Business Context and Reporting Period
American Equity Investment Life Holding Company and subsidiaries filed this unaudited Form 10-Q for the three months ended March 31, 2013. The filing identifies the registrant as American Equity Investment Life Holding Company, not American National Group Inc. The company primarily sells individual deferred annuities and, to a lesser extent, life insurance policies.
The company reported that deferred annuity deposits are generally recorded as policyholder deposit liabilities rather than revenue. Earnings are driven principally by investment income, investment spreads, annuity charges, realized investment gains or losses, and changes in derivative values.
Key Financial Metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenues | $735.2 million | $599.7 million | Up 22.6% |
| Income before income taxes | $39.5 million | $16.1 million | Up 145% |
| Net income | $26.0 million | $10.5 million | Up 148% |
| Diluted earnings per share | $0.38 | $0.16 | Up $0.22 |
| Operating income | $33.5 million | $29.8 million | Up 12% |
| Net income margin | 3.5% | 1.7% | Improved |
| Operating margin | 4.6% | 5.0% | Declined |
| Net investment income | $329.7 million | $326.9 million | Up 1% |
| Net cash from operating activities | $369.6 million | $457.7 million | Down $88.1 million |
Revenue benefited from higher derivative fair values, which increased to $374.0 million from $259.2 million, and higher investment income. Net realized investment gains were $10.6 million versus a $6.1 million loss in the prior-year quarter. Net other-than-temporary impairment losses recognized in operations were $3.2 million versus $2.9 million.
Interest-sensitive and index-product benefits increased to $225.8 million from $139.1 million. Amortization of deferred sales inducements increased 73% to $28.8 million, and amortization of deferred policy acquisition costs increased 35% to $46.2 million.
At March 31, 2013, total assets were $36.9 billion versus $35.1 billion at December 31, 2012. Total investments were $29.2 billion versus $27.5 billion, while cash and cash equivalents declined to $882.1 million from $1.27 billion. Stockholders’ equity was $1.73 billion versus $1.72 billion.
The investment portfolio was primarily fixed income securities, including $25.7 billion of fixed maturity securities and $2.6 billion of commercial mortgage loans. Approximately 94.1% of fixed maturity securities were investment grade based on NRSRO ratings; 98% were investment grade based on NAIC designations.
Notes payable were $313.0 million and subordinated debentures were $245.9 million at March 31, 2013. No borrowings were outstanding under the company’s $160 million revolving credit facility. Parent-company cash was $22.6 million.
Material Changes Versus the Prior Comparable Period
- Net income increased primarily because of higher derivative gains, higher realized investment gains, and growth in the annuity business.
- Operating income increased 12% to $33.5 million, reflecting higher investment spread in dollars and growth in annuity liabilities.
- Average annuity liabilities increased 13% to $28.1 billion from $24.8 billion.
- The investment spread declined to 2.68% from 2.93%, as the average investment yield fell to 5.01% from 5.61%, partly offset by a decline in the aggregate cost of money to 2.33% from 2.68%.
- Net annuity deposits after coinsurance were $887.3 million, up slightly from $880.7 million, although deposits before coinsurance ceded declined 5%.
- Fixed-index annuity deposits increased to $847.8 million from $777.5 million, while fixed-rate annuity deposits declined to $82.1 million from $202.0 million.
- Cash flow from investing activities changed to a use of $1.27 billion from a source of $1.15 billion, primarily because purchases of available-for-sale fixed maturity securities increased to $2.31 billion from $988.5 million.
- Comprehensive income was $0.9 million versus a comprehensive loss of $38.0 million, despite other comprehensive loss of $25.1 million in 2013.
- Mortgage-loan impairment losses declined to $1.1 million from $6.8 million. Mortgage loans in workout or collateral-dependent status represented less than 2% of the mortgage portfolio.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expects the low-interest-rate environment to continue at least through 2014. Lower reinvestment yields may pressure investment spreads, although crediting rates, caps, participation rates, and asset fees can generally be adjusted subject to contractual minimums.
- Management reported $1.3 billion of excess cash and other short-term investments at quarter-end, down from $2.2 billion at year-end 2012. A $678 million call of government agency securities in April 2013 was expected to temporarily interrupt the reduction in excess liquidity.
- Approximately 31% of fixed income securities had call features. Another 8%, or approximately $1.8 billion, was expected to become callable over the following twelve months, creating reinvestment risk.
- Interest-rate risk is significant. A modeled 10% increase in rates, equivalent to 31 basis points, would reduce the fair value of fixed maturity securities by approximately $687.3 million and reduce accumulated other comprehensive income and stockholders’ equity by approximately $219.5 million, subject to the model’s assumptions.
- Derivative and embedded-derivative valuations are highly sensitive to discount rates and market indices. A 100-basis-point increase in the discount rate used for fixed-index annuity embedded derivatives would reduce their fair value by approximately $261.8 million; a 100-basis-point decrease would increase it by approximately $291.9 million.
- The company recorded a $17.5 million estimated litigation liability related to a purported class action concerning annuity sales practices and suitability for purchasers over age 65. No formal settlement had been reached, and the estimate could change.
- On March 25, 2013, the company issued notice of mandatory redemption for its 2024 convertible notes. Holders converted $25.8 million principal amount before the April 30 redemption date; the remaining $2.5 million was to be redeemed for cash using parent cash and a potential draw on the revolving credit facility.
- Management stated that insurance subsidiaries had adequate cash flows to meet policyholder and other obligations and expected parent-company liquidity to fund reasonably foreseeable 2013 obligations. Distributions from insurance subsidiaries remain subject to statutory and regulatory restrictions.
- The company adopted new accounting disclosure requirements for reclassifications from accumulated other comprehensive income. Management reported no material changes in risk factors and concluded that disclosure controls were effective.
Most Important Facts for Investors to Verify
- Confirm the correct issuer and filing: the supplied filing is for American Equity Investment Life Holding Company, while the request metadata names American National Group Inc.
- Assess the sustainability of earnings excluding volatile derivative fair-value changes and realized investment gains or losses; operating income was $33.5 million compared with GAAP net income of $26.0 million.
- Monitor the 2.68% investment spread, declining portfolio yields, low interest rates, and the effect of future callable-security redemptions on reinvestment returns.
- Review the credit quality, unrealized losses, other-than-temporary impairments, and international exposure of the fixed maturity portfolio.
- Evaluate mortgage-loan credit performance, including $47.7 million of workout or collateral-dependent loans, $22.6 million of related allowances, and $73.0 million of unfunded commitments.
- Review the $17.5 million litigation accrual and the possibility of additional losses or settlement costs.
- Verify the cash requirements for the 2024 note redemption, the availability of the $160 million credit facility, and restrictions on distributions from insurance subsidiaries.