Business context and reporting period
The supplied filing is American Equity Investment Life Holding Company’s Form 10-K for the fiscal year ended December 31, 2015, filed February 26, 2016. It is not an American National Group filing. The company operates primarily as a seller of fixed-index and fixed-rate annuities through its insurance subsidiaries, with a smaller life-insurance business.
The filing reports annual 2015 results and unaudited fourth-quarter information. The business had approximately 35,000 independent agents under contract, 490 full-time employees and licenses in all 50 states and the District of Columbia.
Key financial metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total revenues | $1.519 billion | $2.169 billion | Down 30% |
| Net income | $219.8 million | $126.0 million | Up 74% |
| Diluted EPS | $2.72 | $1.58 | Up 72% |
| Operating income, non-GAAP | $195.8 million | $190.6 million | Up 3% |
| Diluted operating EPS, non-GAAP | $2.42 | $2.39 | Up 1% |
| Net investment income | $1.692 billion | $1.532 billion | Up 10% |
| Annuity deposits before coinsurance | $7.084 billion | $4.185 billion | Up 69% |
| Net annuity deposits after coinsurance | $6.612 billion | $4.013 billion | Up 65% |
| Aggregate investment spread | 2.77% | 2.80% | Down 3 basis points |
| Average yield on invested assets | 4.73% | 4.90% | Down 17 basis points |
| Aggregate cost of money | 1.96% | 2.10% | Down 14 basis points |
| Operating cash flow | $504.8 million | $707.8 million | Down 29% |
Reported net income benefited materially from fair-value movements in derivatives and embedded derivatives. In 2015, derivative-related revenue was a $336.1 million loss, while the change in fair value of embedded derivatives was a $464.7 million benefit to expenses. These amounts are highly market-sensitive and make GAAP earnings volatile.
At December 31, 2015, total investments were $39.570 billion, total assets were $49.041 billion, policy benefit reserves were $45.495 billion, notes payable were $400.0 million, subordinated debentures were $246.5 million and stockholders’ equity was $1.945 billion. Cash and cash equivalents were $397.7 million, including $38.9 million at the parent company.
The fixed-maturity portfolio was 96.5% investment grade under the NRSRO presentation, while 3.5% was below investment grade. Gross unrealized losses increased to $856.6 million from $156.0 million, primarily because of wider credit spreads and weakness in energy and metals-and-mining sectors.
The company paid a $0.22 per-share dividend in 2015, compared with $0.20 in 2014. Book value per share was $23.83, compared with $27.93 at year-end 2014; book value excluding accumulated other comprehensive income increased to $21.36 from $18.52.
Material changes versus the prior comparable period
- Fixed-index annuity deposits increased substantially, to $6.792 billion from $3.999 billion. Fixed-index products represented 96% of gross annuity deposits.
- Average annuity liabilities outstanding increased 14% to $38.1 billion, and dollar investment spread increased to $924.8 million from $809.5 million.
- Investment yield declined as new investments were purchased at lower rates, but lower policy crediting costs partially offset the pressure. Management stated that the 2.77% spread remained below its 3.00% target.
- GAAP revenue declined because 2014 included a large positive derivative fair-value impact. The 2015 derivative loss was partially offset by a more favorable embedded-derivative adjustment.
- Interest-sensitive and index product benefits declined 34% to $968.1 million, primarily because index credits fell to $587.7 million from $1.097 billion. Lifetime income benefit rider expense increased to $121.5 million from $92.6 million.
- Deferred policy acquisition costs and deferred sales inducements increased to $2.905 billion and $2.232 billion, respectively, reflecting substantial new business growth and market-value adjustments.
- The company completed a common-stock offering. It received approximately $104.5 million of initial net proceeds and entered into forward-sale agreements with expected net proceeds of approximately $134.6 million if physically settled.
- All convertible notes were extinguished by 2015. Remaining notes payable primarily consisted of $400 million of 6.625% senior unsecured notes due 2021.
- Accumulated other comprehensive income fell to $201.7 million from $721.4 million, primarily due to the decline in unrealized investment gains.
Fourth-quarter 2015 information
For the quarter ended December 31, 2015, total revenues were $541.9 million and net income was $33.8 million, or $0.40 diluted EPS. Net investment income was $438.3 million. The quarter included a $69.3 million positive change in derivative fair value and $13.3 million of net OTTI losses recognized in operations.
Guidance, outlook, risks, contingencies and unusual items
- Management did not provide formal quantitative earnings guidance. It expects continued strong annuity sales but identified the prolonged low-interest-rate environment as a major headwind.
- Management may further reduce new-money and renewal crediting rates. Approximately 0.48% of average rate-reduction capacity remained before the minimum guaranteed rates would be reached for the entire in-force book.
- Approximately 99% of annuity liabilities were subject to annual discretionary crediting-rate adjustments, subject to contractual minimums. Rising rates could increase surrenders and force asset sales at losses; falling rates could compress reinvestment yields and spreads.
- The company recognized $19.5 million of net OTTI losses in 2015, primarily involving corporate securities with metals-and-mining exposure and an asset-backed security with energy exposure.
- Reinsurance creates counterparty and recapture risk. Coinsurance deposits were approximately $0.8 billion with EquiTrust and $2.4 billion with Athene. The company remains liable to policyholders if reinsurers fail to perform.
- The Hannover financing reinsurance arrangement produced a $480.7 million statutory reserve credit at year-end. The company may recapture the risks after June 30, 2016, and the agreement becomes punitive if not recaptured by the first quarter of 2018.
- American Equity Life’s risk-based-capital ratio was 336%, compared with 372% in 2014. Up to $241.3 million could be distributed by American Equity Life in 2016 without prior Iowa regulatory approval, subject to applicable restrictions.
- The company had an $11.1 million accrued litigation liability related to the settled Los Angeles annuity-practices class action. The Ninth Circuit affirmed the settlement in February 2016, after year-end.
- Management and KPMG identified a material weakness in internal control over financial reporting involving implementation of changes to lifetime income benefit reserve calculations. An immaterial after-tax error was corrected before issuance of the financial statements, but KPMG issued an adverse opinion on internal control effectiveness. Remediation was in progress and had not yet been deemed complete.
- Management’s reserve, derivative, deferred acquisition cost and lifetime-income-rider calculations depend on assumptions regarding interest rates, lapse rates, withdrawals, mortality, policy persistency and rider utilization. Changes in these assumptions can materially affect earnings and equity.
Most important facts an investor should verify
- Confirm the issuer identity: the supplied document is American Equity Investment Life Holding Company, not American National Group Inc.
- Reconcile GAAP net income with non-GAAP operating income and isolate the effect of derivative and embedded-derivative fair-value changes.
- Evaluate whether the 2.77% investment spread can recover toward management’s 3.00% target as portfolio yields decline and minimum crediting-rate constraints become more binding.
- Review the $856.6 million of unrealized investment losses, especially energy, metals and mining, structured securities and other below-investment-grade exposures.
- Assess liquidity under higher surrender scenarios, including the ability to fund approximately $2.77 billion of projected policyholder payments due within one year.
- Review reinsurance collateral, counterparty strength and the potential economic consequences of the Hannover recapture deadline.
- Monitor remediation and external-auditor conclusions regarding the material weakness in lifetime income benefit reserve controls.
- Verify the settlement liability, remaining litigation exposure and the effect of regulatory or Department of Labor fiduciary-rule changes on IRA-related annuity sales.