美國再保險集團 (RGA) 2008 Q3 法說會逐字稿

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

Today's call is being recorded.

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

Greig Woodring, and Senior Executive Vice President and Chief Financial Officer, Mr.

Jack Lay.

Please go ahead, Mr.

Lay.

Okay.

Thank you.

Good morning to everyone.

Thanks for joining us this morning for the third quarter conference call.

I'll turn the call over to our CEO, Greig Woodring, in just a minute.

Greig will comment on our results which we released at the end of the day yesterday and then we'll respond to any questions from our 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 are cautioned that actual results could differ materially from expected results.

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

In addition, during the course of the call we will 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 the press release for more information on this measure and a reconciliation of operating income to net income for our various business segments.

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

Good morning.

Thank you for taking the time to join us for the call.

After a few brief comments, we'll open the line for questions.

We reported strong operating results for the quarter on a consolidated basis.

It was a strong operating quarter with operating income for the quarter 24% up to $118.5 million from $95.6 million in the prior year.

On a per share basis our reported operating income for the quarter was 1.86 per diluted share, up 25%.

Reported net income for the quarter totaled $25.2 million or $0.40 per diluted share compared to $1.19 last year.

Net income for the quarter included $99.8 million in net unrealized-- or net realized securities related losses including investment impairments and losses on the sale of certain securities.

This amount is pre-tax and before the impact of deferred acquisition costs.

After tax and DAC the losses totaled $75.4 million or approximately 3% per shareholders' equity.

Net income for the quarter also includes unrealized losses of $21.1 million after tax and DAC, due to the decline in the fair value of competitive derivatives associated with modified coinsurance and funds withheld treaties, which is also referred to as B-36.

This non-cash unrealized loss is due to the impact of widening credit spreads on the investment portfolios underlying certain of our funds withheld annuity reinsurance treaties.

I will comment further on investment losses, our investment portfolio and capital toward the end of my prepared remarks.

Net premium flow during the quarter increased 6% to $1.3 billion.

The comparison is distorted by choppy client reporting in Asia Pacific in particular last year that led to usually high premiums in last year's third quarter.

You may remember we reported a similar high premium level in that part of our operations in the second quarter of this year.

The year to date rate of increase for the Company as a whole of 11% is in the range of expectations which we set out in the beginning of the year, which was 10 to 13%.

Net investment income totaled $220.2 million, down from the second quarter total of $254.9 million.

The decrease is largely due to our funds withheld portfolios in the US asset intensive segment.

Investment income in that segment can bounce around due to movements in the fair value of equity options associated with large equity indexed annuity funds withheld treaties.

You'll see a corresponding decrease in interest credited expense within the segment as well.

Thus little impact to the bottom line.

Our general account portfolio yield has been relatively stable at 6.01% for the quarter.

Turning to our operating segments now.

First in the US, pre-tax operating income totaled $84.2 million compared to $89.9 million last year.

Claim levels were approximately $20 million higher than expected.

That level of variance is well within statistical norms for the US business, given its size.

Premiums increased 7% for the quarter, and are up 7% on a year to date basis.

That rate of increase is likely where we'll be at year end, absent any blocked transactions during the fourth quarter.

The US mortality market continues to be in -- stable in terms of pricing and competition.

We believe that current pressure on capital levels in the industry and the absence of a securitization market will lead to increased opportunities for us, but time will tell.

Our US asset intensive business contributed $8.3 million in pre-tax operating income to the quarter, up from $4.8 million last year.

The prior quarter reflects $5.5 million in capital losses in our funds withheld portfolios, while the current quarter includes approximately $7.8 million in capital losses.

Under GAAP these losses get reflected in our net investment income and therefore we include them in our operating income figures.

Despite the market volatility, this business is performing within our expectations.

We continue to see opportunities in the market and have grown even more selective, given market conditions.

Turning to Canada.

