美國再保險集團 (RGA) 2007 Q3 法說會逐字稿

Good day and welcome to the Reinsurance Group of America third quarter conference call.

Today's call is being recorded.

At this time, I would like to introduce the President and Chief Executive Officer, Mr.

Greig Woodring, and Senior (sic) Vice President and Chief Financial Officer, Mr.

Jack Lay.

Please go ahead, Mr.

Lay.

Okay, thank you, good morning.

Thanks to everyone for joining us for the call this morning.

I will turn the call over to Greig Woodring, our Chief Executive Officer, in just a minute.

Dave Atkinson, our COO, is also with us this morning for the call.

Greig will comment on the results we released yesterday and then we will respond to any questions from participants.

As a reminder, during the call, we plan to make certain statements and discuss certain subjects that will contain forward-looking information, including, among others, statements relating to projections of revenue or earnings and future financial performance and growth potential of RGA and its subsidiaries.

You're cautioned that actual results could differ materially from expected results.

A list of important factors that could cause those actual results to differ from expected results is included in the earnings release we issued yesterday.

In addition, during the course of the call, we'll make comments about our results based upon operating income both on a pre-tax and after-tax basis.

Under SEC regulations, operating income is considered a non-GAAP financial measure.

We believe this measure better reflects the ongoing profitability and underlying trends of our continuing operations.

Please refer to the tables in our press release for more information on this measure and reconciliations of operating income to net income for our various business segments.

With that, I will turn the call over to Greig for his comments on the third quarter.

Good morning.

Thank you for taking the time for this call.

Like the first two quarters of the year, overall results were strong in the third quarter.

On a consolidated basis, operating income increased 28% to $95.6 million from $74.7 million.

On a per-share basis, our reported operating income for the quarter increased 26% to $1.49 per share, a record level.

Reported net income for the quarter totaled $76.5 million, or $1.19 per diluted share, versus $74 million and $1.17 per share last year.

The net income was adversely affected by a $53 million pre-tax decline in the fair value of embedded derivatives associated with our funds withheld treaties due to the impact of credit spread widening on the underlying investment portfolios held by our seating companies.

To remind you, this is a non-cash item and it does not affect the cash flows of the underlying treaties and can be viewed similarly to a FAS 115 mark-to-market adjustment.

The $53 million decline is substantially offset by additional DAC amortization of $39.2 million.

We exclude the net impact of these embedded derivatives revaluations each quarter from our calculation of operating earnings.

Net income also includes $9.1 million in [net] investment-related losses due primarily to security sales to reposition certain portfolios.

Additionally, we impaired one Sallie Mae holding by approximately $2.7 million based on its current trading value and our intent to sell that security.

Despite the recent market turbulence caused by the sub-prime mortgage crisis, our investment portfolio continues to perform very well.

Our total portfolio remains 97% investment-grade, our ABS sub-prime mortgage exposure totals approximately $270 million in face value with over 85% rated either AA or AAA.

In aggregate, the market value to book value is approximately 94%.

While there were nearly 1900 negative rating actions in the sector in recent months, our holdings were not affected, and in fact we experienced positive rating actions on three of our holdings.

As we indicated in our second quarter 10-Q, we do not expect any significant losses in this portfolio.

Net premiums totaled $1.2 billion, about 14% over last year.

The year-to-date rate of increase is 13% as reported and 11% when you exclude foreign currency translation.

Net investment income was $190.5 million versus $183.4 million last year.

Yield on our general account portfolio is basically flat.

Turning in turn to our operating segments, first in the U.S., pretax operating income totaled $89.9 million compared with $84.9 million last year.

Claims levels were within an expected range given the size of our book of business and statistical norms.

The mix of business between YRT and coinsurance can also influence this ratio as YRT business while the higher claim ratio as a percent of premium but little to net expenses in the form of allowances.

Premiums increased 7% for the quarter and were up 8% for the year at the bottom of the guidance we issued at beginning of the year.

Our U.S.

asset-intensive business contributed $4.8 million in pre-tax operating income to the quarter, down from $5.6 million last year.

The decline is the result of approximately $5.5 million of capital losses in the funds withheld portfolios.

Under GAAP accounting, those losses get reflected in net investment income.

Those losses were done to achieve better asset liability matching.

Also, net investment income is down significantly from last year due to the fluctuation in values associated with the equity options that support the crediting rates under the large block of equity index annuities that we reinsure.

You will see a similar decline in the interest credited expense line item.

Despite this volatility and the associated vagaries, we continue to make our targeted spreads on our annuity business.

Additionally, we recently executed our first GMXB treaty.

This is a product segment that we have followed for years but had avoided.

However, we now believe that product designs and the pricing have significantly improved to the point where the risks can be appropriately priced and can be appropriately hedged and can be reinsured.

Experience during the quarter under this new treaty was good.

