American Equity Investment Life Holding Company — 2017 Q1 Form 10-Q Summary
Entity note: The supplied filing is for American Equity Investment Life Holding Company, not American National Group Inc. The report covers the three months ended March 31, 2017, with balance-sheet comparisons to December 31, 2016 and operating comparisons to the three months ended March 31, 2016. The filing was signed May 9, 2017.
Business context and reporting period
The company primarily sells individual annuities, especially deferred and fixed index annuities, and sells life insurance to a lesser extent. Premiums for deferred annuities are generally recorded as deposit liabilities rather than revenue. Profitability depends principally on invested assets, investment spreads, policyholder crediting rates, option costs, acquisition expenses, persistency and operating expenses.
Management stated that annuity sales slowed amid intensified competition and uncertainty surrounding the U.S. Department of Labor fiduciary rule. The company continued to operate in a low-interest-rate environment that pressured investment yields and product spreads.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total revenues | $927.3 million | $417.6 million |
| Income (loss) before taxes | $81.5 million | $(69.1) million |
| Net income (loss) | $53.9 million | $(44.8) million |
| Diluted earnings (loss) per share | $0.60 | $(0.55) |
| Non-GAAP operating income | $59.6 million | $21.0 million |
| Operating cash flow | $497.9 million | $141.6 million |
| Investing cash flow | $(519.9) million | $(956.1) million |
| Financing cash flow | $403.5 million | $1,123.9 million |
| Cash and cash equivalents at period-end | $1.173 billion | $707.2 million |
| Balance-sheet metric | March 31, 2017 | December 31, 2016 |
|---|---|---|
| Total assets | $57.549 billion | $56.053 billion |
| Total investments | $46.032 billion | $44.758 billion |
| Policy benefit reserves | $52.701 billion | $51.637 billion |
| Total liabilities | $55.112 billion | $53.762 billion |
| Stockholders’ equity | $2.436 billion | $2.292 billion |
| Notes and loan payable | $494.1 million | $493.8 million |
| Subordinated debentures | $241.9 million | $241.9 million |
- Average invested assets, excluding derivatives, increased 10% to $43.6 billion, while net annuity account balances increased 9% to $45.6 billion.
- Average yield on invested assets declined to 4.48% from 4.58%; aggregate investment spread increased to 2.71% from 2.65%.
- Investment spread in dollars increased to $278.6 million from $243.6 million.
- Fixed maturity securities represented approximately 91.6% of investments. Approximately 96% of the fixed maturity portfolio was investment grade under the company’s NRSRO presentation, and 97% was investment grade under NAIC designations.
- Gross unrealized losses on available-for-sale fixed maturity securities declined to $460.5 million from $584.7 million at year-end 2016. Management concluded the losses were temporary.
- The estimated statutory risk-based capital ratio increased to 353% at March 31, 2017 from 342% at December 31, 2016.
Material changes versus the prior comparable period
- Total revenue increased 122%, primarily because the change in fair value of derivatives shifted to a $386.5 million gain from a $74.1 million loss.
- Net income improved by $98.8 million, from a $44.8 million loss to $53.9 million of income. Reported earnings remained significantly affected by fair-value movements in derivatives and embedded derivatives.
- Non-GAAP operating income increased 184% to $59.6 million. The 2016 comparison was reduced by an unlocking charge that increased amortization of deferred sales inducements and deferred policy acquisition costs.
- Net investment income increased 8% to $485.6 million, primarily due to growth in the annuity business and invested assets, partially offset by lower portfolio yields.
- Interest-sensitive and index product benefits increased 329% to $419.1 million, principally because index credits increased to $321.9 million from $6.5 million as underlying indices performed better.
- Annuity deposits before coinsurance declined 48% to $1.079 billion; net deposits after coinsurance declined 38% to $1.008 billion. Fixed index annuity deposits declined to $1.029 billion from $1.688 billion.
- Operating cash flow increased substantially, while financing cash flow declined because policyholder deposits were lower. Cash used in investing also declined as purchases of fixed maturity securities were lower.
