.4 billion, of which $2.9 billion were funds withheld at interest.
Of the $2.9 billion of total funds withheld balance as of September 30 2006,
89.0% of the balance is associated with one client.
Total benefits and expenses decreased $10.0 million for the third quarter of
2006, but increased $2.2 million during the first nine months of 2006. Issue B36
related expenses decreased $1.0 million for the third quarter of 2006 and $8.3
million during the first nine months of 2006. The remainder of the change in
total benefits and expenses, which are comprised primarily of interest credited
and policy acquisition costs, decreased 14.9% from the third quarter of 2005,
but increased 6.7% year to date. Interest credited decreased $15.0 over the
third quarter of 2005. As stated above, this decrease relates to the decrease in
investment income. Year-over-year, total benefits and expenses are up primarily
due to increased deferred acquisition costs related to new business. A portion
of this increase can be attributed to a new variable annuity deal effective in
the second quarter of 2006.
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 are assumed by the Company and retroceded to other insurance
companies or brokered business in which the company does not participate in the
assumption of risk. The fees earned from the assumption of the financial
reinsurance contracts are reflected in other revenues, and the fees
19
paid to retrocessionaires are reflected in policy acquisition costs and other
insurance expenses. Fees earned on brokered business are reflected in other
revenues.
Income before income taxes increased 10.4%, in the third quarter of 2006 and
9.1% for the first nine months compared to the same periods in 2005. The
increase in income primarily relates to several new transactions that were
executed in late 2005.
At September 30, 2006 and 2005, the amount of reinsurance provided, as measured
by pre-tax statutory surplus, was $1.75 billion and $1.55 billion respectively.
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
life and health reinsurance and non-guaranteed critical illness products.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES:
Net premiums $103,316 $ 89,074 $294,838 $239,684
Investment income, net of related
expenses 27,578 22,728 78,881 67,637
Investment related gains, net 1,419 678 3,565 2,980
Other revenues (452) (319) 315 (266)
-------- -------- -------- --------
Total revenues 131,861 112,161 377,599 310,035
BENEFITS AND EXPENSES:
Claims and other policy benefits 95,854 73,810 280,382 216,707
Interest credited 211 266 623 875
Policy acquisition costs and other
insurance expenses 18,146 22,474 51,735 43,304
Other operating expenses 4,188 3,921 11,892 11,000
-------- -------- -------- --------
Total benefits and expenses 118,399 100,471 344,632 271,886
Income before income taxes $ 13,462 $ 11,690 $ 32,967 $ 38,149
-------- -------- -------- --------
Income before income taxes increased by $1.8 million or 15.2%, and decreased by
$5.2 million or 13.6%, in the third quarter and first nine months of 2006,
respectively. A stronger Canadian dollar resulted in an increase in income
before income taxes of $1.2 million and $3.1 million in the third quarter and
first nine months of 2006, respectively, as compared to 2005. Results in 2006
reflect unfavorable mortality experience relative to mortality experience in
2005.
Net premiums increased by $14.2 million, or 16.0%, and $55.2 million or 23.0%
for the third quarter and first nine months of 2006, respectively. The increases
are primarily due to new business from new and existing treaties. A stronger
Canadian dollar resulted in an increase in net premiums of $6.8 million and
$21.7 million in the third quarter and first nine months of 2006, respectively,
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 $4.9 million, or 21.3%, and $11.2 million, or
16.6%, in the third quarter and first nine months of 2006, respectively. A
stronger Canadian dollar resulted in an increase in net investment income of
20
$2.1 million and $6.0 million in the third quarter and first nine months of
2006, respectively. Investment income represents an allocation to the segments
based upon average assets and related capital levels deemed appropriate to
support business volumes. Investment performance varies with the composition of
investments and the relative allocation of capital to the operating segments.
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.
