美國再保險集團 (RGA) 2014 Q4 法說會逐字稿

Good day, and welcome to the Reinsurance Group of America fourth-quarter 2014 results 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 Executive Vice President and Chief Financial Officer Mr. Jack Lay.

Please go ahead, Mr. Lay.

Okay, thank you.

Good morning and welcome, everyone, to RGA's fourth-quarter 2014 conference call.

Joining me this morning in St.

Louis is Greig Woodring, our CEO.

Greig and I will discuss the fourth-quarter results after a quick reminder about forward-looking information and non-GAAP financial measures.

Following our prepared remarks we will be happy to take questions.

To help you better understand RGA's business we will make certain statements and discuss certain subjects during this call that will contain forward-looking information including, among other things, investment performance, statements relating to projections of revenue or earnings, and future financial performance and growth potential of RGA and its subsidiaries.

Keep in mind 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 this call we will make comments on a pretax and after-tax basis for operating income, which is considered a non-GAAP financial measure under SEC regulations.

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

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

These documents and additional information may be found on our investor relations website at RGARE.com.

With that, I will turn the call over to Greig.

Thank you, Jack.

Good morning, everyone, and thanks for joining us this morning.

I will provide general overview comments on the quarter, then Jack will open the financial results and guidance, and then we will open it up for Q&A.

Our fourth-quarter results were strong and they capped off a very good year for us.

A highlight in the quarter was favorable mortality experience in our US traditional business, but more broadly it was another quarter in which our global operating model worked to our benefit and our earnings diversity by geography and product continued to serve us well.

Operating EPS was $2.99 per diluted share, including $0.55 in unusual tax-related benefit.

Results were strong with or without the tax boost.

Full-year EPS was $9.12 including the tax-related benefits that I just mentioned.

Fourth-quarter reported premiums were up modestly as foreign currency fluctuations and the Pacific Life retrocession transaction we recently announced had meaningful effects.

Excluding those effects, premium growth was 9% for the quarter and was 8% for the year, good indications that are top-line growth remains quite healthy.

Underwriting experience on a global basis was slightly favorable for the quarter as the US, Asia, and EMEA were all favorable, offsetting continued weakness in Canada.

While I'm very pleased with these results, I remind everyone that ours is a long-term business and the results this year reflect much hard work over the years to expand our footprint and bring innovative solutions and innovations to clients around the world.

And I am also pleased as I think about the very active year we had in terms of successfully executing on transactions that will add to our operating financial success in the years ahead including block acquisitions and capital generating transactions such as the embedded value securitization announced in December and the retrocession transaction involving some of our US mortality risks.

We continue to be active and disciplined in our management of deployable capital, and as a result of the recent activity we ended the year with close to $1.2 billion of excess capital.

Thus, 2014 was a very successful year in terms of both putting excess capital to work in attractive opportunities, enhancing our capital position and flexibility, and returning capital to shareholders in an efficient and balanced way.

The embedded value transaction that we announced in early December was an opportunistic move, a chance for us to improve our capital flexibility and efficiency and also demonstrate the underlying inherent value of our in-force book of business.

In the US mortality retrocession transaction, we retroceded about 35% of our underperforming block from the 1999 to 2004 era, allowing us to release the capital backing that business.

We expect that the freed-up capital can be redeployed to achieve higher returns over time.

Each of the transactions is expected to be accretive to EPS and ROE over time as the capital is fully deployed.

Going forward, we continue to see demand for our solutions and services.

We have a breadth and depth of expertise that we offer clients, and we are finding more ways to leverage our capabilities across our global platform.

We have good balance across our range of businesses and geographies as more developed markets provide us with solid profit streams and excess capital generation while other markets offer more vibrant opportunities to market growth, regulatory changes, or demographic influences.

We have done a lot of work behind the scenes to prepare for likely regulatory developments and thus feel we are well prepared to manage changes as they apply to both RGA and to our industry.

With that, I will turn it back over to Jack to discuss the financial and segment results.

Okay, I'll give a quick synopsis of the financial results and then provide our intermediate-term guidance and some additional forward-looking thoughts.

We reported operating income of $208 million this quarter or $2.99 per diluted share, a 38% increase over the $2.17 per share we reported a year ago.

