Business Context and Reporting Period
This Form 10-Q was filed by American Equity Investment Life Holding Company, not American National Group Inc. It covers the three and six months ended June 30, 2012, with comparative periods ended June 30, 2011. The company specializes primarily in individual deferred annuities and, to a lesser extent, life insurance. The financial statements are unaudited and prepared under U.S. GAAP.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2012 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 |
|---|---|---|---|---|
| Total revenues | $193.0 million | $294.9 million | $792.7 million | $747.8 million |
| Income before taxes | $28.7 million | $27.9 million | $44.8 million | $76.2 million |
| Net income | $18.8 million | $18.3 million | $29.2 million | $49.6 million |
| Diluted earnings per share | $0.30 | $0.28 | $0.46 | $0.77 |
| Operating income | $27.4 million | $29.0 million | $57.1 million | $59.6 million |
| Net cash from operating activities | Not separately provided | Not separately provided | $500.4 million | $185.5 million |
- Net investment income increased 8% in the second quarter and 10% for the six-month period, reaching $320.3 million and $647.2 million, respectively.
- Annuity product charges increased 10% in the second quarter and 12% year to date, reaching $21.9 million and $41.3 million.
- The reported investment spread declined to 2.70% in the second quarter and 2.81% year to date, versus 3.05% and 3.10% in the comparable 2011 periods.
- Total assets were $33.1 billion at June 30, 2012, compared with $30.9 billion at December 31, 2011. Stockholders’ equity increased to $1.58 billion from $1.41 billion.
- Investments totaled $25.4 billion, including $22.0 billion of fixed maturity securities and $2.7 billion of commercial mortgage loans.
- Cash and cash equivalents were $1.41 billion at June 30, 2012, compared with $405.0 million at year-end 2011.
- Notes payable were $303.6 million and subordinated debentures were $256.1 million. No borrowings were outstanding under the $160 million revolving credit facility.
Material Changes Versus the Prior Comparable Period
- Second-quarter net income increased modestly, but six-month net income declined 41% primarily because of unfavorable fair-value changes in embedded derivatives and other non-core items.
- Operating income decreased 6% in the quarter and 4% year to date, reflecting lower investment spreads and higher operating costs.
- Annuity deposits before coinsurance declined 17% in the quarter and 23% year to date. Management attributed the decline to the low interest-rate environment, aggressive competitor pricing, and stronger 2011 sales ahead of a rate reduction.
- Average annuity liabilities increased 17% in the quarter and 18% year to date, supporting higher investment income despite lower investment yields.
- The average yield on invested assets declined to 5.34% in the quarter and 5.47% year to date, compared with 5.78% and 5.87% in 2011.
- Interest-sensitive and index product benefits declined 40% in the quarter and 29% year to date, primarily because of lower index credits.
- Net OTTI losses recognized in operations declined to $1.0 million for the quarter and $3.9 million year to date, versus $2.2 million and $8.8 million in 2011.
- Prospective adoption of revised policy acquisition-cost accounting increased operating expenses by $2.0 million in the quarter and $5.0 million year to date, reducing net income by $1.3 million and $3.1 million, respectively.
- In May 2012, the company issued notices for mandatory redemption of its 8% convertible junior subordinated debentures. As of June 30, $12.4 million of principal had been converted into common stock; an additional $8.2 million was converted in July 2012.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected the 2011 reductions in policyholder crediting rates to provide an additional 0.15% to 0.20% decline in aggregate cost of money during the remainder of 2012, although lower reinvestment yields could offset the benefit.
- Management expected elevated cash levels to persist because approximately $2.6 billion of fixed-income securities were expected to become callable during the following twelve months. This creates reinvestment risk in a low-rate environment.
- Approximately 98% of the fixed maturity portfolio was investment grade under NAIC designations. Gross unrealized losses declined to $124.9 million from $178.9 million at December 31, 2011.
- Commercial mortgage loans totaled $2.7 billion. Loans in workout, delinquent, or collateral-dependent status totaled approximately $106.5 million, and management warned that weakness in commercial real estate could produce losses exceeding recorded allowances.
- The company had $54.7 million of commitments to fund commercial mortgage loans. The mortgage loan allowance was $36.6 million at June 30, 2012.
- Derivative and embedded-derivative fair values create substantial earnings volatility. A 100-basis-point increase in the discount rates used for fixed-index-annuity embedded derivatives would reduce their fair value by approximately $195.5 million, with related effects on deferred costs.
- Major risks include interest-rate movements, investment impairments, credit and liquidity conditions, competition in annuity sales, policyholder withdrawals, regulatory changes, tax-law changes, and counterparty risk on derivatives.
- The company was defending a purported class action alleging improper sales practices involving annuity sales to persons over age 65. No class had been certified, and management could not estimate a loss or outcome.
- Management stated that parent-company liquidity should be adequate through the remainder of 2012. Parent cash was $12.8 million at June 30, 2012, and up to $195.5 million could be distributed by American Equity Life without prior regulatory approval, subject to statutory and contractual restrictions.
- 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 registrant identity: the supplied filing is for American Equity Investment Life Holding Company, rather than American National Group Inc.
- Reconcile GAAP net income with operating income and assess the effect of derivative and embedded-derivative fair-value changes.
- Monitor annuity deposit trends, investment spreads, crediting-rate actions, and the effect of continued low interest rates on reinvestment returns.
- Review the quality, duration, unrealized losses, and impairment risk of the fixed-income and residential mortgage-backed securities portfolios.
- Assess commercial mortgage loan workouts, troubled debt restructurings, foreclosures, delinquency trends, and adequacy of loss allowances.
- Review the pending annuity sales-practices litigation and any subsequent settlement or regulatory developments.
- Verify post-quarter-end conversion and cash settlement activity related to the subordinated debentures.