Our Canadian operation produced another strong quarter on very favorable mortality.

Pre-tax operating income totaled $32 million, versus $20.3 million last year, which was also characterized by favorable mortality.

Operating income results so far this year are well ahead of expectations due to this favorable mortality.

As with negative quarterly fluctuations, positive fluctuations or even yearly fluctuations are not necessarily indicative of long-term trend.

Premiums in Canada were up 4% for the quarter and 18% on a year to date basis.

For the year, premiums have increased 9%, this measured in Canadian dollars, just below expected levels.

Regarding our international operations, Asia Pacific continued its string of strong quarters with pre-tax operating income of $25 million, compared with $17.6 million last year or a 42% increase, with some help from stronger foreign currencies.

That strong result was driven by favorable mortality results in three of our emerging markets, Japan, South Korea and Taiwan.

Quarterly volatility is still a reality, but our longer term trends in Asia continue to develop nicely.

Premiums increase 6% for the quarter, and 23% on a year to date basis.

Quarterly comparison to prior year is difficult due to client reporting last year.

On an original currency basis premiums have increased 18%, on a year to date basis, ahead of the expectations we set at the beginning of the year.

We continue to be pleased with our progress, particularly in the growing reinsurance markets of Japan and South Korea.

We continue to enjoy strong a market position in Asia.

Our other international operation, Europe and South Africa, also reported strong results driven by the UK.

Pre-tax operating income increased to $25.2 million from $12.6 million last year, when we experienced high claim levels in this segment.

In addition to slightly favorable claim levels in the UK, pre-tax income benefited from the treaty recapture, a result of the acquisition of one of our clients.

That recapture after recognition of related Ps in premium and reserve adjustments benefited pre-tax operating income by about $8.7 million.

For the quarter net premium increase 3% on a US dollar basis and 9% on a original currency basis.

On a year to date basis net premiums increased 9% on a US dollar basis and 10% on original currency basis, slightly below the 12 to 15% guidance range we set in January.

The UK market continues to be one of our most competitive markets as well as the largest market in this operating segment.

We're beginning to see good growth rates coming from other parts of Europe with new representative offices in Germany, Poland and France.

We're also seeing good contributions from Spain; however, we're starting from a low base in continental Europe, so results in this segment remain dominated by the UK.

Now let me turn back to investments and related topics.

As I indicated earlier we recorded about $100 million in net investment losses for quarter, pre-tax and pre-DAC.

These losses were primarily associated with RGA's investments in the financial services sector including Lehman Brothers, AIG, Washington Mutual, Fannie Mae, Freddie Mac and various subprime mortgage and Alt-A structured securities.

After giving effect to these impairment losses, and security sales, our book value exposure including funds withhold portfolios to the following companies is Lehman Brothers $1.4 million, Washington Mutual $2.6 million, Fannie Mae and Freddie Mac.

$0.9 million, AIG $54.2 million.

Less than $8 million of this is Holding Company exposure.

We impaired our Holding Company exposure to $0.50 on the dollar on average and did not impair the holdings of the various operating subsidiaries of AIG.

Our press release provides details on subprime and Alt-A exposure, so I won't repeat them here.

However, we did take approximately $26 million in write downs on these securities, which is at the upper end of our range of expectations in terms of the ultimate expected actual losses on these securities.

Under GAAP, evaluating securities for other than temporary impairment requires extensive management judgment including factoring in our intent to hold securities.

In applying that judgment this quarter we've tried to err on the side of being aggressive in taking write downs in order to give us more management flexibility going forward.

Of course, the existing market uncertainty makes it difficult to predict losses on asset exposures with a high degree of certainty.

Our investment security portfolio is 97% investment grade.

Our common and preferred equity portfolio is less than $200 million.

Gross unrealized losses have grown from $487 million to $961 million due to the increasingly wide credit spreads and duration of our portfolio, which is about six years in the US excluding Timberlake.

