Business Context and Reporting Period
The filing is a Form 10-Q for American Equity Investment Life Holding Company and subsidiaries, not American National Group Inc. It covers the three and nine months ended September 30, 2016, with comparative periods ended September 30, 2015. The company primarily sells individual deferred annuities and, to a lesser extent, life insurance policies.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenues | $630.1 million | $127.0 million | $1,597.5 million | $977.1 million |
| Net income (loss) | $(7.4) million | $97.3 million | $(37.6) million | $186.1 million |
| Diluted EPS | $(0.09) | $1.19 | $(0.45) | $2.33 |
| Operating income (loss), non-GAAP | $(4.7) million | $45.9 million | $66.4 million | $145.7 million |
| Net cash from operating activities | Not separately provided | Not separately provided | $944.5 million | $71.1 million |
| Cash and cash equivalents | $812.8 million at September 30, 2016 | $397.7 million at December 31, 2015 |
- Net investment income increased 6% in the quarter to $463.6 million and 10% for the nine months to $1.37 billion, primarily from growth in invested assets.
- The aggregate investment spread declined to 2.57% in the quarter and 2.61% for the nine months, compared with 2.83% and 2.81%, respectively, in the prior-year periods. Average yields declined to 4.46% and 4.52% from 4.79% and 4.77%.
- Assets increased to $55.85 billion from $49.03 billion at December 31, 2015. Total investments increased to $45.81 billion from $39.57 billion.
- Stockholders' equity increased to $2.81 billion from $1.94 billion, principally reflecting $762.1 million of other comprehensive income, partly offset by the nine-month net loss.
- Policy benefit reserves increased to $50.81 billion from $45.50 billion.
Material Changes Versus the Prior Comparable Period
- Reported profitability deteriorated sharply: the company recorded net losses in both the quarter and nine months, compared with net income in the prior-year periods.
- Revenue benefited from favorable derivative fair-value changes. Derivative gains were $103.8 million in Q3 2016 versus a $351.4 million loss in Q3 2015; for the nine months, the company recorded a $68.8 million gain versus a $405.5 million loss.
- Embedded-derivative results also improved year over year but remained volatile. The related gain was $144.4 million in Q3 2016 and $694.6 million for nine months, compared with losses of $414.7 million and $583.1 million in the prior-year periods.
- Operating income declined despite growth in the in-force business. Management cited lower investment yields, lower spreads, and unfavorable assumption updates for deferred acquisition costs, deferred sales inducements, and living income benefit rider reserves.
- Gross annuity deposits before coinsurance decreased 16% in Q3 to $1.54 billion but increased 16% for nine months to $5.74 billion. Net deposits after coinsurance were $1.13 billion in Q3 and $4.27 billion for nine months.
- Fixed index annuity deposits declined 27% in Q3 and 5% for nine months, while multi-year guaranteed annuity deposits increased materially. Bank and broker-dealer fixed index annuity sales increased 97% in Q3 and 158% for nine months.
- The company settled forward sale agreements in August 2016, issuing 5.59 million shares and receiving $134.7 million of net proceeds, which were contributed to American Equity Life.
Debt, Liquidity, Outlook, Risks and Unusual Items
- On September 30, 2016, the company entered into a $100 million term loan maturing in 2019 and a $150 million unsecured revolving facility maturing in 2021. No revolving borrowings were outstanding at quarter-end. Notes and loan payable totaled $493.4 million, and subordinated debentures totaled $241.8 million.
- The credit agreement requires American Equity Life to maintain a minimum risk-based capital ratio of 275%, a maximum adjusted debt-to-total-adjusted-capital ratio of 0.35, and specified statutory surplus levels. The estimated RBC ratio was 327% at September 30, 2016, or 338% pro forma for the $100 million capital contribution made on October 3, 2016.
- Management expects the prolonged low-interest-rate environment to continue pressuring investment yields, spreads, and product profitability. Renewal rate adjustments on approximately $16 billion to $17 billion of account values began in September 2016 and are expected to reduce cost of money by approximately eight basis points when fully implemented. Additional adjustments on $7.4 billion of account values were scheduled to begin in December 2016.
- The Department of Labor fiduciary rule was identified as a significant business risk because a substantial portion of fixed index annuity sales involve qualified accounts and independent agents. Management was assessing compliance and product responses before the anticipated April 2017 effective date.
- Investment risks include interest-rate sensitivity, credit deterioration, impairment losses, reinvestment risk, and exposure to energy, metals and mining, structured securities, and international issuers. The company recorded $13.1 million of net OTTI losses for nine months, including $3.0 million in Q3.
- The company reported $184.9 million of gross unrealized losses on fixed maturity securities at September 30, 2016, versus $856.6 million at December 31, 2015, and concluded the losses were temporary. Approximately 96.2% of fixed maturity securities were investment grade based on NRSRO ratings.
- A 100-basis-point decrease in the discount rate used to value fixed index annuity embedded derivatives would increase the liability by approximately $532.7 million and increase combined deferred acquisition cost and sales inducement balances by approximately $313.5 million. A 100-basis-point increase would have the opposite effect, with different amounts disclosed by the company.
- The company reduced its litigation liability for the Los Angeles annuity sales-practices settlement by $6.4 million during the quarter and estimated the remaining liability at $4.7 million. Unfunded commitments included $110.1 million for mortgage loans, $58.8 million to limited partnerships, and $35.3 million to secured bank loans.
- Disclosure controls were deemed ineffective at September 30, 2016 because a previously reported material weakness in internal control over financial reporting remained outstanding. The weakness involved controls over implementation and review of code changes used to calculate lifetime income benefit reserves. Remediation procedures had been implemented but not tested for a sufficient period.
Investor Verification Priorities
- Confirm the registrant identity: the supplied filing is for American Equity Investment Life Holding Company, not American National Group Inc.
- Assess the sustainability of operating income excluding volatile derivative and embedded-derivative fair-value effects.
- Monitor investment spread compression, renewal-rate actions, new-money yields, and the effect of the low-rate environment on future profitability.
- Review fixed index annuity sales trends, coinsurance arrangements, and the potential impact of the Department of Labor fiduciary rule.
- Evaluate the sensitivity of earnings, equity, and reserves to interest rates, policyholder lapses, withdrawals, index performance, and embedded-derivative assumptions.
- Verify remediation and eventual resolution of the material weakness in internal control over financial reporting.
- Review credit quality, unrealized losses, OTTI activity, and concentrations in energy, metals and mining, structured securities, and international investments.
- Confirm compliance with the new credit agreement's RBC, leverage, and statutory-surplus covenants and the availability of dividends from the insurance subsidiary.