Loss ratios for this segment were 92.8% and 95.1% in the third quarter and first
nine months of 2006, respectively, compared to 82.9% and 90.4% in the comparable
prior-year periods. During 2005, the Company entered into two significant
creditor reinsurance treaties. The loss ratios on this type of business are
normally lower than traditional reinsurance, however allowances are normally
higher as a percentage of premiums. Excluding creditor business, the loss ratios
for this segment were 102.2% and 103.4% in the third quarter and first nine
months of 2006, respectively, compared to 97.8% and 96.9% in the comparable
prior-year periods. The higher loss ratios in 2006, particularly for the
year-to-date results, are primarily due to unfavorable mortality experience
compared to the prior year. Historically, the loss ratio increased primarily as
the result of several large permanent level premium in-force blocks assumed in
1997 and 1998. These blocks are mature blocks of 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 73.2% and 75.0% in
the third quarter and first nine months of 2006, respectively, compared to 66.0%
and 70.5% in the comparable prior-year periods. 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 17.6% and 17.5% in the third quarter and first nine months of
2006, respectively, compared to 25.2% and 18.1% in the comparable prior-year
periods. 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 12.2% and 13.3% in the third quarter and first nine
months of 2006, respectively, compared to 15.0% and 13.7% in the comparable
prior-year periods. Overall, while these ratios are expected to remain in a
certain range, they may fluctuate from period to period due to varying allowance
levels, significantly caused by the mix of first year coinsurance business
versus yearly renewable term business. 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.
Other operating expenses increased $0.3 million, or 6.8%, and $0.9 million or
8.1% in the third quarter and first nine months of 2006, respectively. The
increase in expenses is primarily due to the strengthening of the Canadian
dollar. Other operating expenses as a percentage of net premiums totaled 4.1%
and 4.0% in the third quarter and first nine months of 2006, respectively,
compared to 4.4% and 4.6% in the comparable prior-year periods.
EUROPE & SOUTH AFRICA OPERATIONS
The Europe & South Africa segment has operations in India, Mexico, Poland,
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 critical illness coverage.
Reinsurance agreements may be either facultative or automatic agreements
covering primarily individual risks and in some markets, group risks.
21
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES:
Net premiums $145,769 $137,145 $436,993 $411,475
Investment income, net of related
expenses 4,210 3,184 11,475 8,214
Investment related losses, net (91) (16) (238) (182)
Other revenues 206 88 119 258
-------- -------- -------- --------
Total revenues 150,094 140,401 448,349 419,765
BENEFITS AND EXPENSES:
Claims and other policy benefits 101,492 97,039 308,172 305,488
Interest credited 133 109 479 662
Policy acquisition costs and other
insurance expenses 28,110 20,262 69,188 70,177
Other operating expenses 11,546 7,264 29,631 20,042
-------- -------- -------- --------
Total benefits and expenses 141,281 124,674 407,470 396,369
Income before income taxes $ 8,813 $ 15,727 $ 40,879 $ 23,396
======== ======== ======== ========
Income before income taxes was $8.8 million in the third quarter of 2006 as
compared to $15.7 million for the third quarter of 2005, this decrease was
primarily the result of an increase in policy acquisition costs and other
insurance expenses over the prior period. Income before income taxes was $40.9
million for the first nine months of 2006 as compared to $23.4 million for the
first nine months of 2005, this increase was primarily the result of adverse
mortality and morbidity experience in the UK for the first nine months of 2005.
Foreign currency exchange fluctuations resulted in an increase to income before
income taxes totaling approximately $0.3 million for the third quarter and a
decrease to income before income taxes totaling approximately $1.1 million for
the first nine months of 2006.