Ignoring the current-quarter favorable tax-related adjustments, which added about $0.55 per share, operating EPS still increased 12%.

Reported net premiums were modestly higher quarter over quarter despite the effects of the retrocession agreements that Greig mentioned and the foreign currency headwinds.

Adverse currency movements reduced current-period operating income by about $0.09 per diluted share compared with the prior year.

Excluding the spread business, our average investment portfolio yield was 4.94% this period, up 14 basis points versus the third quarter.

Our new money yield was around 4.2%.

We benefited again this quarter from higher variable items such as bond and mortgage loan prepayments.

We did not purchase any stock in the fourth quarter -- repurchase any stock in the fourth quarter, but we closed the previously announced Voya transaction and then executed the embedded value and retrocession transaction.

As Greig mentioned, we ended 2014 with close to $1.2 billion of excess capital compared to $600 million at the end of the third quarter.

Now turning to our segment results, the US and Latin America traditional subsegment reported pretax operating income of $134 million versus $124 million last year, reflecting favorable individual results in both years and improved group results versus a year ago.

Individual mortality claims this quarter benefited from more favorable frequency and severity relative to what we expected.

Premiums were down 1.9%, due primarily to the effect of the retrocession agreement.

Absent that, premiums would have been up 8.5%.

That retrocession transaction was retroactive to October 1 and reduced premiums by about $130 million but had a relatively insignificant effect on the bottom-line results for the quarter.

The Voya transaction was also retroactive to October 1 in terms of premiums and claims flow.

Because this transaction did not close until late in the quarter, we did not get the related asset transfer and associated investment income benefits, so the impact on the bottom line was minimal in the quarter for that transaction.

That transaction added about $35 million of premiums for the quarter.

Our asset-intensive business in the US recorded a tax operating income of $56 million, benefiting from continued favorable investment spreads and higher-than-expected commercial loan prepayments.

We estimate a reasonable pretax run rate for that business to be at least $40 million per quarter going forward.

Our financial reinsurance line reported pretax operating income of $12.5 million, reflecting strong fee income growth from transactions added over the past several years.

Canada had another soft quarter and posted pretax operating income of $20 million compared to $47 million last year.

Higher large claims and a weaker Canadian dollar contributed to the shortfall.

Given the relative persistency of the unfavorable claims levels in 2014, we continue to analyze those claims results.

But at this time we haven't seen anything definitive in terms of what to expect going forward.

Fourth-quarter and full-year premiums were only slightly higher and were hampered by a significant currency effect as premiums in Canadian dollars increased a healthy 9% in both periods.

Full-year pretax operating income was off 33%, primarily due to the elevated claims I mentioned previously.

In our Europe, Middle East, and Africa segment pretax operating income increased to $34 million from $12 million a year ago, due primarily to the ongoing impact from Global Financial Solutions transactions that we executed earlier in the year; a smaller GFS deal that we booked this quarter; and, additionally, favorable claims experience overall with particularly favorable experience in the UK.

The EMEA premiums were up 4%, or 9% excluding adverse foreign currency effects with good underlying growth in most of the EMEA markets.

Turning to Asia-Pacific, pretax operating income totaled $25 million, down from a very strong $27 million a year ago.

This year's quarter reflected ongoing growth in various regions and favorable claims experience in Japan.

Australia was once again in line with our expectations, producing a small profit.

Net premiums were up 3% for the segment in translated currencies and 10% in original currencies with a majority of the growth coming from Hong Kong and the Southeast Asia region this quarter.

Our corporate segment reported a pretax gain of about $23 million this quarter, reflecting the FIN 48-related interest expense reversal of approximately $44 million during the quarter.

Without that reversal, the segment whatever posted a pretax operating loss of about $21 million, reflecting a higher level of expenses this quarter relating primarily to consulting fees on various new initiatives and some higher incentive comp accrual.

Going forward, we expect a run rate of tax operating income to be a loss of around $10 million to $12 million per quarter, although it can be somewhat uneven.

Our fourth-quarter effective tax rate on operating income of 31.5% was below our expected run rate, primarily due to the adjustment I described earlier and the AFE extension.

Going forward, our best estimate for our effective tax rate is approximately 34%.

