REINSURANCE GROUP OF AMERICA INC quarterly report, Q3 FY2015

Reinsurance Group of America, Incorporated — Q3 2015 Form 10-Q

Reporting period: Quarterly and year-to-date periods ended September 30, 2015; comparative periods ended September 30, 2014. Financial statements are unaudited. RGA provides traditional and non-traditional life, health, disability, annuity, longevity and financial reinsurance globally.

Financial Overview

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Net premiums	$2.089 billion	$2.168 billion	$6.242 billion	$6.452 billion
Total revenues	$2.439 billion	$2.717 billion	$7.590 billion	$8.207 billion
Income before taxes	$140.1 million	$231.8 million	$538.1 million	$731.8 million
Net income	$83.5 million	$158.0 million	$339.0 million	$493.0 million
Diluted EPS	$1.25	$2.28	$5.01	$7.03
Net income margin	3.4%	5.8%	4.5%	6.0%
Net cash from operations	—	—	$878.5 million	$1.238 billion

Margins: Pretax margin was approximately 5.7% in Q3 2015 versus 8.5% in Q3 2014, and 7.1% for the first nine months versus 8.9% in the prior-year period.

Investment income, net of related expenses, was $389.6 million in Q3 and $1.267 billion for the first nine months. The nine-month amount increased modestly year over year, despite lower yields, due primarily to a larger invested-asset base and investment prepayments.
Investment-related losses were $111.3 million in Q3 and $119.9 million for the first nine months, compared with gains of $22.3 million and $225.4 million, respectively, in the comparable periods.
Income taxes were $56.6 million in Q3 and $199.0 million for the first nine months. Effective tax rates were 40.4% and 37.0%, compared with 31.8% and 32.6% in the prior-year periods.

Balance Sheet, Debt and Liquidity

Total assets were $47.606 billion at September 30, 2015, up from $44.680 billion at December 31, 2014. Total investments were $38.947 billion and cash and cash equivalents were $1.748 billion.
Stockholders’ equity was $6.241 billion, down from $7.023 billion at year-end, primarily reflecting a $750.7 million decline in accumulated other comprehensive income and $333.4 million of treasury-stock purchases.
Long-term debt was $2.313 billion and collateral finance and securitization notes were $914.5 million. RGA reported compliance with its debt covenants.
Liquidity, defined by the company as cash and cash equivalents plus short-term investments, was $1.806 billion at September 30, 2015. The revolving credit facility had $552.1 million of availability, and the company reported $958.7 million of potential collateralized borrowing capacity from the Federal Home Loan Bank.
Management stated that liquidity was sufficient for at least the next 12 months, including under scenarios involving early treaty recapture and higher-than-expected death claims. No cash borrowings were outstanding under the $850 million revolving credit facility; $297.9 million of letters of credit had been issued under it.

Material Changes Versus the Prior Comparable Period

Q3 income before taxes declined 39.5%, and nine-month income before taxes declined 26.5%. Net income declined 47.1% in Q3 and 31.2% for the first nine months.
Net premiums decreased 3.6% in Q3 and 3.3% year to date, mainly because of a large fourth-quarter 2014 retrocession transaction and unfavorable foreign-currency movements. New business partially offset these effects.
Results were adversely affected by unfavorable mortality experience, particularly in the U.S. and Latin America Traditional segment, including elevated claims in individual life and group disability business. The U.S. Traditional loss ratio increased to 91.2% in Q3 from 87.9% and to 91.1% for the first nine months from 88.7%.
Foreign-currency fluctuations reduced pretax income by approximately $14.4 million in Q3 and $35.9 million for the first nine months.
Changes in fair values of embedded derivatives, particularly those related to variable annuity guarantees and modified coinsurance or funds-withheld treaties, materially reduced earnings. Management characterized these effects as largely unrealized and not affecting current cash flows, policyholder crediting rates or underlying spread performance.
Gross unrealized losses on fixed maturity and equity securities increased to $452.1 million from $134.9 million at December 31, 2014. Other-than-temporary impairments on fixed maturity securities were $29.8 million for the first nine months, versus $1.4 million in the prior-year period.
In April 2015, RGA acquired Aurora National Life Assurance Company for $191.5 million net of cash acquired. The acquisition added approximately $3.7 billion of assets and $3.5 billion of liabilities and had no material consolidated impact, according to the filing.
RGA repurchased 3.574 million shares for $324.3 million during the first nine months and had $125.7 million remaining under its $450 million authorization at September 30, 2015. Dividends paid were $69.1 million.

