REINSURANCE GROUP OF AMERICA INC annual report, FY2012

Business context and reporting period

Reinsurance Group of America, Incorporated filed its Form 10-K for the fiscal year ended December 31, 2012. The filing reports full-year results; fourth-quarter information is provided only in the unaudited quarterly table. RGA is a global life and health reinsurer offering traditional life, group, health, disability, critical illness, longevity, annuity, asset-intensive, and financial reinsurance. Approximately 66.3% of 2012 net premiums came from the U.S. and Canada. Life reinsurance in force was approximately $2.9 trillion and consolidated assets were $40.4 billion at year-end.

Financial performance and key metrics

Metric	2012	2011	Change
Net premiums	$7,906.6 million	$7,335.7 million	Up 7.8%
Total revenues	$9,840.9 million	$8,829.5 million	Up 11.5%
Investment income, net	$1,436.2 million	$1,281.2 million	Up 12.1%
Investment-related gains, net	$254.1 million	$(36.1) million	Improved by $290.2 million
Income before taxes	$919.2 million	$763.6 million	Up 20.4%
Net income	$631.9 million	$546.0 million	Up 15.7%
Diluted EPS	$8.52	$7.37	Up 15.6%
Operating cash flow	$1,974.5 million	$1,309.5 million	Up $665.0 million
Cash and cash equivalents	$1,259.9 million	$962.9 million	Up $297.0 million
Stockholders’ equity	$6,910.2 million	$5,818.7 million	Up 18.8%

Net income margin was approximately 6.4% of total revenues, compared with approximately 6.2% in 2011. Pretax margin was approximately 9.3%, compared with 8.6% in 2011. The effective tax rate increased to 31.3% from 28.5%, partly because 2011 included a $30.7 million cumulative Canadian tax-rate benefit.

Total cash and invested assets increased to $34.2 billion from $25.9 billion, primarily reflecting growth in the U.S. asset-intensive business.
Fixed maturity securities were $22.3 billion and represented 65.2% of cash and invested assets; approximately 94.2% were investment grade.
Policy liabilities increased to $27.9 billion from $21.1 billion, including interest-sensitive contract liabilities of $13.4 billion versus $8.4 billion.
Long-term debt increased to $1.815 billion from $1.415 billion following issuance of $400 million of 6.20% subordinated debentures due 2042. The average interest rate on long-term debt was 5.99%.
The company had no cash borrowings under its $850 million revolving facility and had $402.9 million of issued but undrawn letters of credit. Management reported compliance with debt covenants.
Quarterly dividend declarations totaled $0.84 per share for 2012, including an increase to $0.24 per share beginning in the third quarter.

Material changes versus the prior comparable period

Growth in net premiums occurred across all operating segments and reflected higher life reinsurance in force. Assumed life reinsurance in force increased to $2,927.6 billion from $2,664.4 billion.
New business production was $426.6 billion, broadly comparable to $428.9 billion in 2011, while Europe & South Africa and Asia Pacific in-force amounts continued to grow.
U.S. income before taxes increased to $636.4 million from $425.6 million, principally because of the asset-intensive sub-segment and favorable embedded-derivative results.
Canada income before taxes rose to $187.0 million from $165.0 million, aided by a $16.2 million reserve decrease for group creditor business and $6.3 million of income from a recapture.
Europe & South Africa income before taxes fell to $73.9 million from $83.1 million because of unfavorable U.K. claims experience, particularly critical illness and mortality.
Asia Pacific income before taxes increased modestly to $45.4 million from $42.2 million, despite a $46.5 million increase in benefit reserves in Australia.
Corporate and Other shifted to a $23.5 million pretax loss from $47.6 million of income. The 2011 period benefited from a $65.6 million gain on repurchase of collateral finance facility securities.
Investment yield, excluding funds withheld and other spread business, declined to 4.98% from 5.28% as low interest rates pressured reinvestment returns.
The company adopted amended accounting guidance for deferred policy acquisition costs retrospectively. At January 1, 2012, the adoption reduced deferred acquisition costs by $470.1 million and stockholders’ equity by $318.4 million.

Guidance, outlook, commentary, risks, and unusual items

The filing does not provide a formal earnings or revenue forecast. Management expects continued demand from mortality-risk outsourcing, capital management, industry consolidation, international expansion, and asset-intensive products. It also expects low interest rates to continue pressuring investment yields. Management stated that reserves and capital were expected to remain adequate even if interest rates stayed at then-current levels for five years, assuming other factors remained constant.

A large fixed deferred annuity transaction in the second quarter increased invested assets by approximately $5.4 billion and required approximately $350 million of capital. It materially increased asset-intensive revenues and liabilities.
Investment-related earnings were materially affected by changes in credit spreads, interest rates, equity markets, hedging results, and fair values of embedded derivatives. These changes were largely unrealized and did not directly affect current cash flows or underlying treaty spread performance.
RGA remains exposed to mortality, morbidity, longevity, lapse, recapture, policyholder behavior, interest-rate, equity-market, foreign-currency, investment-credit, counterparty, collateral, and regulatory risks.
Approximately $341.7 billion of gross assumed in-force business was subject to treaties allowing recapture if specified financial condition or rating thresholds were not maintained.
Collateral and trust arrangements were significant: $2.14 billion of securities supported certain RGA subsidiaries, $7.55 billion supported third-party treaties, and $909.2 million supported the Timberlake collateral facility.
Timberlake Re remained below its $35 million licensing-order capital and surplus requirement, with year-end surplus of $33.0 million. Dividend and interest payments required regulatory approval.
RGA had a maximum potential $560 million obligation to provide statutory reserve support to a third party through 2035, although management considered funding requirements remote at year-end.
There was no material litigation, and management and the independent auditor concluded that internal control over financial reporting was effective. The independent auditor issued an unqualified opinion.
Subsequent events included a January 2013 repurchase of $160 million face amount of Timberlake notes, expected to produce a $46.5 million pretax gain in the first quarter of 2013, and authorization of a new $200 million common-stock repurchase program.

Most important facts for an investor to verify

How much of 2012 earnings growth reflects recurring underwriting and investment income versus volatile embedded-derivative and market-related gains.
The sustainability of the large U.S. asset-intensive annuity transaction, including spread income, lapse behavior, concentration with one client, and required capital.
Future investment yields and spread compression under a prolonged low-interest-rate environment.
Actual mortality, morbidity, disability, critical illness, and lapse experience, particularly in the U.K. and Australia.
Availability and cost of collateral for Regulation XXX and other statutory reserve requirements, including the status of Timberlake Re.
Potential liquidity effects from treaty recaptures, ratings downgrades, collateral calls, guarantees, and regulatory dividend restrictions.
Credit quality, valuation assumptions, and impairment risk within the expanded fixed maturity, mortgage loan, structured security, and Level 3 investment portfolios.
The financial impact of the retrospective deferred acquisition cost accounting change and the expected effect of subsequent insurance-accounting guidance on 2013 results.