Approximately $470 million or nearly 50% of the gross unrealized losses is associated with our US corporate bond portfolio, where credit spreads have widen significantly, particularly in the finances services sector.

Some of the largest unrealized loss exposure are associated with Citigroup.

Morgan Stanley, Wachovia, Goldman Sachs, Fifth Third Bank, Regents Banks, Santander Bank and various AIG operations, et cetera.

We don't believe these securities are other than temporarily impaired but it will take time for credit spreads and fair values to return to more normal levels.

Because over 90% of our business is traditional mortality, we are consistently cash flow positive, and therefore we believe that we're able to hold these securities until fair values recover to a more reasonable level.

Relative to others in the financial services industry our asset leverage is low.

We believe we have a strong liquidity profile with positive cash flows, no commercial paper programs immaterial securities lending, and no significant near term debt maturities.

We also have back up liquidity in the form of our syndicated credit facility and the Federal Home Loan Bank lending program.

On the capital front we feel our current capital base is adequate to support our business at current operating levels.

Despite the significant investment losses this year, we've added to that capital base this quarter in the form of retained earnings.

Absent a change in view from the rating agencies, any future capital raises will likely be driven by business opportunities, and as always, we'll move forward on these opportunities if they're accretive to shareholders.

We're currently seeing significant opportunities as direct companies explore alternatives to strengthen their own capital positions and reduce their risk profiles.

These opportunities in total exceed the capital we currently have available, therefore we are in a position of having to selectively focus on those that we believe have the highest return.

On October 6th, we announced that our board of directors has authorized and will recommend that the holders of class A common stock and class B common stock approve a proposal to convert the class B common stock into class A on a one-for-one basis pursuant to the existing conversion terms contained in RGA's articles of incorporation.

Special shareholders meeting to consider the proposal is scheduled for November 25th.

So in conclusion, it was a strong operating quarter.

Our results so far this year demonstrate the mortality volatility that exists on a quarterly basis; however, over time mortality rates become predictable and we have a long track record of generating solid returns on mortality businesses.

We continue to execute a strategy to grow our business in a disciplined fashion.

The current economic turmoil does not significantly alter our plans or projected business results.

We have limited exposure to the equity markets and therefore our revenue streams and profits are largely unaffected by the stock market.

Over the short and intermediate term we believe the current environment will actually increase new business opportunities as companies look to relieve capital pressure and increase stability.

We appreciate your support and interest in RGA and are ready now to take any questions you may have.

Operator, I think we're ready to take questions at this point.

Certainly.

(OPERATOR INSTRUCTIONS) We'll take our first question from Jimmy Bhullar, JP Morgan

Good morning.

I have a few questions.

The first one is just your comfort with your liquidity and capital position.

You mentioned you'd have to raise equity if you see opportunities to write large blocks of business.

But given what's going on in the credit markets, do you need to raise equity absent that, and if you can give us an idea on -- like you had $100 million of investment losses in the third quarter, how much more can you sustain in realized losses before having to raise equity, ignoring the new business opportunities.

Jimmy, this is Jack, let me take a crack at that.

In, first of all, on the liquidity front, we-- we can pretty much schedule cash outflows for the most part, and we feel like we're in a very liquid position in terms of cash and cash equivalents on hand as well as access to our line of credit and the FHLB lending facilities, so we very feel comfortable in that respect.

In term of capital.

It's always hard to gauge exactly where we are because we're dealing with our own capital model and those discrete models of each agency.

But, best estimate is we probably have about $150 million or so of excess capital at this point, so in terms of a question, what-- at what point would additional asset losses hamper that.

You saw what we considered to be a fairly extraordinary securities related losses in the third quarter, and we still added not a great deal, but we at least added some to the retained earnings base, so it would take, I guess, to answer your question, it would take another quarter or more-- probably emphasis on more-- of similar sort of impairments and securities losses, in our view before it would really hamper the capital base.