Net premiums increased $8.6 million, or 6.3%, in the third quarter compared to
the same period last year, and increased $25.5 million or 6.2% for the nine
months ended September 30, 2006 compared to the same period last year. This
increase was primarily the result of new business from both existing and new
treaties. The rate of growth in net premiums is below historical levels due to
increased competition in the UK and a slowing of growth in the UK retail
mortgage market. During the third quarter of 2006, several foreign currencies,
particularly the British pound and the euro strengthened against the U.S. dollar
and increased net premiums by approximately $4.6 million and for the first nine
months of 2006, these currencies weakened against the U.S. dollar and adversely
affected net premiums by $6.9 million. A significant portion of the net premiums
were due to reinsurance of critical illness coverage, primarily in the UK. This
coverage provides a benefit in the event of the diagnosis of a pre-defined
critical illness. Net premiums earned from policies including this coverage
totaled $54.5 million and $156.1 million in the third quarter and first nine
months of 2006, respectively, compared to $49.2 million and $149.4 million in
the comparable prior-year periods. 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 $1.0 million for the third quarter compared to the
same period in 2005 and increased $3.3 million for the nine months ended
September 30, 2006 compared to the same period in 2005. This increase was
primarily due to 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.
22
Loss ratios decreased from 70.8% for the third quarter of 2005 to 69.6% for the
third quarter of 2006, and from 74.2% for the nine months ended September 30,
2005 to 70.5% for the nine months ended September 30, 2006. As mentioned above,
unfavorable mortality experience in the UK market for the nine months ended
September 30, 2005 contributed to the relative decrease in the loss ratio for
the nine months ended September 30, 2006. 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 19.3% in the third quarter of 2006 compared to 14.8% in the third
quarter of 2005, and 15.8% for the nine months ended September 30, 2006 compared
to 17.1% for the nine months ended September 30, 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.
Other operating expenses for the quarter increased from 5.3% of net premiums in
2005 to 7.9% in 2006, and for the first nine months it increased from 4.9% to
6.8%. 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 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.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES:
Net premiums $178,550 $135,336 $486,615 $398,562
Investment income, net of related
expenses 7,036 5,409 20,354 15,418
Investment related gains (losses), net (46) 21 (123) 75
Other revenues 1,243 699 4,734 2,647
-------- -------- -------- --------
Total revenues 186,783 141,465 511,580 416,702
BENEFITS AND EXPENSES:
Claims and other policy benefits 134,177 114,059 376,399 315,336
Policy acquisition costs and other
insurance expenses 20,658 18,758 70,230 66,599
Other operating expenses 11,570 7,232 30,234 19,065
-------- -------- -------- --------
Total benefits and expenses 166,405 140,049 476,863 401,000
Income before income taxes $ 20,378 $ 1,416 $ 34,717 $ 15,702
======== ======== ======== ========
Income before income taxes increased $19.0 million in the third quarter of 2006,
and $19.0 million for the nine months ended September 30, 2006, as compared to
the same periods in 2005, after being relatively consistent for the first six
months of each year. The increase in income before income taxes for the third
quarter of 2006 compared to the third quarter of 2005 was primarily the result
of a $43.2 million increase in net premiums, accompanied by improvements in the
mortality experience as compared to the third quarter of 2005, particularly in
the New Zealand, Hong Kong and Taiwan markets.
23
Foreign currency exchange fluctuations were neutral to income before income
taxes for the third quarter of 2006, but such fluctuations have resulted in a
decrease in income before income taxes totaling approximately $0.9 million for
the first nine months of 2006.
Net premiums grew $43.2 million, or 31.9%, in the current quarter, and $88.1
million, or 22.1%, for the nine months ended September 30, 2006, as compared to
the same periods in 2005. This premium growth was primarily the result of
continued increases in the volume of business in Japan, Korea and Taiwan.
Collectively, for these three locations net premiums increased by $39.3 million
in the third quarter of 2006, and $75.4 million for the nine months ended
September 30, 2006, as compared to the same periods in 2005, primarily due to
the growth in business with significant clients. Premium levels are
significantly influenced by large transactions and reporting practices of ceding
companies and can fluctuate from period to period.
A portion of the net premiums for the segment in each period presented
represents reinsurance of critical illness coverage. This coverage provides a
benefit in the event of the diagnosis of a pre-defined critical illness.