As you know, we have historically provided intermediate-term guidance at this time of the year.

And I want to give you further perspective on 2014 EPS and then thoughts going forward.

In terms of our intermediate-term guidance we expect our operating EPS growth to be in the range of 5% to 8% and our operating return on equity to be in the range of 11% to 12%.

These targets are consistent with what we have suggested over the last several years and assume a continued low interest rate environment and continued execution of our capital management strategies.

This guidance is really based upon a normalized EPS pattern.

For 2014, there were a couple of items that were unusual and could be thought of as generally nonrecurring and should be excluded when estimating a more normalized EPS rate.

The largest item was the tax-related benefit of $0.55 per diluted share, which essentially reflected five years worth of tax and interest accruals released in one year as well as some other tax-related adjustments.

That occurred because in 2014 we settled five separate tax years with the Internal Revenue Service.

A more typical pattern going forward would likely reflect settling no more than one or two years at a time.

Next was the effect of several commercial loan prepayments, primarily in our US asset-intensive business, which added approximately $0.25 per share for the year.

Thus, we would suggest a more normalized EPS pattern for 2014 would be around $8.30 per share, a strong result nonetheless.

This more normalized result was particularly strong as more of the variables that affect our results went our way this year.

So looking forward, we reaffirm our intermediate-term guidance range and emphasize that our underlying business momentum remains strong.

We also want to identify a few items that will affect 2015, in particular.

First, we expect to have a meaningful benefit from the more recent larger transactions we have announced, Voya and Aurora in particular.

The Voya transaction will contribute a full year's effect and hopefully we will close the Aurora transaction at a time that will allow it to affect roughly three quarters of our results.

We expect a negative net impact going forward to our core investment yields, driven by lower bond and mortgage loan prepayments and by a lower effective yield on new investments, given the current low level of rates.

These things are hard to call but the effect is expected to represent a headwind of roughly $0.30 per share, assuming a gradual rise in rates throughout 2015.

It is also difficult to predict the relative movement of the US dollar.

We estimate foreign currency to have a negative effect of about $0.30 a share as well, as our largest currencies are expected to remain weaker relative to the dollar throughout the year.

On the capital management front, you should expect us to continue to strive for a balanced approach in terms of the use of excess capital.

We have increased our capital flexibility, efficiency, and effectiveness in 2014, and we will continue to strive to deploy capital into attractive opportunities including in-force transactions.

We can also use excess capital to buy back our own common shares, as we have demonstrated in recent years.

Our board has recently authorized a $300 million share repurchase.

Our current excess capital position gives us additional flexibility, but we don't expect a dramatic change in our approach and we will seek to maximize our returns over time.

Our guidance assumes that we will continue to find avenues to deploy a considerable amount of the capital we generate from operations each year.

With that, I'll turn it over to Greig for some final thoughts.

So in summary, we are very pleased with our financial results and feel good about the overall business momentum as we look forward.

And we expect to continue to produce an attractive EPS growth rate over the intermediate term, supported by effective capital management.

Business dynamics for us on a global basis remain positive as clients face numerous regulatory and environmental challenges, and we have an effective solution set to offer to them.

2015 could provide some notable headwinds in terms of foreign currency variable investment income and interest rates, but we still believe our intermediate-term guidance targets are achievable over this period.

Thank you and appreciate your support and interest in RGA.

And with that, we'll take any questions you may have.

(Operator Instructions)

Jimmy Bhullar with JPMorgan.

I had a couple of questions.

First, if you could talk about just what's going on in the Canada business.

You've had weak margins in the last several quarters.

Anything that you found there in terms of a pattern, whether it relates to frequency, severity, or business written in a certain vintage year?

And then, secondly, thoughts on the timing of completing the $300 million share buyback program.

Should we assume that, absent any additional large deals, that you would complete the program in 2015?

Let me take the first one and I'll turn it over to Jack for the comment on the second one, Jimmy.

In Canada, the excess claims are all attributable to what we call large cases, $1 billion and over type cases.

And while this appeared to be a fluctuation, it has been going on pretty consistently throughout the whole year.

And if you recall four or five years before that were extremely good years, in some cases, and good years in all of those five years.