Turning to Canada, we had another very strong quarter helped further by a strong Canadian dollar.

Pre-tax operating income totaled $20.3 million, up significantly from $12.1 million.

The stronger Canadian dollar contributed approximately $1.9 million to the result.

Mortality experience was quite favorable as it was in the second quarter and premium flow was also strong, up 20% in U.S.

dollars and 12% in Canadian dollars.

Through three quarters, results have been very good and we remain in a major player in the market.

Regarding international operations, Asia-Pacific reported pre-tax operating income of $17.6 million.

That level of earnings is below the prior year.

However, the prior year was an unusually strong one, making for a difficult comparison this quarter.

The segment-wide mortality was slightly better than expected, as was the case in the second quarter.

Results in Australia, our largest market in the region, were particularly good.

Premium flow was up a very strong 35% to $240.5 million.

Growth in South Korea was particularly strong.

However, we experienced some quarterly choppiness in the client reporting there.

On a year-to-date basis, premiums have increased 29% with about 6% of that increase attributable to foreign currencies.

Our other international operation, Europe and South Africa, experienced higher than expected claim levels in South Africa, and to a lesser extent, also in the UK.

Pre-tax operating income totaled $12.6 million, up from $8.9 million in 2006 with about $1.5 million of the current quarter result coming from stronger foreign currencies.

The prior-year quarter reflected unfavorable mortality.

On a year-to-date basis, segment-wide mortality is in line with our expectations.

Net premiums increased 17% on a U.S.

dollar basis and 9% on an original currency basis.

A strong British pound and euro helped the reported number.

We are beginning to see some let-up in the competitive pricing environment in the UK.

Turning to the Corporate and Other segment, as indicated in the press release, the quarter's results benefited about $0.10 per share from the reversal of interest expense associated with FIN 48 and various tax positions.

The amount reversed in this quarter is approximately equal to the expense we recorded in the first two quarters of the year and is the result of the favorable resolution of various tax positions.

Our effective tax rate was also lower this quarter as a result of this and various adjustments to our tax accrual.

We would expect the tax rate for the fourth quarter to return to a more typical 34% to 35% rate.

In conclusion, we have reported a string of strong quarters, a reflection of our large base of profitable in-force business, well over $2 trillion, and an increasing geographical diversification of our earnings.

We enjoy a position of strength within the market that has seen other competitors stumble or be sold.

We are well positioned to take advantage of significant growth opportunities in international markets and we are increasingly looking at new opportunities in the North American market.

We appreciate your support and we'll be happy to take any questions you may have now.

(OPERATOR INSTRUCTIONS).

Eric Berg, Lehman Brothers.

My first question relates to Canada.

Your premium growth in the September quarter, while not as strong as the year-to-date number, 12% versus 18%, was nonetheless, to me at least, surprisingly strong, given that Canada -- I think most commentators view it as a mature and sort of stable and slow-growing market.

What is going on there that would permit such, if you agree with my premise, surprisingly rapid premium growth?

And how should we think about the rate at which this business will expand from here?

That is my first question, I'll have one follow-up.

Eric, we've been a little bit surprised at the strength of the premium growth in the last couple of years in Canada.

We expected good results, but they have exceeded a bit our expectations.

It's really due to perhaps some market share increases slightly, some growth in the overall market that's a little stronger than we expected.

Even though, as you say, it is a mature market, it does seem that there has been some growth in the overall marketplace in the last couple of years.

We are still feeling the effects of the removal of ERC from the market a number of years ago where business has then been reapportioned to the three reinsurers that remain.

The Canadian market still shows a very strong session rate, and that has not changed.

We do expect that in the future, the pressures will be in the direction of decreasing that session rate similar to what happened in the US.

We cannot predict when or how, but we do expect that this growth in Canada will settle down in future years somewhat.

My second and final question relates to your reinsurance of the stock market guarantees which you indicated you did for the first time in the September quarter.

Was it a GMWB that you reinsured?

And what specifically happened in the marketplace that got you comfortable five years after the first GMWB came on in the marketplace?

It's my sense, Greig, that for the longest of time, you were -- made somewhat anxious personally by this business and were -- I'm just surprised that you went forward, given that you've indicated in the past that this type of activity made you uneasy.

At least, that is my sense, in the past.

Eric, we looked at this business a long time ago, back when there was just GMDB, and what direct writers wanted to reinsure was all of the risk simply on the rider for [a 8-basis] point price.

Pricing has changed a little bit, as have the techniques developed to manage the business.

The direct riders without the reinsurance support have had to develop the programs, they've had to price the riders appropriately.

We have taken a long look at this business.

We entered this treaty after something approaching nine months of study and modeling on this particular transaction.

We will take measured steps forward here and see how it goes.

We are very happy with the transaction that we did.

There are a number of other reinsurers that have begun to look at this space as well.

