Business Context and Reporting Period
Company: Reinsurance Group of America, Incorporated (RGA)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: RGA is a life reinsurance holding company. As of June 30, 2008, MetLife, Inc. owned approximately 51.7% of RGA's outstanding common stock. On June 2, 2008, MetLife and RGA announced a proposed transaction for MetLife to dispose of its majority interest, subject to shareholder and regulatory approval.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2008 | Six Months Ended June 30, 2007 |
|---|---|---|
| Net Premiums | $2,656.6 million | $2,333.1 million |
| Total Revenues | $3,002.9 million | $2,843.4 million |
| Net Income | $142.2 million | $153.7 million |
| Income from Continuing Operations | $147.4 million | $156.0 million |
| Diluted EPS (Continuing Ops) | $2.30 | $2.43 |
| Total Assets | $22,410.2 million | $21,598.0 million |
| Total Investments | $16,806.6 million | $16,397.7 million |
| Cash and Cash Equivalents | $362.7 million | $404.4 million |
| Long-term Debt | $926.1 million | $896.1 million |
| Stockholders' Equity | $3,061.4 million | $3,189.8 million |
Investment Yield: The average yield on investments (excluding funds withheld) increased to 6.06% for the six months ended June 30, 2008, compared to 5.92% in the prior year period.
Material Changes vs. Prior Period
- Revenue Growth: Net premiums increased 13.9% year-over-year, driven by growth in life reinsurance in force (increasing to $2.2 trillion) and favorable foreign currency fluctuations.
- Profitability Decline: Net income decreased 7.5% year-over-year. Income from continuing operations before taxes decreased 6.3% primarily due to unfavorable mortality experience in the U.S. and Europe & South Africa segments.
- Investment Losses: Investment-related losses, net, increased significantly by $142.5 million year-over-year. This was largely driven by a $155.7 million unrealized loss related to changes in the value of embedded derivatives (Issue B36) due to widening credit spreads and changes in risk-free rates.
- Cash Flow: Net cash provided by operating activities decreased $149.2 million to $366.3 million, primarily due to higher cash outflows for claims and acquisition costs.
Guidance, Outlook, and Risks
Management Commentary:
- Embedded Derivatives: Management notes that fluctuations in embedded derivatives (related to equity-indexed annuities and Issue B36) do not affect current cash flows or spread performance. They expect the cumulative effect of these accounting adjustments to be immaterial over the life of the treaties.
- Mortality Experience: The U.S. Traditional segment experienced unfavorable mortality in the first quarter of 2008 (approx. $50 million higher than expected), which management views as normal volatility inherent in the business.
- MetLife Transaction: The proposed divestiture by MetLife could be completed as early as the third quarter of 2008.
Risks and Contingencies:
- Subprime Exposure: RGA holds approximately $256.8 million in amortized cost of securities with subprime mortgage exposure. Management believes the portfolio is high quality (weighted average S&P rating of "AA-") and does not expect material losses, though fair values have declined.
- Unrealized Losses: As of June 30, 2008, 1,618 securities were in an unrealized loss position totaling $486.7 million. 95.2% of these were investment-grade, and 67.0% were less than 20% below cost. Management does not consider these other-than-temporary impaired.
- Legal Proceedings: A ceding company has raised a claim of $4.9 million related to life reinsurance; RGA has not accrued this amount and believes it has substantial defenses.
- Ownership Change: A divestiture by MetLife increases the risk of an "ownership change" under Section 382 of the Internal Revenue Code, which could limit the use of net operating loss (NOL) carryforwards.
Investor Verification Checklist
- MetLife Divestiture Status: Verify the progress of the proposed transaction for MetLife to dispose of its majority stake and potential regulatory hurdles.
- Embedded Derivative Volatility: Monitor the impact of widening credit spreads and interest rate changes on the valuation of embedded derivatives, which caused significant non-cash losses in the first half of 2008.
- Subprime Portfolio Performance: Track the actual default rates and fair value recovery of the $256.8 million subprime exposure to confirm management's assessment of "no material losses."
- Mortality Trends: Review subsequent quarter results to determine if the unfavorable mortality experience in Q1 2008 was an isolated event or a trend.
- Section 382 Limitations: Assess the potential impact of an ownership change on the utilization of RGA's significant net operating loss carryforwards (approx. $932 million deferred tax asset).