At some point you have to begin to question whether, because this is sort of a steady drip, whether it is a fluctuation or whether this is something that's going to continue.

In other words, the five-year period prior to that may have been a period of unusually good experience that we shouldn't expect going forward and we should expect more of a return to normal.

But it's a little bit difficult since we are only talking about handful of cases each quarter.

It's not a large number of policies that are making up this trouble for us; it's an excess in cases or something in the quarter.

And so, until we get a little more perspective it's hard to tell exactly where the mark should be.

But it doesn't look like it's as simple as saying it's a fluctuation, but it's not clear exactly whether this is an extended bad patch or it's a return to more of a normal patch.

Yes, I'll comment on the buyback.

Maybe a few data points would be helpful.

Our best estimate is that we will generate about $350 million or so of excess capital.

That would be capital generated above and beyond what we would typically need to back our current business and the generic business flows.

So that's one data point.

And we also commented we ended 2014 with about $1.2 billion of excess capital.

Now, some of that will be put to use when we close the Aurora transaction.

So maybe you can think of it, ex- the Aurora transaction as about $1 billion of excess capital.

So, we don't want to continue to just stockpile capital, so we always look at opportunities to deploy both into the business and also then to take out some of our shares.

I think 2014 was a great example where we were able to execute on both fronts, and that would be our desire in 2015.

But certainly, if we didn't see any opportunities or simply weren't able to execute on any M&A or block deals into the business, you can expect us to take advantage of this $300 million authorization and begin to take out shares.

And lastly, could you just discuss what your energy exposure is in the investment portfolio?

Yes.

In round numbers we've got roughly $2.1 billion of exposure.

Most of that is investment-grade; I think about $180 million of that is not investment grade.

So we feel we are in a pretty manageable position there.

Thank you.

Steven Schwartz with Raymond James & Associates.

I want to talk a little bit about taxes, Jack.

What years are still open?

We've closed through 2010, so 2011 on would be open still.

Okay.

And the guidance that you gave for the tax rate, the 34% -- that did not assume an extension of the AFE again?

No, it does assume an extension of the AFE.

It does assume that.

Okay.

Honestly, that's really all I had.

Jimmy got the others.

I appreciate it.

Sean Dargan with Macquarie.

I wanted to follow-up on the retrocession agreement.

You did give up quite a bit of premium, but I'm just wondering what the characteristics of this block are in terms of volatility.

Are you modeling, I guess, lessened earnings volatility from mortality without that block in your results?

Volatility -- that block is aged and seasoned.

It should be no more volatile than the rest of our business, maybe a little bit less even.

But it is, as we've spoken about it before, a period from 1999 to 2004 of essentially low returns.

So RGA is a company that has a lot of mortality risk, of course.

And so a lot of our capital is attributable to it.

And we don't use mortality as a diversifier.

We are basically constrained by mortality.

In other words, we have higher capital backing mortality pound for pound than companies who have more asset risk in other types of it.

So this was a nice transaction from both sides' point of view.

We are able to take the capital away, and the reason it doesn't affect earnings very much is we were earning a low return based on the large amount of capital we had associated with it.

And we will be able to redeploy that capital at more effective rates over time and increase the earnings rather than to see a falloff.

And are there other counterparties, do you think, that would be amenable to similar transactions?

Well, we will certainly be looking for doing that once again if we can find the right situation.

Okay.

And just one more question about the $0.30 per share headwinds from FX.

Can you give us a little sensitivity as to what buckets that will impact between Canada, Europe and South Africa, and Asia PAC?

Yes.

Well, as you can imagine, our estimation is the dollar will progress against most of the currencies in which we write business.

But the biggest impact, maybe the biggest concern is versus the Canadian dollar.

So I think probably 40% to 50% of what we're projecting in terms of headwinds would relate to that currency and the rest reasonably well spread amongst -- the primary European currencies are the euro and the pound sterling, and then a smattering of currencies in Asia as well.

All right.

Thank you.

(Operator Instructions) Ryan Krueger with KBW.

First, I had a question on interest rates, the $0.30 EPS headwind you mentioned.

I think last quarter you mentioned something closer to $0.10.

I know interest rates are generally down since then, so I just want to better understand.

