Athene Holding Ltd. annual report, FY2016

Athene Holding Ltd. 2016 Form 10-K Summary

Business context and reporting period

Athene Holding Ltd. is a Bermuda-based retirement services company that issues, reinsures and acquires fixed annuities, including fixed indexed annuities (FIAs), fixed-rate annuities and payout annuities. Its principal reportable segment is Retirement Services; Corporate and Other includes corporate activities and German operations. This Form 10-K covers the fiscal year ended December 31, 2016, with comparative information for 2015 and 2014. Athene completed its Class A common share IPO in December 2016.

Key financial metrics

Metric	2016	2015	Change
Total revenues	$4.107 billion	$2.616 billion	+57%
Income before income taxes	$753 million	$592 million	+$161 million
Net income available to AHL shareholders	$805 million	$562 million	+43%
Operating income, net of tax	$760 million	$740 million	+3%
Net investment income	$2.916 billion	$2.508 billion	+16%
Operating ROE excluding AOCI	12.5%	15.6%	Down
Total assets	$86.720 billion	$80.854 billion	+7%
Investments, including related parties	$72.433 billion	$64.525 billion	+12%
Total AHL shareholders’ equity	$6.905 billion	$5.362 billion	+29%
Reserve liabilities	$70.951 billion	$65.271 billion	+9%

GAAP diluted EPS was $4.21 for Class A shares; basic EPS was $4.31. The effective tax rate was negative 7%, primarily because Athene released $102 million of deferred tax valuation allowance after identifying a tax plan supporting realization of U.S. tax attributes.

Cash flow, margins, debt and liquidity

Net cash provided by operating activities was $1.199 billion, compared with $1.049 billion in 2015.
Investing activities used $2.602 billion, mainly reflecting investment purchases exceeding sales, maturities and repayments. The company also purchased approximately $1.1 billion of primarily non-agency RMBS from Apollo Commercial Real Estate Finance in the third quarter.
Financing activities provided $1.155 billion, supported by $5.791 billion of deposits on investment-type policies and contracts, partially offset by $4.617 billion of withdrawals.
Cash and cash equivalents, including consolidated VIE cash, declined by $261 million to approximately $2.459 billion at year-end.
The deferred annuity investment margin increased to 2.77% from 2.45%, reflecting a 4.73% net investment earned rate versus a 1.96% cost of crediting.
Athene had no financial leverage and no borrowings outstanding under its $1.0 billion revolving credit facility. FHLB funding agreements outstanding totaled $691 million.
Liquid assets available for liquidity monitoring were approximately $44.0 billion. Management reported more than $1.5 billion of capital in excess of its current operating needs.

Material changes versus the prior comparable period

Organic premiums and deposits increased to $9.258 billion from $4.313 billion. FIA deposits rose to $5.322 billion from $2.808 billion, while fixed-rate annuity deposits increased to $3.565 billion from $883 million.
Retail fixed annuity sales increased to $5.3 billion from $2.5 billion, and flow reinsurance deposits rose to $3.5 billion from $1.1 billion.
Reserve liabilities increased 9% to $71.0 billion, primarily reflecting strong new deposits and growth in the annuity book.
Investment-related gains improved to $652 million from a $430 million loss, primarily due to favorable equity-index hedging results, tightening credit spreads and changes in reinsurance embedded derivatives.
Benefits and expenses increased to $3.354 billion from $2.024 billion. Interest-sensitive contract benefits increased to $1.293 billion, and future policy and other policy benefits increased to $1.043 billion.
Annual assumption unlocking was unfavorable by approximately $158 million across rider reserves and DAC, DSI and VOBA, compared with a $24 million benefit in 2015. Higher persistency, lower projected investment returns and growth in the FIA block contributed to the adverse adjustment.
Retirement Services operating income increased to $809 million from $769 million, while Corporate and Other operating loss widened to $49 million from $29 million.
The U.S. RBC ratio declined to 478% from 552%, primarily because capital was deployed to support organic growth. ALRe’s BSCR ratio was 228%; the company cautions that the 2015 and 2016 BSCR ratios are not directly comparable because of a change to the Bermuda capital framework.
Gross unrealized losses on available-for-sale fixed maturity securities declined to $636 million from $1.274 billion. Net OTTI losses were $30 million in both years.