It's not just RGA, but I think the reinsurance world, at least in part, has come to the conclusion that this part of the market is now priced appropriately and can be controlled appropriately.

And just to clarify, now that this risk is on your books, it has been shifted from the seated to RGA.

Are you engaging in a hedge program?

Yes we are, of course.

Steven Schwartz, Raymond James.

First, I just want to follow-up on -- which benefit are you guys going to be reinsuring?

Well, we will reinsure all of the benefits that they have.

We are quota-sharing the base plan and all of the benefits.

We are taking something like less than a 20% quota share.

Okay, but depending upon -- not getting into the product that's being reinsured, but this could be AB, IB, WB, whatever it is.

The predominant benefit will be WB, with some DB as well.

Okay.

And then a quick question on the asset-intensive business.

There were $5.5 million in losses in the funds withheld portfolio.

Was that in the quarter, or was there some differences?

Was that directly offset in the interest expense line?

Was that more than offset?

Was that less than offset?

It sounded from what you said like it was less than offset, at least temporarily.

It was less than offset.

That's a unique part about our business under these sort of funds withheld.

Transactions, capital losses under GAAP accounting appear as operating losses to us, and vice versa.

And then just quickly on London, I was kind of interested that you mentioned that you thought that the competitive pressures there were easing a bit.

It was my understanding that the London market is kind of winner takes all where you have maybe just one company on a treaty and then that turns over, which is why the competitive dynamics have been what it is.

Is that changing, that practice, is that changing, or is it beginning to do what we do in the states where you have to whole number of reinsurers under contract?

Steve, I don't notice that that's changing noticeably.

What companies tend to do is they reinsure each treaty separately or each part of a treaty separately, but it is winner take all.

My comments probably shouldn't be overinterpreted, but we have been a little bit more successful with winning some pieces of business in the UK and are seeing that we should probably expect a resumption of some growth in the UK going forward.

Andrew Kligerman, UBS.

A couple of questions.

Just quickly on a GMWB, [GMBB] risks, could you give a sense of how much in deposits that is going to represent, and how big an appetite do you have for that product area over the next year or so?

Andrew, I'm not sure how much in the way of deposits we will ultimately get on this, but I would expect that we might get about $1 billion a year, something in that ballpark, give or take a little bit of breathing room because I'm doing that off the top of my head.

Because of our big mortality book, the WB benefit in particular has a lot of negative correlations with other risks we have on the books.

That's very attractive in some ways.

We don't want to become an annuity company, but we can take quite a bit of that business before we run into a situation where we have too much longevity risk, if you will.

And then with respect to a line discontinued operations, loss from discontinued accident and health operations net of the income taxes, there is a $4.3 million loss.

Could you give a little the color around that?

Yes, Andrew.

The reason that's a little bit bigger than it has been, and we probably should have mentioned that earlier in the discussion of the results, is that we did commute one of the treaties that was underlying that business.

If you took that business, about half of the reserves come from one source and a little over half of that amount was commuted during the quarter.

So, somewhere around a quarter, maybe a little bit more of our total reserves that are remaining in that book of business was commuted, so it should show no future losses from that piece.

So you're sort of advancing all future years' and future quarters' earnings results into this quarter for that piece.

Thanks.

What would be a good sort of run rate going forward?

Less than $1 million a quarter, or any thoughts on that?

Andrew, you're not far off there.

I think $1 million to $2 million would be a (inaudible).

Unfortunately, it's not consistent, it's a little choppy and we'll sustain smaller numbers than that in some quarters.

And then, if we have any [vent], for instance, in arbitration or commutation, as Greig suggested, then that could accelerate some of that loss a little bit.

But that portfolio has run down considerably.

It's at a point where, even when we have a situation like we had in the third quarter where we had a fairly major commutation, it was about $25 million in reserves, it really does have an insignificant impact on the bottom line.

And then the last question, in the press release, and I think even on the call, you had mentioned that the Asia claims were favorable.

And correct me if I'm doing it the wrong way, but as a percentage of premium, it was about 82%-plus, and in the second quarter it was 76%, last year it was 76%.

So maybe just help me understand why it was favorable and to what degree it was favorable in Asia and whether I was looking at it the right way.

Yes, it's certainly a fair question, and your numbers are right.

I will remind you, you almost have to look at the various underwriting and policy expenses at the same time and kind of combine those into, more broadly speaking, a loss rate of sorts.

I think if you combined all of that, you would be a little less than 92%, which is --

Yes, the amortization ratio was pretty low, you know, definitely.

That's right, and you really have to look at those in unison.

We don't want to oversell that.

It wasn't like it was we had a tremendous pickup, but all things considered, it was positive.

Jimmy Bhullar, J.P.

Morgan.

I just have a couple of questions.

The first one on your outlook for premium growth in the U.S.

business, I think your had said initially your target for '07 was 9%.