Is the change from around $0.10 to $0.30 all driven by the recent declines in interest rates this year?

Or did you also refine your estimates more, I guess, or is something else going on?

Ryan, I think the $0.10 related more to 2014 versus the prior year.

So 2015 versus 2014 -- it's a number of things.

We benefited from, broadly speaking, what we characterize as variable income.

And that includes bond make wholes and commercial loan prepayments and some other alternative investment pass-throughs and that sort of thing.

And we just think 2014 was a year where a lot of that fell together.

And you saw our investment yield hold up very well.

We don't expect to benefit nearly as much as from some of those kind of ancillary effects in 2015.

And because of what's happened with the yield environment we just expect, absent that, other headwinds associated with just lower reinvestment rates.

So you combine all that.

And our best estimate is around $0.30, as we suggested.

And then the $8.30 normalized EPS number for 2014 -- in that you had already excluded some of that variable investment impact.

Yes.

So should I think of that $0.30 drag relative to the $8.30 or relative to a higher number?

Yes.

You can think of it relative to the $8.30.

You are absolutely right; we did call out some of the impact of variable income to normalized 2014.

But you can look at it as we pulled out some of the more extraordinary impacts.

We still think there will be additional headwinds associated with variable income even after this.

Okay, got it.

So if I take all of this together, the $0.30 headwind from interest rates, $0.30 from FX but also the meaningful benefit from the Voya and the Aurora transactions that you cited, I know your guidance is a bit longer-term.

But do you think you can still achieve the 5% to 8% type EPS growth in 2015 relative to the normalized 2014 number?

Yes.

Certainly that's one way to look at it, and that's one reason we tried to normalize 2014, that we didn't want investors to think that -- and the same way if you look at last year, where we had a difficult year because of the situation in Australia.

And that kind of -- there was a part -- the run rate sort of argument.

And this year we had a positive result and we wanted to kind of do the same thing, to encourage investors to look at it on the normalized basis.

And that's what we tried to do.

So I don't think it's inappropriate to look at it the way you're suggesting.

Okay, thanks, guys.

Dan Bergman with UBS.

Just a question on excess capital, I know in the past you've talked about a cushion -- I think it was around $300 million -- that you'd like to hold.

I just wanted to see if that still the case, or should we think about that full $1 billion kind of post Aurora deal as available for the right block acquisition.

And just in general, any thoughts around what's the largest deal you would consider, given your capital position and free cash flow.

Yes, I think -- we're often asked that sort of question.

We would characterize that entire $1 billion as available if the right deal came along.

Now, having said that, we have commented in the past that our goal is to keep a cushion.

And we've indicated $300 million is a good estimate.

I'd say, as we become a little bit bigger, we think of that cushion in a little stronger terms.

In other words, I think now we look at it more as $300 million to $500 million as a nice cushion.

But having said that, we would eat into that cushion if the right deal came along because we have a fairly predictable generation of capital and earnings model and portfolio of risk that really throws off a fairly predictable earnings level.

So we are not reticent to eat into that cushion because we can rebuild it fairly predictably.

Great, that was very helpful.

And then on a related topic, I just wanted to see if you had any updated thoughts on the block acquisition landscape just both in terms of the number of deals you are seeing in the market and level of competition.

And I was just curious whether there's any impact, either positive or negative, from the recent decline in interest rates, on the market and kind of the likelihood of your completing a deal.

I would say the block acquisition market looks about the same at this point this year as it did last year.

You never can predict which things will come our way.

The competition is always present and it's always meaningful.

We think we have some advantages in some situations and some disadvantages in other situations.

But it's really hard to predict these things, but I would say that, in basic response to your question, the pipeline of opportunities, the opportunity set, looks pretty good.

In terms of, say, Solvency II capital-motivated transactions in Europe, that looks like a pretty attractive landscape as well.

Great, thank you.

Mike Zaremski with BAM Funds.

A couple questions on the guidance, to the extent you can comment or maybe just comment on the issue separately.

Does the operating earnings guidance take into account year-to-date changes in foreign currencies?

Also, I was curious if it assumes mortality in Canada normalizes.

And maybe you can also comment on how you are thinking about Australia in 2015.

Thanks.

Maybe I can comment there.

