Reinsurance Group of America, Incorporated — 2012 Q3 Form 10-Q
Business context and reporting period
RGA is a global life and health reinsurer serving individual and group life, longevity, disability income, annuity, critical illness and financial reinsurance markets. This unaudited quarterly filing covers the three and nine months ended September 30, 2012, with comparisons to the corresponding 2011 periods.
Operations are reported across the U.S., Canada, Europe and South Africa, Asia Pacific, and Corporate and Other. Results reflect the retrospective adoption of revised deferred policy acquisition cost accounting.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net premiums | $1.913 billion | $1.776 billion | $5.727 billion | $5.301 billion |
| Total revenues | $2.449 billion | $1.995 billion | $7.118 billion | $6.481 billion |
| Income before taxes | $201.5 million | $156.4 million | $598.1 million | $570.3 million |
| Net income | $144.5 million | $134.6 million | $408.9 million | $407.5 million |
| Diluted EPS | $1.95 | $1.81 | $5.52 | $5.49 |
| Net margin | Approximately 5.9% | Approximately 6.7% | Approximately 5.7% | Approximately 6.3% |
| Operating cash flow | Not separately provided | Not separately provided | $1.529 billion | $834.0 million |
Q3 income before taxes increased 28.8%, while nine-month income before taxes increased 4.9%. Net income increased 7.3% in the quarter but was broadly flat for the nine-month period. The effective tax rate was 28.3% in Q3 and 31.6% for the first nine months, compared with 13.9% and 28.6%, respectively, in 2011.
At September 30, 2012, total assets were $39.924 billion, stockholders’ equity was $6.734 billion, and total liabilities were $33.190 billion. Cash and cash equivalents were $1.604 billion, while total cash and invested assets were $33.699 billion. Reported liquidity, including cash, cash equivalents and short-term investments, was $1.695 billion.
Long-term debt was $1.815 billion, up from $1.415 billion at December 31, 2011. The collateral finance facility was $652.0 million. RGA issued $400.0 million of 6.20% fixed-to-floating subordinated debentures due 2042 in August 2012, generating approximately $393.7 million of net proceeds. The company stated that it was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Net premiums increased 7.7% in Q3 and 8.0% for the first nine months, primarily from growth in life reinsurance and new business production.
- Investment income increased 47.9% in Q3 and 9.2% year to date, supported by the larger invested asset base and a large fixed annuity transaction. However, the underlying investment yield declined to 4.98% from 5.29% in Q3 and to 5.03% from 5.31% for the first nine months.
- Investment-related gains were $76.1 million in Q3 versus a $139.6 million loss in the prior-year quarter, and $143.4 million for the first nine months versus $11.4 million in 2011. The improvement was driven largely by favorable changes in embedded derivative values as credit spreads tightened and benchmark interest rates declined.
- A large fixed deferred annuity reinsurance transaction executed in Q2 increased invested assets by approximately $5.4 billion and required approximately $350 million of capital. The transaction materially increased U.S. Asset-Intensive results and balance-sheet scale.
- Asia Pacific reported a $16.5 million pretax loss in Q3 versus $25.6 million of income in the prior-year quarter. Results reflected unfavorable Australian claims experience and a $27.9 million increase in Australian group reinsurance claim liabilities.
- U.S. operations benefited from Asset-Intensive performance, but U.S. Traditional pretax income declined 17.2% in Q3 because of unfavorable mortality and group claims experience.
- The quarterly dividend increased to $0.24 per share from $0.18 per share; dividends declared for the first nine months were $0.60 per share versus $0.42 in 2011.
- The company retrospectively adopted revised deferred acquisition cost guidance, increasing acquisition expense and reducing previously reported 2011 net income by $12.8 million for Q3 and $33.6 million for the first nine months.
Guidance, outlook, commentary, risks and unusual items
No formal quantitative earnings guidance is provided in the filing. Management expects industry consolidation and continued demand for mortality-risk reinsurance to support growth, although at rates below historical levels in some markets. Management believes current liquidity and capital are adequate and sufficient to fund obligations for at least the next 12 months, including scenarios involving early treaty recapture and higher-than-expected death claims.
Management cautioned that sustained low interest rates will pressure investment yields and earnings. The company does not rely on short-term funding or commercial paper and reported no liquidity pressure. It stated that reserves would remain sufficient and that no capital augmentation or deferred acquisition cost write-down would be expected solely from rates remaining at current levels for five years, assuming other factors are unchanged.
- Derivative and embedded derivative fair-value changes can create substantial earnings volatility without affecting current cash flows, policyholder crediting rates or underlying spread performance. The filing identified a $104.8 million favorable pretax year-over-year impact from three categories of embedded derivatives in Q3.
- Claims experience is volatile over short periods. The principal adverse item was Australian group life and disability claims development, including the $27.9 million liability increase.
- The investment portfolio had $21.658 billion of fixed maturity securities at fair value, approximately 95.4% investment grade, and $153.7 million of gross unrealized losses. Other-than-temporary impairments totaled $36.6 million for the first nine months.
- RGA had no sovereign fixed maturity exposure to Europe’s peripheral region, but held $92.7 million of non-sovereign securities and equity exposure from that region at fair value.
- The company had $169.7 million of limited partnership commitments, $62.1 million of commercial mortgage loan commitments, $7.5 million of private placement commitments and $35.8 million of bank loan commitments.
- Treaty guarantees had $669.4 million of supported liabilities and $445.7 million of net exposure after assets held in trust. Guarantees related to borrowed securities totaled $237.5 million.
- Timberlake Re’s surplus was $32.3 million, below its $35.0 million licensing threshold; quarterly regulatory approval for interest payments on the related surplus note had been granted through December 28, 2012.
- Management reported no material litigation and no material change in previously disclosed risk factors. Forward-looking results remain exposed to mortality, morbidity, lapses, recaptures, market values, interest rates, credit spreads, currencies, collateral requirements, counterparty performance, regulation and catastrophes.
Most important facts for investors to verify
- Whether favorable embedded derivative gains and tighter credit spreads are recurring or primarily mark-to-market effects.
- The sustainability of U.S. Asset-Intensive profitability and the performance, capital usage and concentration associated with the large fixed annuity transaction.
- Further claims development in Australia and other markets, including the adequacy of strengthened claim liabilities.
- The effect of continued low interest rates on investment yield, spreads, reserves and capital.
- Debt covenant compliance, rating-sensitive derivative provisions and the company’s ability to access liquidity and collateral facilities.
- Credit performance of structured securities, commercial mortgage-backed securities, mortgage loans and Level 3 assets.
- The regulatory status and funding requirements of Timberlake Re and the collateral finance arrangements.
- Comparability of 2011 results after the retrospective deferred acquisition cost accounting change and the impact of unusual 2011 Canadian tax benefits.