REINSURANCE GROUP OF AMERICA INC quarterly report, Q2 FY2015

Business Context and Reporting Period

Reinsurance Group of America, Incorporated (RGA) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. RGA provides traditional and non-traditional life, health, disability, critical illness, longevity, asset-intensive and financial reinsurance through geographic segments covering the U.S. and Latin America, Canada, EMEA, Asia Pacific, and Corporate and Other.

Effective January 1, 2015, RGA refined its segment presentation by separating traditional and non-traditional businesses in Canada, EMEA and Asia Pacific; prior periods were adjusted for comparability.

Key Financial Metrics

Metric	Three months ended June 30	Six months ended June 30
Net premiums	$2.129 billion, versus $2.183 billion	$4.153 billion, versus $4.284 billion
Total revenues	$2.630 billion, versus $2.833 billion	$5.151 billion, versus $5.490 billion
Income before income taxes	$213.8 million, versus $300.5 million	$397.9 million, versus $500.0 million
Net income	$130.4 million, versus $198.3 million	$255.5 million, versus $335.0 million
Diluted EPS	$1.94, versus $2.84	$3.76, versus $4.75
Net investment income	$450.5 million, versus $410.6 million	$877.4 million, versus $815.0 million
Investment-related gains, net	$(16.2) million, versus $118.5 million	$(8.6) million, versus $203.1 million

Approximate margins were 8.1% pretax and 5.0% net for the quarter, and 7.7% pretax and 5.0% net for the six-month period.

Operating cash flow was $605.7 million for the first six months, down from $907.8 million in the prior-year period.
Cash and cash equivalents were $1.336 billion at June 30, 2015, compared with $1.646 billion at December 31, 2014. Cash and invested assets totaled $40.937 billion, compared with $38.342 billion.
Total assets were $47.460 billion, up from $44.680 billion. Stockholders’ equity declined to $6.483 billion from $7.023 billion, primarily reflecting a $507.8 million after-tax decline in other comprehensive income and share repurchases.
Long-term debt was $2.313 billion, essentially unchanged from $2.314 billion. Collateral finance and securitization notes increased to $926.4 million from $782.7 million.
The company reported no cash borrowings under its $850.0 million revolving credit facility and had $448.1 million of available capacity. It also reported $751.4 million of borrowing capacity through collateralized Federal Home Loan Bank arrangements.
Investment yield, excluding spread-related business, increased to 4.88% for the quarter and 4.83% for the six months, compared with 4.79% and 4.76%, respectively.
Dividends paid were $44.5 million. Share repurchases totaled $262.5 million in the cash flow statement, including 2.79 million shares purchased during the first six months at an average price of $90.85.

Material Changes Versus the Prior Comparable Period

Quarterly and year-to-date pretax income declined 28.9% and 20.4%, respectively, primarily because of unfavorable mortality experience, lower investment-related gains and adverse foreign currency movements.
Net premiums decreased 2.5% for the quarter and 3.1% year to date. Drivers included a large fourth-quarter 2014 retrocession transaction and foreign currency effects, partly offset by new business and growth in existing treaties.
Investment income increased 9.7% for the quarter and 7.7% year to date, supported by a larger average invested asset base and higher investment yield.
Investment-related gains declined sharply because of unfavorable changes in embedded derivatives associated with modified coinsurance and funds-withheld treaties. These changes are largely unrealized and do not affect current cash flows, underlying crediting rates or spread performance.
U.S. and Latin America pretax income decreased to $153.2 million from $189.5 million for the quarter and to $225.5 million from $323.6 million year to date. U.S. Traditional results were pressured by elevated individual mortality and group disability claims.
EMEA pretax income declined to $40.6 million from $61.3 million for the quarter and to $70.7 million from $76.5 million year to date, reflecting claims variability, lower investment-related gains and foreign exchange effects.
Asia Pacific pretax income fell to $2.9 million from $34.9 million for the quarter, primarily due to the absence of prior-year Australian and Japanese treaty fees and unfavorable Australian claims experience. Six-month pretax income increased to $65.7 million from $61.2 million.
RGA completed the acquisition of Aurora National Life Assurance Company on April 1, 2015, for $191.5 million net of cash acquired. The transaction added approximately $3.7 billion of assets and $3.5 billion of liabilities and had no material consolidated income statement impact.
In May 2015, an RGA Barbados subsidiary obtained CAD$200 million of collateral financing through 2020 to support Canadian reinsurance collateral requirements.

Guidance, Outlook, Risks and Unusual Items

No formal earnings or revenue guidance was provided. Management stated that results for the six months are not necessarily indicative of full-year results.
Management expects continued pressure on investment yields from the low-interest-rate environment, although it reported that the capital base and liquidity were adequate for current operating levels.
Management stated that reserves were expected to remain sufficient and that no deferred acquisition cost write-down or capital augmentation was expected over the next five years if interest rates remained at current levels and other factors were unchanged.
RGA reported gross unrealized investment losses of $393.8 million at June 30, 2015, up from $134.9 million at year-end, primarily due to higher interest rates. Gross unrealized gains remained higher at $2.151 billion. Management stated it had no intent or expectation to sell securities with unrealized losses where the issuer’s credit remained acceptable.
Material risks include mortality, morbidity, longevity, lapses and recaptures; interest rates, credit spreads, equity markets and currencies; investment impairments; counterparty and retrocessionaire collectability; collateral and regulatory reserve requirements; credit ratings; litigation; regulatory changes; catastrophe exposure; and operational or information-security failures.
RGA had $147.2 million of undrawn letters of credit in favor of third parties and $1.160 billion of undrawn letters of credit primarily supporting intercompany reinsurance. It also disclosed treaty guarantees of $790.5 million and a maximum potential statutory reserve support obligation of approximately $6.382 billion, although management considered funding under those commitments remote.
Reinsurance ceded receivables increased to $711.5 million from $578.2 million, partly because of a large retrocession transaction. Claims recoverable over 90 days past due increased to $19.6 million from $10.9 million.
The effective tax rate increased to 39.0% for the quarter and 35.8% year to date, partly because of an accrual related to the U.S. Active Financing Exception business extender provision and a loss in Australia.
The company was in compliance with debt covenants. Its agreements require minimum consolidated net worth of $2.8 billion and limit consolidated indebtedness to 35% of indebtedness plus adjusted consolidated equity.
Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting. No material change to previously disclosed risk factors was reported.

Investor Verification Checklist

Verify the sustainability of mortality and disability experience, particularly in U.S. Traditional, EMEA Traditional and Australia.
Separate recurring operating performance from volatile, largely unrealized embedded-derivative gains and losses.
Monitor investment yield, interest-rate sensitivity, unrealized losses, impairments and the concentration of assets in corporate and long-duration fixed-income securities.
Review liquidity available after letters of credit, collateral requirements, policyholder withdrawals, treaty recaptures and potential derivative collateral calls.
Assess the effect of the Aurora acquisition and the CAD$200 million collateral financing on future earnings, capital and cash flows.
Track regulatory changes affecting captives, Regulation XXX and A-XXX reserve financing, certified reinsurer requirements and the availability and cost of collateral.
Evaluate counterparty concentration, including $4.2 billion of funds withheld associated with one client and increased reinsurance ceded receivables.
Confirm the status and pace of the expanded $450.0 million share repurchase authorization and the July 2015 dividend increase to $0.37 per share.