If you still believe that is achievable, given the weakness in the third quarter.

And then secondly, just a comment on market conditions in the U.S.

business.

What do you expect -- recession rates have been coming down the last few years.

Do you see that stabilizing, or do you expect further declines?

Jimmy, the guidance we gave at the beginning of the year was 8% to 10%, and you've sort of centered it at 9%, which would have been our point estimate I guess.

And as we commented here, we're at the low end of that.

But we'll take a good look at this as we sort of polish up our outlook for next year and the next quarter, but it is certainly trending down a bit.

In terms of market conditions in the U.S., we feel the pricing environment is pretty stable still, that we are writing -- the run rate, if you ignore sort of reporting fluctuations, is pretty consistent this year and last year for RGA.

And that we do expect the market maybe to go down a bit this year.

We've heard estimates in the sort of 5% range, but we have no way of knowing really until we see all the numbers roll up at the end of the year.

But it wouldn't surprise us if the market drifts downward a little bit more this year.

And also, just following up on your realized losses, the amount that you consider portfolio repositioning, do you expect a benefit on the yield from that going forward, or is that more just adjusting your portfolio in response to a previous asset liability mismatch?

It's as much duration as anything.

Any impact going forward on an effective yield would be insignificant.

I wouldn't read anything into that.

Jeff Schuman, KBW.

Greig, I was wondering if we could come back a little to your entry into the GMWB and GMDB market and get a little bit better understanding of what kind of the generic appeal of that market is to reinsurers like you.

If you think about your traditional mortality risk business, it's a pretty obvious strategic basis for that business to exist.

I mean, you can pool insurance risk at a very high level and potentially have much lower cost of capacity than your clients in some cases because of the pooling mechanism.

But when we think about these other benefits, this is more about market risk which can't be necessarily diversified in the same way.

Is your proposition based on the idea that you do have an enormous sort of co-variance benefit that can reduce your cost of capacity, or is it that you can get better scale and mass in terms intellectual expertise?

What is your core proposition in your?

First of all, the motivation on the part of the seating company, Jeff, is that they are writing a lot of this business and that they are overflowing with the risks associated with this sort of business.

On the other hand, we do have a big covariance bucket and very little -- almost -- well, none of this sort of risk to begin with.

So there's sort of a natural basis for a reinsurance agreement to lay off some of that business.

There is a lot of discussion in the marketplace between us and other reinsurers of these sorts of transactions.

There is a lot of appetite for variable annuity reinsurance right now for those reasons.

Companies simply have too much of it on their books.

Some other reinsurers like RGA have a lot of capacity available because we have none of it on our books.

And while like I said we don't want to become an annuity reinsurer, we will take the opportunity to, at the right price, reinsure some of this business.

Joan Zief, Goldman, Sachs.

I just wanted to know if you were particularly comfortable with the way the equity hedges worked this last quarter.

Were they as effective as you had expected?

And did you take into account as you took on -- as you're taking on this risk on the annuity side, did you take into account that you might have higher costs of hedging going forward?

Yes to both of those.

The hedges work very well.

The whole treaty worked very well and we do expect that costs going forward might be more.

Do you know -- would you wager a guess as to how much more?

No, I wouldn't.

I wouldn't do that, but I think that we have done a lot of modeling of this business.

The people who are working on this have built a fair amount of expertise in this area and it's all rolled up into the pricing that we have done.

(OPERATOR INSTRUCTIONS) Eric Berg, Lehman Brothers.

Would it be correct to, just in terms of thinking of RGA at a high-level, to say that as we think of the sources of growth from here, that in order to achieve what I believe is -- I don't if it's right to call it your target, but certainly what has been your signature, which is high single-digit, low double-digit earnings growth, and low double-digit returns from here, that we really need to focus on the international businesses simply because growth in the U.S.

is settling down in the, as you said, the mid to maybe, 6%, 7% area, and that in order to achieve this higher level of growth that if not your target has certainly been as I say your signature, then it has really got to come from Asia and Europe?

Is that how we should think of your company from here?

Well, that is certainly true, Eric, that the growth from the international segments of our businesses is much stronger and projected to be much stronger than the core North American growth because of the opportunities that exist there, first of all.

In Asia, insurance is a growing business at a very rapid clip.

In Europe, we have not penetrated much of that market yet, and we have a long way to go there.

So overall, our growth rates in those two segments should be far eclipsing our North American segments.

(OPERATOR INSTRUCTIONS).

We have no further questions at this time.

I will turn the call back over to our speakers for any closing comments.

Okay, thanks to everyone for joining us this morning for the call.

To the extent any other questions come up, feel free to give us a call here in St.

Louis.

And with that, we will end the third quarter earnings release conference call.

Thank you very much.

This does conclude today's conference call.

We appreciate your participation.

You may disconnect at this time.