Business Context and Reporting Period
This Form 10-Q covers the quarter and six months ended June 30, 2015, for American Equity Investment Life Holding Company, not American National Group Inc. The company specializes in individual annuities, primarily deferred annuities, and also sells life insurance.
Results are unaudited and are not necessarily indicative of full-year 2015 performance. The company reported effective disclosure controls and no material changes to internal control over financial reporting.
Financial Performance and Position
| Metric | Three months ended June 30, 2015 | Six months ended June 30, 2015 |
|---|---|---|
| Total revenues | $441.1 million | $850.1 million |
| Income before income taxes | $126.6 million | $135.6 million |
| Net income | $82.8 million | $88.7 million |
| Diluted earnings per share | $1.05 | $1.12 |
| Operating income, non-GAAP | $50.9 million | $99.8 million |
| Net cash provided by operating activities | Not separately provided | $265.5 million |
- Net investment income was $418.2 million for the quarter and $817.8 million for the six months, supported by growth in annuity liabilities and invested assets.
- The aggregate investment spread was 2.84% for the quarter and 2.80% for the six months, compared with 2.70% and 2.74%, respectively, in the prior-year periods.
- Average invested assets excluding derivatives increased 14% for the quarter and 13% for the six months year over year. Average yield declined to 4.78% and 4.76%, respectively.
- Annuity deposits before coinsurance ceded were $1.8 billion for the quarter and $3.1 billion for the six months. Net deposits after coinsurance were $1.7 billion and $2.9 billion, respectively.
- Total assets were $46.2 billion at June 30, 2015, versus $44.0 billion at December 31, 2014. Stockholders’ equity declined to $1.9 billion from $2.1 billion, principally reflecting a $332.6 million after-tax other comprehensive loss.
- Cash and cash equivalents were $733.8 million at June 30, 2015. Operating cash flow was $265.5 million, investing cash flow was negative $2.25 billion, and financing cash flow was positive $2.02 billion for the six months.
- Notes payable were $422.2 million and subordinated debentures were $246.3 million. No borrowings were outstanding under the $140 million revolving credit facility.
- The fixed maturity portfolio totaled $34.0 billion and was 95.9% investment grade based on agency ratings; 98% was investment grade based on NAIC designations.
Material Changes Versus Prior Comparable Period
- Second-quarter net income increased 125% from $36.7 million to $82.8 million; six-month net income increased 229% from $27.0 million to $88.7 million.
- Operating income increased 32% for the quarter and 31% for the six months.
- Total revenues declined from $670.7 million to $441.1 million for the quarter and from $1.12 billion to $850.1 million for the six months, primarily because prior-year periods benefited from substantially larger derivative fair-value gains.
- Derivative fair-value results shifted from gains of $270.9 million in the second quarter of 2014 and $319.4 million in the first six months of 2014 to losses of $23.0 million and $54.1 million, respectively, in 2015.
- Embedded derivative results also shifted from income of $80.9 million for the second quarter of 2014 and $173.6 million for the first six months of 2014 to expenses of $219.6 million and $168.4 million in 2015. Management attributed the 2015 results primarily to higher discount rates and lower expected index credits.
- Interest sensitive and index product benefits decreased 17% for the quarter and 14% for the six months, while amortization of deferred sales inducements and deferred policy acquisition costs increased with business growth.
- Operating cash flow decreased from $395.4 million to $265.5 million, while net cash used in investing increased substantially because of higher purchases of fixed maturity securities.
- Other comprehensive income changed from income of $223.6 million in the second quarter of 2014 and $509.9 million in the first six months of 2014 to losses of $505.0 million and $332.6 million, respectively, mainly from lower unrealized investment gains.
Guidance, Outlook, Risks and Unusual Items
- No formal earnings guidance was provided. Management expects continued growth in invested assets and operating income but identified the low-interest-rate environment as a headwind to restoring the 3.00% investment-spread target.
- The company reduced new-money crediting rates by approximately 0.20% in March 2015 and began additional renewal-rate reductions. Management stated that approximately 0.57% of additional rate-reduction capacity remained before guaranteed rates would be reached across the in-force book.
- Management cited strong annuity sales, including effects from a competitor’s withdrawal of a guaranteed-income product, a temporary agent incentive program, product pricing, and demand for principal-protection products.
- Investment and market risks include interest-rate changes, credit spreads, defaults, impairments, reinvestment risk, derivative valuation volatility, policyholder withdrawals, competition, regulatory changes, and limits on the ability to adjust crediting rates.
- Gross unrealized losses on fixed maturity securities increased to $422.6 million from $156.0 million at December 31, 2014. Management concluded that the losses were temporary, but future impairment conclusions could materially affect earnings.
- The company reported $1.0 million of net other-than-temporary impairment losses for the six months and had $11.1 million accrued for the Los Angeles annuity sales-practices litigation. The claims process remained subject to an appeal and final liability could differ from the estimate.
- Commercial mortgage loans totaled $2.5 billion. Loans in workout, delinquent, or collateral-dependent status totaled approximately $22.6 million, including $6.8 million of loans delinquent by 60 days or more.
- The $22.4 million carrying amount of the 3.50% convertible senior notes due September 15, 2015 was expected to be extinguished using parent-company cash.
- The filing describes an August 2015 equity offering and forward-sale transactions. Note 9 describes 8.6 million shares plus 1.29 million option shares, while MD&A describes 9.89 million shares; investors should reconcile this apparent inconsistency.
- Subsequent to quarter-end, Standard & Poor’s and Fitch upgraded certain company and insurance-subsidiary ratings. The filing states that the equity offering would support general corporate purposes and insurance-subsidiary capital and surplus.
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 conflicting descriptions of the August 2015 equity offering, including total shares, forward-sale shares, proceeds, and settlement terms.
- Assess earnings quality by separating operating income from volatile derivative and embedded-derivative fair-value changes.
- Monitor investment spreads, portfolio yields, guaranteed crediting rates, and the effect of prolonged low interest rates.
- Review the $422.6 million unrealized-loss position, watch-list securities, below-investment-grade exposure, and future OTTI risk.
- Verify statutory capital, risk-based capital, dividend capacity, debt covenants, and the planned repayment of the 2015 convertible notes.
- Track developments in the Los Angeles litigation and the adequacy of the $11.1 million accrued liability.
- Evaluate annuity sales growth against liquidity, capital requirements, surrender activity, and the company’s ability to maintain desired financial-strength ratings.