American Equity Investment Life Holding Company — FY2014 Form 10-K Summary
Filing identity: The supplied filing is for American Equity Investment Life Holding Company (NYSE: AEL), not American National Group Inc. The report covers the fiscal year ended December 31, 2014, with comparative data for 2013 and 2012. The filing was signed February 26, 2015.
Business context and reporting period
The company operates primarily through wholly owned life insurance subsidiaries and focuses on fixed index and fixed rate annuities, with a smaller life insurance business. It sells products in all 50 states and the District of Columbia through approximately 38 national marketing organizations, more than 30,000 independent agents, and expanding broker-dealer, bank and registered investment adviser channels. Fixed index annuities represented 96% of gross annuity deposits collected in 2014.
Key financial metrics
| Metric | 2014 | 2013 | Change or comment |
|---|---|---|---|
| Total revenues | $2.169 billion | $2.611 billion | Down 17%, primarily reflecting lower derivative fair-value gains |
| Net income | $126.0 million | $253.3 million | Down 50% |
| Operating income | $190.6 million | $163.4 million | Up 17%; non-GAAP measure |
| Diluted EPS | $1.58 | $3.38 | Down 53% |
| Net investment income | $1.532 billion | $1.384 billion | Up 11% from growth in invested assets |
| Investment spread | 2.80% | 2.72% | Improved, but below the 3.00% target |
| Average yield on invested assets | 4.90% | 4.98% | Declined as new investments carried lower yields |
| Aggregate cost of money | 2.10% | 2.26% | Improved through lower crediting rates |
| Net cash provided by operating activities | $707.8 million | $862.7 million | Down 18% |
| Cash and cash equivalents | $701.5 million | $897.5 million | Down $196.0 million |
| Total investments | $36.0 billion | $30.3 billion | Up 19% |
| Total assets | $44.0 billion | $39.6 billion | Up 11% |
| Policy benefit reserves | $39.8 billion | $35.8 billion | Up 11% |
| Stockholders’ equity | $2.140 billion | $1.385 billion | Up 55%, mainly from higher AOCI |
Gross annuity deposits were $4.185 billion, down 1% from 2013; net deposits after coinsurance were $4.013 billion, also down approximately 0.4%. Average annuity liabilities outstanding, net of coinsurance, increased 13% to $33.4 billion. Fixed index annuity deposits increased to $3.999 billion from $3.882 billion.
Comprehensive income was $801.2 million, compared with a comprehensive loss of $387.3 million in 2013, principally because accumulated other comprehensive income benefited from higher unrealized investment gains. Book value per share increased to $27.93 from $19.40, while book value per share excluding AOCI declined slightly to $18.52 from $18.75.
The investment portfolio was predominantly fixed income: $32.5 billion of fixed maturity securities, $2.4 billion of commercial mortgage loans, and $731.1 million of derivative instruments. Approximately 95.9% of fixed maturity securities were investment grade based on NRSRO ratings, and 98% were investment grade based on NAIC designations. Net unrealized investment losses declined to $156.0 million from $861.4 million.
Debt at December 31, 2014 included $421.7 million of notes payable and $246.2 million of subordinated debentures. The company had no borrowings under its $140 million revolving credit facility. Approximately $22.4 million principal amount of 3.50% convertible notes due September 2015 remained outstanding and was expected to be retired at maturity using available parent-company cash and resources. Parent-company cash was $61.1 million.
Material changes versus prior comparable period
- Net income declined substantially because 2013 benefited from $1.076 billion of derivative fair-value gains, compared with $504.8 million in 2014. The change is volatile and largely reflects index performance and interest-rate effects.
- Operating income increased despite lower GAAP net income, supported by higher investment spread dollars, larger annuity liabilities, lower amortization of deferred acquisition costs and sales inducements, and lower operating expenses.
- Net investment income increased, but average portfolio yield fell as the company reinvested at lower rates and held excess liquidity following calls of government agency securities.