The currency situation is tricky and it changes daily, as you know.

So we established that guidance early this year.

Currencies have actually moved against us a little bit more since then.

So rather than continuing to change our expectation, it's just hard to call that guidance -- so you could put a bracket around that $0.30.

It could go either way from there.

As stated, it has moved against us a little bit in the last couple of weeks or so.

With respect to your other comments, Mike, I think the 5% to 8% guidance is, for us, a reflection of how we believe this portfolio of different businesses by geography and product line will perform.

Some will do better than expected; some will do worse than expected.

But we have enough things going and enough momentum that we are pretty confident in it.

In terms of Canada, so, like I said, we are looking at this situation.

And at some point you have to say that this continuous stream of large cases in excess of what we had expected a year ago, say, and what we had actually experienced for the prior five years will be something we might have to start factoring into our expectations.

In terms of Australia, we do expect a modest step forward in terms of core operating results, say before expense allocation and things like that, in Australia in 2015.

We are expecting them to carry a little bit more of the expense overhead load, but that's all sort of internal.

So Australia will take a small step forward, as we expect it to, over time.

Thank you.

(Operator Instructions) Ryan Krueger with KBW.

I just want to see if you guys could comment a little bit on the pricing and competitive conditions, I guess, specifically in the US and how they have changed maybe over the last year or so.

I'd say the pricing environment is okay in the US.

It's not great and it's not bad, it's just okay.

It's maybe a little bit more competitive than it was three or four years ago, from our perspective.

I'm not sure everybody would share that assessment, but that's how I think we would probably characterize it.

The market continues to decline a bit in terms of the overall session rate, and so that naturally fuels, I think, a little bit of competition.

But we're very pleased with our US performance in this type of market, given some of the characteristics of what we see out there.

And we have a good team in the US we are very happy with.

Okay.

And then the last one -- can you just talk about how your long-term care business performed in the quarter?

And then do you need to revisit any of your assumptions, given some of the reviews, I guess, at some of your clients that are going on right now?

Yes.

The long-term care performed very much as expected.

It's early days still; we haven't been in that business long enough to develop a lot of actual claims coming in.

But it's, if anything, maybe a little bit -- it's a little bit to the good side.

But it's hard to draw any conclusions yet.

We are very comfortable with the long-term care.

We have avoided a lot of the problems that have caused difficulty.

We haven't done any unlimited-benefit type business or limited-paid business.

So some of the things that have caused severe problems in the marketplace, we came in after that and actually steered away from those issues.

We are probably expecting another predictable year in 2015, based on what we've seen so far.

Thank you.

Tom Gallagher with Credit Suisse.

Good morning, this is Eric Cho for Tom Gallagher.

I just wanted to ask a quick question related to interest rate and FX headwinds that you guys mentioned.

Can you talk about some management actions that you are taking to offset that drag, perhaps hedging activities in terms of FX or changes in investment strategies that would allow RGA to capture more NII to offset the lost income perhaps from prepayment and low rate?

I can comment on the FX situation.

We really -- it's difficult to hedge foreign currencies in a way that really protect the US GAAP earnings stream.

So we only had significant net investment positions, and we don't have that many.

So we have a fairly significant position against the Canadian dollar, certainly less so against the Aussie dollar and some of the other currencies now.

So we've got a fairly broad array of currencies in which we write business.

So there's some natural hedge there.

Now that the US dollar is advancing against all of those, it doesn't provide much protection.

But suffice it to say we don't try to hedge the P&L impact to any meaningful degree.

That's really hard to do.

Now, on the investment front, it's kind of a difficult call.

So we don't want to be in a position where we are guessing exactly what's going to happen in terms of the fixed-rate markets and that sort of thing.

We tried to come up with a diversified portfolio to provide some protection, but we don't try to artificially immunize some of the investment positions.

So it's not like we've overlaid a lot of protection against that investment portfolio.

Got it.

Thank you, that's helpful.

And we have no further questions at this time.

Okay.

Well, thanks to everyone for joining us this morning.

And we are certainly here to respond to any questions, should anything else come up.

Just give us a call here at our offices in St.

Louis.

And with that, we will end the fourth quarter conference call.

Thank you.

This concludes today's conference.

Thank you for your participation.