Reinsurance of critical illness in the Asia Pacific operations is offered
primarily in Australia and Korea. Net premiums earned from policies including
this coverage totaled $12.6 million and $47.4 million for the third quarter and
first nine months of 2006, respectively, compared to $12.2 million and $46.5
million for the comparable prior-year periods.
Foreign currencies in certain significant markets, particularly the Australian
dollar and the Japanese Yen, began to weaken against the U.S. dollar in 2006, as
compared to the same periods in 2005. However, the Korean Won has generally
strengthened throughout the nine months ending September 30, 2006 as compared to
the same period of 2005. The overall effect of changes in local Asia Pacific
segment currencies was an increase in net premiums of approximately $1.7 million
in the third quarter of 2006, but a decrease in net premiums of approximately
$7.2 million for the nine months ended September 30, 2006 as compared to the
same periods in 2005.
Net investment income increased $1.6 million in the current quarter compared to
the prior-year quarter, and $4.9 million for the nine months ended September 30,
2006 compared to the nine months ended September 30, 2005. 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 $0.5 million for the third quarter of 2006, as
compared to the same period in 2005, and increased by $2.1 million for the nine
months ended September 30, 2006, as compared to the same period in 2005. The
primary source of other revenues in 2006 has been fees from financial
reinsurance treaties.
Loss ratios were 75.1% and 84.3% for the third quarter of 2006 and 2005,
respectively, and 77.4% and 79.1% for the nine months ended September 30, 2006
and September 30, 2005, respectively. The relative decrease in the loss ratio
for the third quarter of 2006 was primarily due to adverse mortality in the New
Zealand, Hong Kong and Taiwan markets in the third quarter of 2005. However, the
loss ratio for the nine month period ending September 30, 2006 is relatively
consistent with the loss ratio for the comparable period in 2005. 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 11.6% for the third quarter of 2006, as compared to 13.9% for the
third quarter of 2005. Policy acquisition costs and other insurance expenses as
a percentage of net premiums were 14.4% for the nine months ended September 30,
2006, as compared to a 16.7% ratio for the nine months ended September 30, 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.
Other operating expenses increased to 6.5% of net premiums in the current
quarter, and 6.2% of net premiums for the nine months ended September 30, 2006,
from 5.3% and 4.8% in the comparable prior-year periods. The timing of premium
flows and the level of costs associated with the entrance into and development
of new markets in the
24
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 investment related
gains and losses. 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, an insignificant
amount of direct insurance operations in Argentina and the results from the
Company's collateral finance facility.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES:
Net premiums $ 468 $ 588 $ 1,485 $ 1,766
Investment income, net of related
expenses 19,167 6,191 37,962 22,226
Investment related gains, net 387 2,435 3,362 19,211
Other revenues 2,673 2,811 4,790 13,904
------- ------- -------- --------
Total revenues 22,695 12,025 47,599 57,107
BENEFITS AND EXPENSES:
Claims and other policy benefits 54 4,072 (977) 33,900
Interest credited 77 163 830 378
Policy acquisition costs and other
insurance expenses (7,432) (8,156) (26,162) (16,564)
Other operating expenses 11,643 6,956 35,044 21,651
Interest expense 15,103 10,052 46,884 29,832
Collateral finance facility expense 13,136 -- 13,413 --
------- ------- -------- --------
Total benefits and expenses 32,581 13,087 69,032 69,197
Loss before income taxes $(9,886) $(1,062) $(21,433) $(12,090)
======= ======= ======== ========
Loss before income taxes increased $8.8 million and $9.3 million for the three
and nine month periods ended September 30, 2006, respectively. These increases
are primarily due to increased interest expense related to a higher level of
debt outstanding and increased operating expenses largely due to additional
expense related to equity based compensation plans. Also contributing to the
increased loss before income taxes is a decrease in investment related gains
offset by reduced claims and other policy benefits. The reduction in claims and
other policy benefits is associated with the reinsurance of Argentine pension
accounts which is currently in runoff. 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. Also contributing to the increase in investment income in 2006 is the
impact of the Company's investment of the net proceeds from its collateral
finance facility in June 2006 which is largely offset by the recognition of
collateral finance facility expense and investment income related to the net
proceeds from the issuance of Junior Subordinated Debentures in December 2005.