And can you write new business at margins good enough to really offset, if you have to raise equity at these levels, to offset the dissolution from any share offering?

Well, Jimmy, we don't really know, but for anything that uses large amounts of capital, we will either write them or not write them, if we can get those returns.

We think there are opportunities like that out there, and as we said, there are more opportunities than we have capital for that are lined up, in our shop right now.

And so we're going to be selective in what we do and what we can reach for, and we'll have to make that, that call, whether we think the opportunities are so good or not.

And then I had a question on your corporate and other segment.

On a pre-tax basis excluding realized gains and losses you've had a consistently loss in that segment.

This quarter you had $9.2 million in earnings, I notice interest expense declined a lot.

Is that an ongoing number are or was there something unusual this quarter that you don't expect to repeat?

Yes, Jimmy; this is Jack.

It's more the latter, you may recall we had a similar pattern last year where under FIN-48 once we have settled another tax year then there's -- .

An accrual?

Yes; there's an impact on accrued interest that we set aside, associated with any potential IRS settlements, so that's a fairly typical pattern.

It didn't surprise us, and, in fact, you'll see something similar in the interest expense line in last year's third quarter as well.

That's the primary driver.

Okay.

That's all I have.

Thank you.

(OPERATOR INSTRUCTIONS) We'll take our next question from Andrew Kligerman of UBS Financial.

Hey good morning.

Sorry if I if ask a redundant question.

I got on a little bit late, but maybe first, just with regard to the decline in the fair value of embedded derivatives, the $21.1 million charge there, could you give a little more color around that?

Yes.

Andrew, this is Jack.

You may recall that our what we call B-36, and that relates to the revaluation of any embedded derivative on the funds withheld portfolio, is driven primarily by any changes in credit spreads, and you've seen, obviously, credit spreads expanding, increasing over the last several quarters, and expanding rather dramatically in the third quarter.

The way that that change in the value is calculated, it-- it relates primarily to the change in credit spreads.

Any change in the underlying risk free interest rates have little impact on that change, so it's really more of the same, and if you take a look last four quarters really essentially starting midpoint last year, you'll see that we've had a continued downward revaluation of the embedded derivatives.

Now for all intents and purposes, once, and we obviously hope that credit spreads come in somewhat, then you'll see an opposite impact, or we'll actually see a gain from the revaluation of that embedded derivative.

And then, maybe just in each of your different key regions, given the global economic pressures, I'm sure the market's going to open up massively down this morning or it seems that way, anyway.

What's your thinking for 2009 in terms of the types of primary markets, what, what we're going to see in terms of organic growth in the primary markets?

And then my follow-up question is, in terms of deal activity, what kind of deals are you seeing?

So the first part is just more of an organic look at the life insurance industry, and the second part is, what kind of opportunities are-- is RGA going to see?

Yes, Andrew, in terms of the effect of the macro environment on the primary life insurance industry, it's generally not as affected by recession as other industries, but it, we would expect economic activity to go down considerably and the amount of business flow to just naturally go down.

And of course, we're always in a new environment, compared to past ones, and we can't exactly predict what's going to happen, but we do expect that-- that organic growth will slow down.

Now, remember that our earnings projections and flow projections for next year don't depend really on what happens on the new business front much at all.

Just around the edges.

We basically depend on what's already on the books for producing the income.

Now there might be a little bit extra in the way of pressure on lapses on that, but we really don't expect much because we haven't seen much this year, if any.

And so -- so it doesn't affect our flow of earnings very much next year but it might effect our-- our expectations for new business levels next year.

And, and so in terms of-- and then just sort of shifting to the demand and you said you were seeing a number, of, quote, a number of opportunities, what's the shape and type of those opportunities, could you give us a little color on that?