Segments and Outlook

U.S. and Latin America pretax income decreased to $91.9 million in Q3 from $155.3 million and to $317.4 million for the first nine months from $478.9 million, driven by mortality, derivative valuation changes, currency and the prior-year retrocession transaction.
Canada pretax income increased to $37.3 million in Q3 from $25.0 million and to $90.0 million for the first nine months from $80.1 million, primarily due to favorable mortality and new non-traditional transaction fees, partly offset by a weaker Canadian dollar.
EMEA pretax income was essentially unchanged in Q3 at $45.1 million and declined to $115.9 million for the first nine months from $121.7 million. Currency effects and normalized claims experience offset growth in longevity business.
Asia Pacific pretax income declined to $16.7 million in Q3 from $20.4 million but increased slightly to $82.4 million for the first nine months from $81.7 million. Q3 results reflected higher Australian disability claims, operating expenses and currency effects.
Management expects low U.S. and Canadian interest rates to continue pressuring investment yields. The nine-month investment yield, excluding spread-related business, was 4.77% versus 4.78% in the prior-year period.
The filing does not provide formal earnings or revenue guidance. Management stated that industry consolidation, regulatory change and continued demand for reinsurance should provide growth opportunities, although growth may be slower in some markets.

Risks, Contingencies and Unusual Items

Key risks include mortality, morbidity, longevity, lapses, treaty recapture, investment impairment, interest rates, credit spreads, equity markets, foreign exchange, counterparty defaults, collateral requirements, regulatory changes and litigation.
RGA had $146.2 million of undrawn third-party letters of credit and $1.105 billion of undrawn affiliate-related letters of credit outstanding at September 30, 2015.
Maximum potential obligations under statutory reserve-support commitments totaled approximately $6.382 billion through 2036; management considered funding events remote at the reporting date.
Funds withheld at interest totaled $5.675 billion, with approximately $4.1 billion associated with one client, creating concentration and counterparty exposure.
Reinsurance ceded receivables were $661.2 million, including $211.4 million of claims recoverable; $11.7 million was more than 90 days past due.
On October 1, 2015, after quarter-end, RGA completed the acquisition of the PGGM Netherlands life insurance portfolio. Approximately $416.8 million of assets and $402.3 million of liabilities were transferred; $350.6 million of assets and a corresponding liability had already been recorded before the acquisition date.
Management identified significant judgment in reserves, deferred acquisition costs, investment impairments, embedded-derivative valuations and income taxes. Disclosure controls and procedures were reported effective, with no material change in internal control over financial reporting.

Investor Verification Checklist

Verify whether elevated U.S. mortality and disability claims are temporary volatility or indicate deterioration in older issue-age blocks.
Reconcile GAAP earnings with the impact of embedded-derivative fair-value changes and assess sensitivity to interest rates, credit spreads, equity markets and volatility.
Review investment impairment trends, unrealized losses, below-investment-grade exposure and the concentration of corporate securities.
Assess liquidity, collateral and statutory-capital requirements, including letters of credit, reserve-support commitments and potential rating-triggered derivative settlements.
Monitor the Aurora integration and the post-quarter-end PGGM acquisition, including their effects on capital, earnings and segment mix.
Evaluate the sustainability of share repurchases and dividends against operating cash flow, debt maturities and capital needs.