25
DISCONTINUED OPERATIONS
The discontinued accident and health division reported a loss, net of taxes, of
$1.5 million for the third quarter of 2006 compared to a loss, net of taxes, of
$5.9 million for the third quarter of 2005. As of September 30, 2006, amounts in
dispute or subject to audit exceed the Company's reserves by approximately $23.7
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, 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 periods
ended September 30, 2006 and 2005 were $490.5 million and $271.2 million,
respectively. Cash flows from operating activities are affected by the timing of
premiums received, claims paid, and working capital changes. The $219.3 million
net increase in operating cash flows for the nine months of 2006 compared to the
same period in 2005 was primarily a result of cash inflows related to premiums
and investment income increasing more than cash outflows related to claims,
acquisition costs, income taxes and other operating expenses. Cash from premiums
and investment income increased $315.3 million and $67.9 million, respectively,
and was offset by higher operating cash outlays of $163.9 million for the
current nine month period. 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 used in investing activities was $1.3 billion and $362.6 million in the
first nine months of 2006 and the comparable prior-year period, respectively.
This change is primarily due to the increase in purchases of fixed maturity
securities related to the investment of proceeds from the Company's collateral
finance facility. Additionally, the sales and purchases of fixed maturity
securities are related to the management of the Company's investment portfolios
and the investment of excess cash generated by operating and financing
activities.
Net cash provided by financing activities was $881.9 million and $83.9 million
in the first nine months of 2006 and 2005, respectively. This change was due to
the proceeds from the Company's collateral finance facility partially offset by
$100.0 million principal payments on debt. Also contributing to the change was
an increase in excess deposits from universal life and other investment type
policies and contracts of $58.7 million.
26
Debt and Preferred Securities
As of September 30, 2006, the Company had $702.8 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 largest is a
syndicated credit facility with an overall capacity of $600.0 million that
expires in September 2010. 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 September 30, 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 L15.0 million credit
facility that expires in May 2007 and an Australian $50.0 million credit
facility that expires in June 2011. The Company's foreign denominated credit
facilities had a combined outstanding balance of $54.2 million as of September
30, 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 6.57%. Interest is expensed on the face amount, or
$225 million, of the Trust Preferred Securities at a rate of 5.75%.
Collateral Finance Facility
On June 28, 2006, RGA's subsidiary, Timberlake Financial, L.L.C. ("Timberlake
Financial"), issued $850.0 million of Series A Floating Rate Insured Notes due
June 2036 in a private placement. The notes were issued to fund the collateral
requirements for statutory reserves required by the U.S. valuation of Life
Policies Model Regulation (commonly referred to as Regulation XXX) on specified
term life insurance policies reinsured by RGA Reinsurance Company. Proceeds from
the notes, along with a $112.7 million direct investment by the Company, have
been deposited into a series of trust accounts that collateralize the notes and
are not available to satisfy the general obligations of the Company. Interest on
the notes will accrue at an annual rate of 1-month LIBOR plus a base rate
margin, payable monthly. The payment of interest and principal on the notes is
insured through a financial guaranty insurance policy with a third party. The
notes represent senior, secured indebtedness of Timberlake Financial with no
recourse to RGA or its other subsidiaries. Timberlake Financial will rely
primarily upon the receipt of interest and principal payments on a surplus note
and dividend payments from its wholly-owned subsidiary, Timberlake Reinsurance
Company II ("Timberlake Re"), a South Carolina captive insurance company, to
make payments of interest and principal on the notes. The ability of Timberlake
Re to make interest and principal payments on the surplus note and dividend
payments to Timberlake Financial is contingent upon South Carolina regulatory
approval and the performance of specified term life insurance policies with
guaranteed level premiums retroceded by RGA's subsidiary, RGA Reinsurance
Company, to Timberlake Re.
