Business Context and Reporting Period
Reinsurance Group of America, Incorporated (RGA) filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2012. RGA is a global life and health reinsurer with operations in the U.S., Canada, Europe and South Africa, and Asia Pacific. The filing presents results under U.S. GAAP and retrospectively reflects the 2012 adoption of revised deferred policy acquisition cost accounting.
Key Financial Metrics
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Total revenues | $2.376 billion | $2.204 billion | $4.669 billion | $4.486 billion |
| Net premiums | $1.951 billion | $1.789 billion | $3.814 billion | $3.525 billion |
| Income before income taxes | $215.9 million | $187.2 million | $396.7 million | $413.9 million |
| Net income | $141.1 million | $123.9 million | $264.4 million | $272.9 million |
| Diluted EPS | $1.91 | $1.66 | $3.57 | $3.68 |
| Operating cash flow | Not separately presented | Not separately presented | $818.3 million | $537.8 million |
- Second-quarter net margin was approximately 5.9%, compared with 5.6% in the prior-year quarter. Six-month net margin was approximately 5.7%, compared with 6.1% in the prior-year period.
- Net premiums increased 9.1% for the quarter and 8.2% year to date, driven primarily by growth in life reinsurance and new business production.
- Investment income, net of related expenses, was $328.3 million for the quarter and $669.3 million year to date, down 2.7% and 5.5%, respectively.
- Investment-related gains were $23.8 million for the quarter and $67.3 million year to date, compared with $27.4 million and $151.0 million in the comparable 2011 periods.
- Cash and cash equivalents were $957.3 million at June 30, 2012. Reported liquidity, including cash and short-term investments, was approximately $1.007 billion.
- Total assets were $38.344 billion and stockholders’ equity was $6.248 billion at June 30, 2012.
- Long-term debt was $1.415 billion and the collateral finance facility was $651.9 million. The company reported compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Second-quarter pretax income increased $28.7 million, or 15.3%, primarily because of higher premiums across segments and favorable Asia Pacific mortality experience.
- Six-month pretax income decreased $17.3 million, or 4.2%, primarily because of lower investment-related gains and lower investment income, partially offset by premium growth.
- The U.S. segment produced $140.6 million of second-quarter pretax income, up from $114.3 million, but six-month pretax income declined to $233.3 million from $261.8 million.
- Asia Pacific pretax income increased to $23.9 million for the quarter from $4.3 million and to $55.9 million for the six months from $26.3 million, reflecting premium growth and favorable claims experience.
- Canada’s quarterly pretax income declined to $35.0 million from $44.1 million, while six-month income increased to $90.1 million from $74.0 million.
- Europe and South Africa’s quarterly pretax income increased to $19.6 million from $12.5 million, but six-month income declined to $26.2 million from $35.1 million because of unfavorable claims experience.
- A large fixed deferred annuity reinsurance transaction added approximately $5.4 billion to invested assets and required approximately $350 million of capital. The related investment receivable was recorded at June 30 and settled with assets received on July 31 and August 3, 2012.
- The company retrospectively adopted revised deferred acquisition cost guidance. The amendment reduced deferred acquisition costs and prior-period net income and increased the amount of acquisition-related costs expensed as incurred.
- Gross unrealized gains on available-for-sale fixed maturity and equity securities increased to approximately $2.487 billion, while gross unrealized losses declined to approximately $196.3 million.
- The quarterly dividend was subsequently increased in July 2012 to $0.24 per share from $0.18 per share.
Outlook, Commentary, Risks and Unusual Items
- Management stated that current liquidity is sufficient for at least the next 12 months, including scenarios involving early treaty recapture and higher-than-expected death claims. RGA does not rely on short-term funding or commercial paper.
- Management expects sustained low interest rates to pressure investment yields and earnings. Investment yield excluding funds withheld assets and the new investment receivable declined to 5.05% from 5.35% year over year.
- Management stated that reserves are expected to remain sufficient and that no deferred acquisition cost write-down or capital augmentation is expected even if interest rates remain at current levels for five years.
- Changes in the fair value of embedded derivatives materially affected reported results but generally did not affect current cash flows, policyholder crediting rates or underlying treaty spread performance. The combined after-adjustment effect of three categories of embedded derivatives reduced pretax income by approximately $17.9 million for the quarter and $41.7 million year to date versus the prior-year periods.
- Other-than-temporary impairments on fixed maturity and equity securities were $4.0 million for the quarter and $19.7 million year to date, primarily involving structured securities, corporate and foreign securities, and equity securities.
- Investment commitments at June 30 included $186.2 million for limited partnerships, $49.5 million for commercial mortgage loans and $106.0 million for private placements.
- RGA reported no material litigation. Undrawn letters of credit supporting third-party and affiliated reinsurance totaled approximately $543.7 million, including $263.3 million under the $850 million revolving credit facility.
- Key risks include mortality and morbidity volatility, policyholder lapses and recaptures, low interest rates, credit and impairment risk, equity and currency market movements, counterparty and retrocessionaire credit risk, collateral requirements, regulatory changes and catastrophe exposure.
- The company’s catastrophe coverage provides up to $100 million of protection after a $50 million deductible for events involving at least 10 insured deaths from a single occurrence.
Investor Verification Checklist
- Verify the economic substance, asset quality, capital requirements and profitability of the large fixed annuity reinsurance transaction and the subsequent settlement of the $5.407 billion investment receivable.
- Assess the sustainability of premium growth and favorable Asia Pacific claims experience against normal mortality and morbidity volatility.
- Reconcile reported earnings with results excluding fair-value changes in embedded derivatives and related hedging instruments.
- Review investment impairments, unrealized losses, structured-security exposure and the company’s ability and intent to hold securities through recovery.
- Monitor the effect of continued low interest rates on investment yield, annuity liabilities, embedded derivatives and capital.
- Confirm debt covenant compliance, collateral and letter-of-credit capacity, treaty guarantees and the regulatory approval requirements affecting Timberlake Re.
- Evaluate retrocessionaire collectability and the company’s exposure to client recapture, catastrophe claims and counterparty downgrades.