Business Context and Reporting Period
The provided filing is a Form 10-Q for American Equity Investment Life Holding Company, not American National Group Inc. It covers the quarter and six months ended June 30, 2014, and was filed August 7, 2014. The company primarily sells individual deferred annuities, including fixed index annuities, and also sells life insurance products.
Deferred annuity deposits are generally recorded as policyholder deposit liabilities rather than revenue. Earnings depend principally on invested-asset growth, investment spreads, policy charges, derivative results, acquisition costs and policyholder benefits.
Financial Performance and Position
| Metric | Three months ended June 30, 2014 | Year-over-year change | Six months ended June 30, 2014 | Year-over-year change |
|---|---|---|---|---|
| Total revenues | $670.7 million | Up 49.9% | $1.116 billion | Down 6.4% |
| Income before taxes | $55.6 million | Down 69.9% | $41.0 million | Down 81.7% |
| Net income | $36.7 million | Down 69.4% | $27.0 million | Down 81.5% |
| Diluted EPS | $0.46 | Down from $1.71 | $0.34 | Down from $2.09 |
| Operating income, non-GAAP | $38.5 million | Up 27% | $76.0 million | Up 19% |
| Operating income margin, calculated | 5.7% | Improved from approximately 6.8% based on prior-period revenue | 6.8% | Improved from approximately 5.3% |
Revenue benefited from a $270.9 million quarterly gain and a $319.4 million six-month gain in the fair value of derivatives. Net income was materially affected by volatile derivative and embedded-derivative accounting results, debt-extinguishment losses and other non-core items. Effective tax rates were 33.9% for the quarter and 34.1% for the six months.
- Net investment income increased 10% to $370.9 million in the quarter and 11% to $740.9 million for the six months, primarily from growth in the annuity business and invested assets.
- The aggregate investment spread was 2.70% for the quarter and 2.74% for the six months, compared with 2.70% in both prior-year comparable periods.
- Average annuity liabilities increased 13% to $32.8 billion for the quarter and $32.4 billion for the six months.
- Net annuity deposits after coinsurance were $1.010 billion for the quarter and $1.881 billion for the six months, down 7% and 5%, respectively.
- Cash provided by operating activities was $395.4 million for the six months, compared with $491.3 million in the prior year. Cash used in investing was $716.7 million, while financing activities provided $888.4 million.
- Cash and cash equivalents were $1.465 billion at June 30, 2014, up from $897.5 million at December 31, 2013.
- Total assets were $42.004 billion and stockholders’ equity was $1.914 billion at June 30, 2014, compared with $39.621 billion and $1.385 billion, respectively, at year-end 2013.
Material Changes Versus Prior Comparable Period
- GAAP net income declined substantially despite higher operating income, primarily because 2013 benefited from favorable embedded-derivative valuation changes, while 2014 included less favorable derivative-related effects and $10.6 million of debt-extinguishment losses for the six months.
- Quarterly change in fair value of embedded derivatives was an $80.9 million expense, compared with a $408.4 million benefit in the prior-year quarter. For the six months, the amount was a $173.6 million expense versus a $45.1 million benefit in 2013.
- Management revised lapse-rate and future call-option-cost assumptions in the second quarter. The revisions reduced the embedded-derivative adjustment by $62.6 million and increased after-tax net income by $14.8 million, or $0.19 per diluted share.
- Annuity deposits before coinsurance declined 8% in the quarter and 5% year to date, reflecting competitive pressures. Fixed index annuity index-strategy deposits increased, but fixed-strategy and other annuity deposits declined.
- Net unrealized gains reported in accumulated other comprehensive income increased to $556.1 million from $46.2 million, primarily because of improved fixed-maturity investment values.
- Gross unrealized losses on fixed-maturity securities declined to $192.5 million from $861.4 million at year-end 2013. Management reported that 98% of the fixed-maturity portfolio was investment grade under NAIC designations.
- The company extinguished $36.2 million of principal on the 2029 notes and $46.5 million on the 2015 notes during the six months, issuing common shares as part of the consideration.
Guidance, Outlook, Risks and Unusual Items
- Management expects three initiatives launched in August 2014—a new index-crediting strategy, revised lifetime-income-benefit-rider payouts and a new agent commission option—to improve competitiveness and potentially strengthen second-half sales. No quantitative earnings guidance was provided.
- Persistent low interest rates are pressuring investment yields and reinvestment returns. Management stated that additional reductions in new-money crediting rates are likely if current conditions continue.
- Renewal crediting-rate reductions covering approximately $15 billion of policyholder funds are being implemented over a 15-month period, with most reductions expected by May 15, 2015.
- Interest-rate sensitivity is significant. A modeled 10% increase in market interest rates, equivalent to 34 basis points at period-end, would reduce fixed-maturity fair value by approximately $871.5 million and reduce stockholders’ equity by approximately $253.7 million, subject to model assumptions.
- Fixed-index-annuity embedded derivatives were a significant Level 3 liability of $5.120 billion at June 30, 2014, up from $4.406 billion at year-end 2013. A 100-basis-point increase in the discount rate would reduce their fair value by an estimated $350.0 million; a 100-basis-point decrease would increase it by approximately $391.7 million.
- The company had $474.4 million of notes payable and $246.1 million of subordinated debentures. No borrowings were outstanding under its $140 million revolving credit facility.
- The Los Angeles annuity-sales-practices litigation remained subject to an appeal. The recorded estimated liability was $11.1 million at June 30, 2014, and the company stated that the ultimate claims liability remains uncertain.
- Mortgage-loan credit exposure included $9.3 million of collateral-dependent loans, $2.2 million in workout status and $1.045 million 30–59 days past due; no loans were 60 or more days past due at the reporting date. Unfunded commitments included $38.6 million for mortgage loans, $20.6 million to limited partnerships and $2.4 million to secured bank loans.
- American Equity Life could distribute up to $195.0 million during 2014 without prior Iowa Insurance Commissioner approval, subject to statutory and contractual limitations. Its statutory earned surplus was approximately $1.0 billion at June 30, 2014.
Most Important Facts for Investors to Verify
- Confirm the issuer identity: the filing text identifies American Equity Investment Life Holding Company, while the request metadata identifies American National Group Inc.
- Reconcile GAAP net income with non-GAAP operating income and assess the sustainability of derivative valuation gains, assumption changes and debt-extinguishment effects.
- Evaluate the durability of the 2.74% year-to-date investment spread amid low investment yields, callable securities and planned crediting-rate reductions.
- Review annuity deposit trends, surrender activity, retention and the expected effect of the August 2014 product and distribution initiatives.
- Assess exposure to interest-rate movements, Level 3 embedded-derivative valuation assumptions and counterparty risk on $905.7 million of call-option assets.
- Verify capital, statutory surplus, risk-based capital and dividend capacity at the insurance subsidiaries, including compliance with the revolving-credit covenants.
- Monitor the Los Angeles litigation appeal and the ultimate cost of the $11.1 million recorded liability.