Business Context and Reporting Period
Filing discrepancy: The supplied 10-Q is for American Equity Investment Life Holding Company, not American National Group Inc. The filing covers the quarter and nine months ended September 30, 2012, and was filed November 9, 2012.
The company specializes in individual annuities, primarily deferred fixed index annuities, and also sells life insurance. Annuity deposits are generally recorded as deposit liabilities rather than revenue under GAAP.
Key Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net income (loss) | $(7.8) million in 2012 vs. $(13.1) million in 2011 | $21.4 million vs. $36.5 million |
| Total revenues | $503.9 million vs. $(30.8) million | $1.297 billion vs. $717.1 million |
| Operating income, non-GAAP | $22.2 million vs. $41.5 million | $79.3 million vs. $101.1 million |
| Net investment income | $318.6 million vs. $305.5 million | $965.8 million vs. $894.5 million |
| Investment spread | 2.62% reported; 2.86% adjusted | 2.76% reported; 2.94% adjusted |
| EPS | $(0.13) vs. $(0.22) | $0.35 vs. $0.62 |
| Operating cash flow | Not separately provided | $829.6 million vs. $100.0 million |
At September 30, 2012, total assets were $34.6 billion, policy benefit reserves were $31.0 billion, total liabilities were $32.9 billion, and stockholders’ equity was $1.715 billion. Cash and cash equivalents were $2.397 billion, compared with $405.0 million at December 31, 2011.
Fixed maturity securities totaled $22.5 billion and mortgage loans totaled $2.7 billion. Approximately 94% of fixed maturity securities were investment grade based on NRSRO ratings, while 98% were NAIC Class 1 or 2. Notes payable were $306.7 million and subordinated debentures were $245.8 million. The $160 million revolving credit facility had no borrowings outstanding.
Material Changes Versus Prior Comparable Period
- Third-quarter and nine-month GAAP net income declined despite positive derivative fair-value movements. Results were affected by lower operating income, higher expenses, and a $17.5 million litigation accrual.
- Operating income declined 47% in the quarter and 22% year to date. The filing attributes the decline primarily to unfavorable unlocking effects, lower investment spreads, the new policy-acquisition-cost accounting rule, and the litigation reserve.
- Net investment income increased 4% in the quarter and 8% year to date because average invested assets increased 15% and 17%, respectively. However, average investment yields declined to 5.17% and 5.36% from 5.70% and 5.81%.
- Investment spreads narrowed to 2.62% in the quarter and 2.76% year to date from 2.95% and 3.04%, respectively.
- Annuity deposits before coinsurance declined 23% in both the quarter and the first nine months, to $982.0 million and $2.879 billion. Management cited low interest rates, aggressive competitor pricing, and elevated prior-year sales ahead of a rate reduction.
- Accumulated other comprehensive income increased to $712.2 million from $457.2 million, primarily reflecting higher unrealized investment gains.
- Operating cash flow improved materially to $829.6 million, while investing cash use declined to $420.9 million from $2.413 billion. Financing cash flow was $1.584 billion.
- The company converted approximately $20.8 million of subordinated debentures into common equity and issued 2.55 million shares in connection with the conversion.
Guidance, Outlook, Risks and Unusual Items
- Management expects already implemented renewal rate reductions to lower the aggregate cost of money by approximately 0.20% to 0.25% over the following twelve months and intends to make further adjustments in 2013. Continued low investment yields could offset these benefits.
- Large redemptions of callable government agency securities created excess liquidity and reinvestment risk. Management estimated foregone investment income of approximately $17.7 million in the quarter and $42.0 million year to date. Additional securities totaling approximately $1.9 billion were expected to become callable over the following twelve months.
- The company recorded a $17.5 million estimated liability related to mediation of a purported class action concerning annuity sales practices. No formal settlement had been reached, and the ultimate liability could change.
- Derivative and embedded-derivative fair values materially affect reported earnings. A 100-basis-point increase in the discount rate used for fixed index annuity embedded derivatives would reduce their fair value by approximately $232.6 million, partly offset by lower amortization of deferred costs; a 100-basis-point decrease would have the opposite effect.
- Investment risks include interest-rate changes, credit deterioration, other-than-temporary impairments, mortgage loan losses, reinvestment risk, and exposure to European and other international issuers. Gross unrealized investment losses declined to $83.8 million from $178.9 million at year-end 2011.
- Commercial mortgage loans totaled $2.76 billion of principal outstanding. The portfolio included $44.4 million in workout loans and $36.0 million of collateral-dependent loans; management reported no loans delinquent by 60 days or more at September 30, 2012.
- The filing states that insurance subsidiaries had adequate cash flows for policyholder and other obligations. Parent-company cash was $15.6 million, and management expected available subsidiary distributions and other resources to fund parent requirements through the end of 2012, subject to regulatory and rating-agency restrictions.
- The company adopted revised insurance acquisition-cost guidance prospectively on January 1, 2012. The change increased expense by $2.2 million in the quarter and $7.2 million year to date, reducing after-tax earnings by approximately $1.5 million and $4.6 million, respectively.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Confirm the issuer identity, because the supplied filing is for American Equity Investment Life Holding Company rather than American National Group Inc.
- Reconcile GAAP net income with non-GAAP operating income and isolate the effects of derivative fair-value changes, unlocking, litigation accruals, and the accounting-rule adoption.
- Assess whether lower yields and callable-bond reinvestment pressure will continue to narrow investment spreads.
- Review annuity deposit trends, surrender activity, crediting-rate actions, and the sustainability of policyholder liabilities and cash flows.
- Evaluate the credit quality, unrealized losses, OTTI exposure, and international concentration of the investment portfolio.
- Monitor the Los Angeles annuity-practices litigation, including settlement status and potential changes to the $17.5 million accrued liability.
- Verify statutory capital, dividend capacity, risk-based capital requirements, and restrictions on upstreaming cash from insurance subsidiaries.