Well, they are, if I characterize them, some common themes, they are block transaction possibilities where companies are essentially looking to essentially sell a block of business through reinsurance or reinsure out a block of business is a better way to put it, in order to free up their own capital resources, and there are a number of these that we're seeing from, really, markets everywhere, and there's also potentially supportive acquisitions that companies might want to make.

That's another category of-- of opportunities and we've seen quite a few of these.

With the (inaudible) -- With the movement out there, you would think that there are multitudes of, there's so much capital needed, and Jack just mentioned that you have $150 million or so of excess capital, it would seem that the probability is high that you might need to raise capital in the near term if you are to-- to take advantage of some of those opportunities.

Would you agree that the probability is pretty high?

Well, certainly what we'd agree is that there's a lot more opportunities than we have capital.

And we'll have to nurse them down the road a little bit farther before we could really make that call, Andrew, but if we were to take advantage of these opportunities, yes, we would, we would raise capital.

But we would do it in a way hopefully that, that is accretive to all shareholders if we do that.

Yes it seems you're share price, unfortunately, it,-- it-- on my view it's quite undervalued, and would issuing stock at this price be-- would you be able to manage something accretive by issuing -- .

It's possible, but, obviously the lower the stock price, the tougher that is.

The higher the stock price, the easier that is.

Like I said, we'll have to make the call as we go along here.

Yes, and just the last part and I'll end it on this, but are there private equity opportunities or side car type opportunities that might make some of these new business transactions more viable?

Yes; we're exploring all possibilities, Andrew.

All right.

Thanks a lot.

Your next question from Steven Schwartz of Raymond James & Associates.

Hi, good morning everybody.

First, a follow-up on one of Jimmy's questions and then I want to get into my own.

Jack, on the interest expense in corporate and other, as you noted, we saw it down last year, saw it down again this year.

Should we be modeling a recurring pattern, to see that down again next year?

Yes.

Steven, yes, the answer's yes, as you model the third quarter.

You won't see that pattern every quarter, but if you take a look at last year's kind of pattern and what you've seen so far this year, yes, we would expect that sort of a pattern every year.

Okay.

All right.

And then onto my own, Greig, you-- your going pretty fast, what was the effect of the commutation in Canada?

Do you mean the-- the recapture in Asia Pacific?

On UK?

I thought you were talking about Canada.

Then you were going really fast; then I completely screwed it.

Forget it, I'll go back over the transcript and figure it out.

And then can we just talk about --

There was a recapture in the UK.

There was a recapture in UK?

Yes.

That affected us by about $8.7 million positive pre-tax.

Okay.

All right.

And then I just want to look at that new business assumed, and if you can give me an idea about what's normal and maybe just what's kind of reporting issues, it looks like Europe and South Africa new business assumed was up 60% or maybe even higher ex currency.

Meanwhile, Asia Pacific was probably down 65% and Canada was up 31%?

Well, as you can see, reporting it bounces those numbers all around.

I wouldn't read too much into quarterly numbers because a lot of-- a lot of the reporting, especially for new business, tends to be really chunky.

Okay.

Does looking at year to date make some sense?

Yes.

Yes.

Year to date is a lot better.

All right.

Great that's what I've got.

We'll take our next question from Mark Finkelstein of Fox-Pitt Kelton.

Hey good morning.

Good morning.

A few questions.

I guess, Greig, can you just expand on your comments on the rate environment?

It sounds like you are seeing more opportunity being selective, but I think you said that rates are relatively stable.

I guess in this environment, why aren't we seeing maybe a little bit of firming of rates, and when or if do you expect this to occur?

Mark, I think that there's a distinction to be made between the regular flow of business that is contracted and stays in place for a long period of time, and just takes place.

New opportunities come up to, to quote recently -- There really haven't been a lot of quoting opportunities, say, in the big US market in the last couple of months.

And so testing of the new environment -- we're reflecting the current cost of capital in, in quotes, so that will tend to drive up the price, but what I'm talking about predominantly, when I talk about high return opportunities, are some of these block opportunistic transactions where companies are seeking support from the reinsurance market.