In accordance with Financial Accounting Standards Board ("FASB") Interpretation
No. 46(r), "Consolidation of Variable Interest Entities - An Interpretation of
ARB No. 51," Timberlake Financial is considered to be a variable interest entity
and the Company is deemed to hold the primary beneficial interest. As a result,
Timberlake Financial has been consolidated in the Company's condensed financial
statements. The Company's condensed consolidated balance sheets include the
assets of Timberlake Financial recorded as fixed maturity investments and other
invested assets, which consists of restricted cash and cash equivalents, with
the liability for the notes recorded as collateral finance facility. The
Company's condensed consolidated statements of income include the investment
return of Timberlake Financial as investment income and the cost of the facility
is reflected in collateral finance facility expense.
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.
27
The Company's liquidity position (cash and cash equivalents and short-term
investments) was $293.9 million and $255.0 million at September 30, 2006 and
December 31, 2005, respectively. Liquidity needs are determined from valuation
analyses conducted by operational units and are driven by product portfolios.
Periodic 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 securitized lending
obligations within other liabilities. There were $88.6 million of these
agreements outstanding at September 30, 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 $14.4 billion and $11.8
billion at September 30, 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 5.79% in the third quarter of 2006, compared with 5.89% for the
third 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 September 30, 2006,
approximately 97.3% 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 54.7% of fixed maturity securities as of
September 30, 2006 and had an average Standard and Poor's ("S&P") rating of
"A-". The Company owns floating rate securities that represent approximately
11.5% of the total fixed maturity securities at September 30, 2006. These
investments have a higher degree of income variability than the other fixed
income holdings in the portfolio due to the floating rate nature of the interest
payments. The Company holds these investments to match specific floating rate
liabilities primarily reflected in the condensed consolidated balance sheets as
collateral finance facility.
Within the fixed maturity security portfolio, the Company holds approximately
$425.6 million in asset-backed securities at September 30, 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
28
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.
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 recorded $1.1 million in other-than-temporary write-downs on
fixed maturity securities for the nine months ending September 30, 2006. The
Company did not record other-than-temporary write-downs on fixed maturity
securities for the nine months ending September 30, 2005. During the nine months
ended September 30, 2006, the Company sold fixed maturity securities with a fair
value of $657.7 million, which were below amortized cost, at a loss of $23.6
million.
The following table presents the total gross unrealized losses for 1,026 fixed
maturity securities and equity securities as of September 30, 2006, where the
estimated fair value had declined and remained below amortized cost by the
indicated amount (in thousands):
AT SEPTEMBER 30, 2006
-----------------------------
Gross Unrealized
Losses % of Total
---------------- ----------
Less than 20% $63,900 100.0%
20% or more for less than six months -- --
20% or more for six months or greater -- --
------- -----
Total $63,900 100.0%
======= =====
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.
The following tables present the estimated fair values and gross unrealized
losses for the 1,026 fixed maturity securities and equity securities that have
estimated fair values below amortized cost as of September 30, 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.
