Business Context and Reporting Period
The filing is a Form 10-Q for American Equity Investment Life Holding Company, not American National Group Inc. It covers the three and nine months ended September 30, 2015, with comparative periods ended September 30, 2014. The company specializes in individual annuities, primarily deferred annuities, and also sells life insurance.
Results are materially affected by fair-value changes in derivatives and embedded derivatives associated with fixed-index annuities. Annuity deposits are generally recorded as deposit liabilities rather than revenue under GAAP.
Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net income | $97.3 million, versus $67.8 million | $186.1 million, versus $94.8 million |
| Diluted EPS | $1.19, versus $0.85 | $2.33, versus $1.19 |
| Total revenues | $127.0 million, versus $460.4 million | $977.1 million, versus $1.577 billion |
| Net investment income | $436.1 million, versus $386.9 million | $1.254 billion, versus $1.128 billion |
| Operating income | $45.9 million, versus $64.0 million | $145.7 million, versus $139.9 million |
| Operating spread | 2.83%, versus 2.82% | 2.81%, versus 2.77% |
| Operating cash flow | $71.1 million for nine months, versus $487.4 million |
Reported revenue declined sharply because 2015 included substantial losses from changes in the fair value of derivatives, while 2014 included substantial gains. Net income benefited from favorable changes in embedded-derivative valuations, lower index-credit expense and business growth. The effective tax rate was 34.6% for both the quarter and nine-month period.
At September 30, 2015, total assets were $47.1 billion, versus $44.0 billion at December 31, 2014. Total investments were $38.4 billion, versus $36.0 billion, and stockholders’ equity was $2.15 billion, versus $2.14 billion. Cash and cash equivalents were $523.6 million, versus $701.5 million.
Fixed maturity securities represented 92.4% of investments. Approximately 98% of the fixed maturity portfolio was investment grade under NAIC designations. Gross unrealized losses on fixed maturity securities increased to approximately $498.4 million from $156.0 million at year-end, primarily because of wider credit spreads; management concluded the losses were generally temporary.
Notes payable were $400.0 million and subordinated debentures were $246.4 million. The remaining $22.4 million principal amount of convertible 2015 notes matured and was extinguished on September 15, 2015, with total cash consideration of $48.2 million, including a $25.8 million conversion premium. The company had no borrowings under its $140 million revolving credit facility at September 30, 2015.
Material Changes Versus the Prior Comparable Period
- Net income increased 43% for the quarter and 96% for the nine-month period; diluted EPS increased to $1.19 and $2.33, respectively.
- Operating income decreased 28% for the quarter but increased 4% for the nine-month period.
- Net annuity deposits increased 67% for the quarter and 60% for the nine-month period, to $1.728 billion and $4.668 billion after coinsurance.
- Before coinsurance, annuity deposits increased 70% for the quarter and 63% for the nine-month period, driven primarily by fixed-index annuity sales.
- Average annuity liabilities increased 15% for the quarter and 14% for the nine-month period, while average invested assets increased 15% and 14%, respectively.
- Net investment income rose 13% for the quarter and 11% for the nine-month period, but average investment yields declined to 4.79% and 4.77% from 4.89% in the comparable periods.
- Interest-sensitive and index product benefits declined 50% for the quarter and 28% for the nine-month period, largely because of lower index credits.
- Operating cash flow fell substantially, while investing cash outflows increased to $3.627 billion from $2.198 billion, reflecting continued purchases of investments to support annuity growth.
- The company completed a common-stock offering in August 2015 and contributed $120 million to the capital and surplus of its primary life insurance subsidiary. The filing contains inconsistent share-count descriptions for the offering and forward-sale agreements that should be reconciled.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management expects continued growth in invested assets and operating income if strong annuity sales and retention continue, but cautions that low interest rates are a significant headwind.
- The company reduced new-money crediting rates by approximately 0.20% in March 2015 and began additional renewal-rate reductions. Management stated that approximately 0.56% of additional rate-reduction capacity remained before guaranteed rates would apply to the entire in-force book.
- Management’s 3.00% investment-spread target remains challenged by lower investment yields and narrower credit spreads. The reported aggregate spread was 2.81% for the first nine months.
- Approximately 99% of annuity liabilities were subject to annual discretionary crediting-rate adjustments, subject to minimum guarantees. Management noted that competitive conditions and policyholder behavior could limit the ability to preserve spreads.
- Fair-value accounting produced significant volatility: derivative losses were $405.5 million for the nine months, while embedded-derivative expense was $583.1 million. These amounts are not necessarily indicative of recurring operating performance.
- Deferred policy acquisition cost and deferred sales-inducement unlocking increased nine-month net income by $10.7 million. Revisions to living income benefit rider assumptions reduced nine-month net income by $11.8 million.
- The company recognized $6.2 million of net other-than-temporary impairment losses for the nine months, including a $4.9 million charge related to an other asset-backed security.
- An estimated $11.1 million litigation liability remained related to the Los Angeles annuity-practices settlement. The claims process was stayed pending appeal, and the ultimate liability remains uncertain.
- Unfunded commitments included $64.3 million of mortgage-loan commitments, $28.5 million to limited partnerships and $13.9 million to secured bank loans.
- Principal risks include interest-rate movements, spread compression, investment impairments, credit and liquidity risk, derivative-counterparty risk, annuity persistency and withdrawals, regulatory restrictions on subsidiary distributions, litigation, competition and changes in insurance or tax regulation.
- A 10% increase in interest rates from September 30 levels was estimated to reduce fixed-maturity fair value by approximately $859.9 million and reduce stockholders’ equity by approximately $283.4 million after tax and related adjustments.
Most Important Facts for Investors to Verify
- Confirm the issuer identity: the supplied filing is for American Equity Investment Life Holding Company, not American National Group Inc.
- Reconcile the inconsistent disclosures regarding the August 2015 equity offering: the notes describe 8.6 million shares, while MD&A describes 9.89 million shares and different forward-sale quantities.
- Assess recurring operating earnings separately from volatile derivative and embedded-derivative fair-value changes, OTTI, unlocking and assumption revisions.
- Monitor investment spread performance, crediting-rate reductions, minimum guarantees and the effect of prolonged low interest rates.
- Review the increase in unrealized investment losses and the company’s conclusions regarding temporary versus other-than-temporary impairment.
- Evaluate liquidity and capital at the insurance subsidiary, including statutory capital, risk-based capital, dividend capacity and credit-facility covenants.
- Track the Los Angeles litigation appeal and the adequacy of the $11.1 million recorded liability.