Okay.

I guess just from a trend, I mean, I've started to hear some movement from like YRT into coinsurance and other kind of ways of wanting to place some of these risks, are you-- what are you seeing specifically in terms of those trends?

Yes, we have, we have seen a request or two for coinsurance instead of YRT.

We frankly expected to see a lot more of that earlier and it's been slow to develop.

It wouldn't surprise us to, to begin seeing a lot more requests for coinsurance simply to transfer the, the Triple X problem onto the reinsurers instead of keeping it at the primary companies.

Okay.

I guess, how should we think about earnings going forward in the asset intensive segment just with volatility?

What is the interplay in that area?

I know you have a fairly sizeable index annuity block.

With hedging costs and volatility as high as it is, how should we think about that?

Well, it's clearly not the best of times for any, any of the variable annuity or indexed annuity transactions.

We have fixed annuities in that segment too, and generally, they're performing solidly, given the environment.

Which is to say, less than we expected the run rate to be.

They'll-- they'll probably have some ups and downs over the quarter.

Fortunately, that is a small piece of our-- of our overall business.

Right.

And it doesn't have that big of an effect on our overall rolled up results.

Okay.

All right.

Thanks.

(OPERATOR INSTRUCTIONS) We'll go now to Jeff Schuman of KBW.

Good morning; this is actually Ryan Krueger filling in for Jeff.

Just a couple quick ones.

On the $100 million of GAAP pre-tax impairment, can you-- did those maps right over to stat or is there a difference in the stat impairments?

This is Jack.

Yes they will-- they will mirror to the extent that they are included in RGA Re, which is the primary US operating company, so that $100 million obviously was a consolidated number but a large share of those were in RGA Re.

Okay and then, can you just talk-- are you seeing increased opportunities specifically to reinsure variable annuity business, and if so what's your appetite to participate in that market?

Yes, we are seeing a lot of requests for variable annuity.

Not block transactions, but just, just to regular transactions, I would say.

We're going extremely slow, as you can imagine, in that market.

We're-- we're analyzing these and watching the current environment.

We are not likely to enter into any new deal that we haven't-- we haven't already entered into.

Okay.

We'll go now to Craig Rothman of Millenium Partners.

Thanks, guys, when you say accretive when you're looking at these potential deals, what exactly are you looking at?

Are you looking at accretive to EPS, book value?

And are you making some assumption on your cost of capital there?

EPS.

EPS.

Yes.

Clearly there's an implied assumption about how much we can take capital in and what we can earn on the business.

Okay.

Now, have you guys, I mean, there's a lot of people-- a lot of shareholders out there that would probably very gladly give you capital; at least, that's been my perception.

We'd certainly be one of them.

Have you thought about raising capital privately rather than going to the market, because just mentioning this, clearly has an impact on your stock?

Well, first of all, plans are not-- we have no active plans to, programmed to do anything at the moment.

But we are looking at it very strongly because we do have all these opportunities, and we'll-- we'll try to take the best course possible to actually think about all the different opportunities there might be.

All right.

Well if you're thinking about opportunity, just keep us on your list of calls, because like I said, I think there's a lot of people that would definitely be willing to give you a lot of capital to take advantage of these opportunities.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) And we have no further questions.

I'd like to turn the conference back to our speakers for any additional or closing remarks.

Okay.

Thanks to everyone who joined us on the call this morning.

A couple of notes.

A replay of this call will be available on our website sometime tomorrow morning following the filing of a transcript with the SEC, and given the interest in the investment portfolio and kind of where we-- where we are with respect to any kind of unrealized loss and that sort of thing.

We will have an investment supplement available probably within an hour on our website that will provide more detail than we did in the press release.

With that, we will end the call.

Thank you very much.

This does conclude today's conference.

We thank you for joining us today and hope that you have a great day.