29
AS OF SEPTEMBER 30, 2006
---------------------------------------------------------------------------
EQUAL TO OR
LESS THAN 12 MONTHS GREATER THAN 12 MONTHS TOTAL
----------------------- ----------------------- -----------------------
Estimated Gross Estimated Gross Estimated Gross
Fair Unrealized Fair Unrealized Fair Unrealized
(in thousands) Value Loss Value Loss Value Loss
---------- ---------- ---------- ---------- ---------- ----------
INVESTMENT GRADE SECURITIES:
COMMERCIAL AND INDUSTRIAL $ 638,069 $11,305 $ 242,806 $ 8,198 $ 880,875 $19,503
PUBLIC UTILITIES 178,693 2,494 97,948 3,932 276,641 6,426
ASSET-BACKED SECURITIES 221,722 836 39,515 1,101 261,237 1,937
CANADIAN AND CANADIAN PROVINCIAL
GOVERNMENTS 18,142 129 14,297 181 32,439 310
MORTGAGE-BACKED SECURITIES 649,432 3,819 593,987 13,883 1,243,419 17,702
FINANCE 508,164 3,991 166,182 5,228 674,346 9,219
U.S. GOVERNMENT AND AGENCIES 11,806 23 6,728 153 18,534 176
STATE AND POLITICAL SUBDIVISIONS 35,727 577 5,469 355 41,196 932
FOREIGN GOVERNMENTS 116,275 1,892 9,988 120 126,263 2,012
---------- ------- ---------- ------- ---------- -------
INVESTMENT GRADE SECURITIES 2,378,030 25,066 1,176,920 33,151 3,554,950 58,217
---------- ------- ---------- ------- ---------- -------
NON-INVESTMENT GRADE SECURITIES:
COMMERCIAL AND INDUSTRIAL 66,572 2,008 24,450 1,071 91,022 3,079
FINANCE 500 7 5,371 67 5,871 74
ASSET-BACKED SECURITIES -- -- -- -- -- --
PUBLIC UTILITIES 17,218 356 -- -- 17,218 356
---------- ------- ---------- ------- ---------- -------
NON-INVESTMENT GRADE SECURITIES 84,290 2,371 29,821 1,138 114,111 3,509
---------- ------- ---------- ------- ---------- -------
TOTAL FIXED MATURITY SECURITIES $2,462,320 $27,437 $1,206,741 $34,289 $3,669,061 $61,726
========== ======= ========== ======= ========== =======
EQUITY SECURITIES $ 51,959 $ 1,635 $ 11,571 $ 539 $ 63,530 $ 2,174
========== ======= ========== ======= ========== =======
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 September
30, 2006. The unrealized losses did not exceed 14.9% on an individual security
basis and are primarily a result of changes in interest rates and credit spreads
and the long-dated maturities of the securities.
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 September 30,
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 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.
30
Funds withheld at interest comprised approximately 27.3% and 27.8% of the
Company's cash and invested assets as of September 30, 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 September 30, 2006 and December 31, 2005,
respectively. Other invested assets include common stock, preferred stocks,
restricted cash and cash equivalents and limited partnership interests. The
Company did not record an other-than-temporary write-down on its investments in
limited partnerships in the third quarter of 2006 or 2005. The Company recorded
other-than-temporary writedowns of $3.1 million and $1.3 million on its
investments in limited partnerships in the nine months ended September 30, 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 1 - 3 4 - 5 After 5
Total 1 Year Years Years Years
-------- ------ ----- ----- --------
Contractual Obligations:
Short-term debt, including interest $ 29.1 $ 29.1 $ -- $ -- $ --
Collateral finance facility, including
interest 1,325.3 49.0 98.0 97.9 1,080.4
Life claims payable 920.8 920.8 -- -- --
Operating leases 31.7 5.8 9.2 6.1 10.6
Limited partnerships 37.5 37.5 -- -- --
Mortgage purchase commitments 37.1 37.1 -- -- --
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.
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 39 such cases of
over-retained policies, for amounts averaging $2.0 million over the Company's
normal retention limit. The largest amount over retained on any one life is
$12.6 million. For other countries, particularly those with higher risk factors
or smaller books of
31
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, 2006, 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 terrorism 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 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 September 30, 2006
from that disclosed in the 2005 Annual Report.