- Interest sensitive and index product benefits rose 16% to $1.474 billion, including $1.097 billion of index credits and $92.6 million of lifetime income benefit rider costs.
- Deferred policy acquisition cost amortization fell 55% to $163.6 million, and deferred sales inducement amortization fell 48% to $131.4 million. Assumption unlocking increased 2014 net income by $31.0 million.
- The company retired $69.6 million of 2015 convertible notes and $36.2 million of 2029 convertible notes through exchanges, issuing cash and common stock. It also redeemed or converted the remaining 2029 notes outstanding, generating a $12.5 million pretax loss on debt extinguishment for the year.
- Accumulated other comprehensive income increased from $46.2 million to $721.4 million, primarily due to changes in the fair value of available-for-sale investments.
- The annual cash dividend increased to $0.20 per share from $0.18. No shares had been repurchased under the authorized 500,000-share repurchase program at year-end.
Guidance, outlook, risks and unusual items
Management provided no formal earnings guidance. It expects the low-interest-rate environment to remain a significant headwind in 2015. The company reduced renewal crediting rates, made modest new-money rate reductions in October 2014, and planned more extensive new-money reductions in early March 2015. Management stated that approximately 0.63% of average room remained to reduce rates before reaching minimum guarantees across the December 31, 2014 in-force book.
Management’s stated objectives are to grow annuity sales, improve operating efficiency, manage investment spreads and expand distribution channels. However, the company acknowledged that restoring its 3.00% investment-spread target may be difficult because of low investment yields, narrower credit spreads, competition and reinvestment risk.
- Interest-rate risk could reduce investment fair values, compress spreads, increase surrenders and create liquidity demands. A modeled 28-basis-point rate increase was estimated to reduce fixed maturity fair value by approximately $787.2 million and stockholders’ equity by approximately $249.9 million.
- Derivative and embedded-derivative fair-value accounting creates substantial earnings volatility. A 100-basis-point increase in the discount rate used for fixed index annuity embedded derivatives would reduce related reserves by $377.0 million; a 100-basis-point decrease would increase reserves by $421.9 million, before related deferred-cost effects.
- The company remains liable to policyholders if reinsurers fail to perform. Coinsurance deposits were approximately $0.9 billion with EquiTrust and $2.2 billion with Athene. Athene is an unauthorized Bermuda reinsurer, although ceded assets are held in trusts.
- Approximately 95% of annuity liabilities were subject to surrender penalties, with a weighted-average remaining surrender-charge period of 9.2 years. Rising rates could nevertheless increase policy surrenders and withdrawals.
- The Los Angeles annuity-practices class-action settlement remained subject to appeal. The recorded litigation liability was $11.1 million at December 31, 2014, and claims processing was stayed pending the appeal.
- Statutory capital remained strong: American Equity Life’s risk-based capital ratio was 372%, compared with 344% in 2013. Up to $343.3 million could be distributed to the parent without prior Iowa regulatory approval, subject to statutory and covenant constraints.
- The Iowa Insurance Division and New York Insurance Department had ongoing financial examinations of subsidiaries for prior examination periods. Management reported effective disclosure controls and internal control over financial reporting, and KPMG issued an unqualified audit opinion.
Most important facts for an investor to verify
- Confirm the issuer identity: the supplied filing is American Equity Investment Life Holding Company, not American National Group Inc.
- Reconcile GAAP net income of $126.0 million with non-GAAP operating income of $190.6 million and assess the recurring nature of the adjustments.
- Review the sustainability of the 2.80% investment spread relative to management’s 3.00% target under continued low rates.
- Analyze sensitivity to interest rates, policy surrenders, credit losses, option costs and changes in embedded-derivative assumptions.
- Review reinsurance counterparty exposure, trust collateral requirements and the company’s continuing primary liability to policyholders.
- Confirm repayment of the remaining 2015 convertible notes and the effect of debt extinguishments and share issuance on future diluted EPS.
- Review the status and ultimate cost of the appealed class-action settlement and other regulatory examinations.