- Other-than-temporary impairment losses recognized in operations decreased to $0.1 million from $5.7 million.
Debt, liquidity and capital
- Debt consisted primarily of $400 million of senior notes due 2021, a $100 million term loan due 2019, and $241.9 million of subordinated debentures.
- No amounts were outstanding under the $150 million revolving credit facility at March 31, 2017. The facility terminates in 2021 and is available for general corporate purposes.
- The term loan carried an interest rate of 3.125% during the quarter. Repurchase-agreement borrowings averaged $102.8 million and reached a maximum of $274.5 million during the quarter.
- Parent-company cash was $39.3 million. Management stated that insurance subsidiaries had adequate cash flows to meet policyholder and other obligations.
- American Equity Life could distribute up to $272.7 million during 2017 without prior approval of the Iowa Insurance Commissioner, subject to statutory and contractual restrictions. The parent also had $658.8 million of unrestricted capacity under the credit agreement while remaining in compliance with covenants.
- Credit agreement covenants included a minimum subsidiary risk-based capital ratio of 275% and a maximum adjusted debt-to-total-adjusted-capital ratio of 0.35.
Guidance, outlook, risks and unusual items
- No formal numerical earnings or sales guidance was provided in the filing.
- Management expects continuing low investment yields to pressure investment spreads and product returns. Renewal rate adjustments on approximately $16 billion to $17 billion of account values were expected to reduce the overall cost of money by approximately eight basis points when fully implemented. Additional adjustments applied to $7.4 billion of account values were expected to be implemented over nine to twelve months.
- The DOL fiduciary rule was identified as a material risk to annuity sales, distribution practices, compensation, product offerings, litigation exposure and profitability. The filing noted a delayed implementation schedule and the possibility of further regulatory changes.
- Interest-rate risk is the company’s primary market risk. A modeled 30-basis-point increase in rates was estimated to reduce the fair value of fixed maturity securities by approximately $1.0 billion and reduce accumulated other comprehensive income and stockholders’ equity by approximately $301.5 million after specified adjustments.
- The company’s embedded derivative liability for fixed index annuities was $7.051 billion at March 31, 2017. A 100-basis-point increase in the relevant discount rate was estimated to reduce that liability by $481.9 million and produce related changes in deferred-cost amortization; a 100-basis-point decrease had the opposite, larger effect.
- Unrealized losses were concentrated partly in commodity-related sectors and below-investment-grade securities. Management stated that the losses were temporary, but acknowledged potential exposure to further commodity-price declines, credit-rating downgrades and impairments.
- Mortgage loan commitments totaled $56.8 million. Unfunded commitments to limited partnerships and secured bank loans totaled $48.6 million and $36.9 million, respectively.
- The company disclosed ordinary-course litigation and regulatory inquiries but did not identify a specific probable and estimable material loss. It cautioned that future litigation or regulatory matters could adversely affect results.
- Accounting adoption for share-based payments produced a $1.3 million income-tax benefit in Q1 2017. Several new accounting standards were pending, with impacts not yet determined.
Most important facts for investors to verify
- Confirm that the filing issuer is American Equity Investment Life Holding Company rather than American National Group Inc.
- Separate recurring operating performance from volatile GAAP fair-value gains and losses on call options and embedded derivatives.
- Monitor annuity deposit trends, particularly fixed index annuity sales and the effects of competition and the DOL fiduciary rule.
- Assess sustainability of investment spreads as new-money yields remain below the portfolio yield and policyholder crediting rates approach minimum guarantees.
- Review the credit quality, unrealized losses, commodity-sector exposure and impairment assumptions in the fixed maturity portfolio.
- Verify statutory capital, dividend capacity and compliance with the credit agreement’s risk-based capital and leverage covenants.
- Evaluate interest-rate sensitivity, including potential effects on accumulated other comprehensive income, policy liabilities, deferred costs and equity.
- Review the company’s non-GAAP operating income reconciliation and the limitations of using it instead of GAAP net income.