NEW ACCOUNTING STANDARDS
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108
provides guidance on how prior year misstatements should be considered when
quantifying misstatements in
32
current year financial statements for purposes of assessing materiality. SAB 108
requires that a registrant assess the materiality of a current period
misstatement by determining how the current period's balance sheet would be
affected in correcting a misstatement without considering the year(s) in which
the misstatement originated and how the current period's income statement is
misstated, including the reversing effect of prior year misstatements. SAB 108
is effective for fiscal years ending after November 15, 2006. The cumulative
effect of applying SAB 108 may be recorded by adjusting current year beginning
balances of the affected assets and liabilities with a corresponding adjustment
to the current year opening balance in retained earnings if certain criteria are
met. The Company is currently evaluating the impact of SAB 108 and does not
expect that the pronouncement will have a material impact on the Company's
condensed consolidated financial statements.
In September 2006, the FASB issued SFAS 158, "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements
No. 87, 88, 106, and 132(r)" ("SFAS 158"). The pronouncement revises financial
reporting standards for defined benefit pension and other postretirement plans
by requiring the (i) recognition in its statement of financial position of the
funded status of defined benefit plans measured as the difference between the
fair value of plan assets and the benefit obligation, which shall be the
projected benefit obligation for pension plans and the accumulated
postretirement benefit obligation for other postretirement plans; (ii)
recognition as an adjustment to the ending balance of accumulated other
comprehensive income (loss), net of income taxes, those amounts of actuarial
gains and losses, prior service costs and credits, and transition obligations
that have not yet been included in net periodic benefit costs as of the end of
the year of adoption; (iii) measurement of benefit plan assets and obligations
as of the date of the statement of financial position; and (iv) disclosure of
additional information about the effects on the employer's statement of
financial position. SFAS 158 is effective for fiscal years ending after December
15, 2006 with the exception of the requirement to measure plan assets and
benefit obligations as of the date of the employer's statement of financial
position, which is effective for fiscal years after December 15, 2008. The
recognition provisions of SFAS 158 are to be applied as of the end of the year
of adoption which, for the Company, will be based on balances as of December 31,
2006. The Company is currently evaluating the effect of SFAS 158 on the
Company's condensed consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in GAAP and requires enhanced disclosures about fair value
measurements. SFAS 157 does not require any new fair value measurements. The
pronouncement is effective for fiscal years beginning after November 15, 2006.
The guidance in SFAS 157 will be applied prospectively with the exception of:
(i) block discounts of financial instruments; (ii) certain financial and hybrid
instruments measured at initial recognition under SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"); which are to be
applied retrospectively as of the beginning of initial adoption (a limited form
of retrospective application). The Company is currently evaluating the impact of
SFAS 157 and does not expect that the pronouncement will have a material impact
on the Company's condensed consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation ("FIN") No. 48, "Accounting
for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109"
("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, treatment of interest and penalties, and
disclosure of such positions. FIN 48 will be applied prospectively and will be
effective for fiscal years beginning after December 31, 2006. The Company is
currently evaluating the effect, if any, of FIN 48 on the Company's condensed
consolidated financial statements.
Effective January 1, 2006, the Company prospectively adopted SFAS No. 155,
"Accounting for Certain Hybrid Instruments" ("SFAS 155"). SFAS 155 amends SFAS
No. 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
33
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 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, "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 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 was adopted by the Company
during the first quarter of 2006 and will apply the provisions of SFAS 154 when
applicable.
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 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,
34
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 September 30,
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
Subsequent to September 30, 2006 the Company settled a pending arbitration and a
suit filed against one of its ceding companies in which it was joined. These
settlements were for amounts which were substantially reserved by the Company.
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 a threatened arbitration
related to its life reinsurance business. As of October 31, 2006, the parties
involved in these actions have raised claims, or established reserves that may
result in claims, in the amount of $27.7 million, which is $23.8 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 consolidated financial statements accompanying the 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. The Company cannot 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.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously disclosed
in the Company's 2005 Annual Report.
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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
September 30, 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.
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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
November 6, 2006 By: /s/ A. Greig Woodring
--------------------------------------
A. Greig Woodring
President & Chief Executive Officer
(Principal Executive Officer)
November 6, 2006 By: /s/ Jack B. Lay
--------------------------------------
Jack B. Lay
Executive Vice President &
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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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.
38