Guidance, outlook, commentary and unusual items

Management expects organic deposits and withdrawal experience in the near-to-mid-term to be broadly similar to 2016, assuming acceptable pricing, stable ratings, no significant market disruption and no material regulatory impact.
Athene targets mid-teen returns for organic growth and higher returns for inorganic transactions, but states it will not sacrifice profitability solely to increase market share.
Management expects to pursue retail, flow reinsurance, funding agreements, pension risk transfer transactions and selective acquisitions or block reinsurance.
The company expects an annual investment margin of approximately 2% to 3% over the 7.8-year weighted-average life of its deferred annuities.
A proposed AGER equity offering was intended to raise at least €1 billion from third parties to support European expansion. If completed, Athene expected its German business to become an alternative investment rather than remain consolidated, while retaining a preferred reinsurance relationship. The filing does not establish that the offering was completed.
The Department of Labor fiduciary rule was expected to affect distribution of FIAs and other annuities sold to retirement accounts. Management was preparing for the April 2017 applicability date while anticipating possible delay or modification.
Unusual 2016 items included a $102 million deferred tax valuation allowance release, $79 million of stock-based compensation expense, $22 million of integration, restructuring and other non-operating expenses, and $30 million of net OTTI losses.
Two putative class actions and regulatory or unclaimed-property matters were outstanding. Management stated that no legal proceeding was believed to be material, but reasonably possible losses in certain matters could not be estimated.

Principal risks and contingencies

Results depend heavily on assumptions for interest rates, investment yields, policyholder persistency, surrender activity, mortality, rider utilization and reserve adequacy. Adverse experience could require higher reserves, DAC or VOBA amortization and lower capital or earnings.
The investment portfolio includes material exposures to structured securities, RMBS, CLOs, mortgage loans, real estate-related assets, alternative investments and relatively illiquid assets. Management reported 27% of invested assets in real estate-related assets and $3.4 billion in alternative investments.
Interest-rate changes may reduce investment spreads, affect surrender behavior, depress fixed-income values or create asset-liability mismatches. A 25-basis-point immediate rate increase was estimated to increase pre-tax earnings by $5 million at year-end; a 10% decline in public equity prices was estimated to reduce pre-tax earnings by $118 million.
Reinsurance creates counterparty risk. Reinsurance recoverables totaled $6.001 billion, including $3.914 billion from Global Atlantic and $1.723 billion from Protective. Athene remains legally responsible for policyholder obligations if reinsurers fail to perform.
Athene relies extensively on Apollo and its affiliates for investment management, sub-advisory services and acquisition support. Apollo-related fees totaled $368.3 million in 2016, and the Apollo Group controlled 45% of total voting power.
Dividend capacity is constrained by insurance regulation, capital requirements and contractual restrictions. AAIA’s dividend capacity was considered zero through August 15, 2018 without regulatory approval; German subsidiaries had no distributable amount at year-end.
The company previously identified material weaknesses in internal control over financial reporting related to actuarial balances and income taxes. Management assessed these matters as significant deficiencies at December 31, 2016, and the company was not yet required to provide a Section 404 management assessment or auditor attestation because of its newly public company transition period.
Pending matters include class-action litigation involving captive reinsurance and the Aviva USA acquisition, structured settlement annuity litigation, IRS disputes concerning FIA hedge deductions and a multi-state unclaimed-property examination.

Investor verification points

Verify the sustainability of the 2016 earnings increase, particularly the contribution from derivative gains, tightening credit spreads, alternative investment fair-value changes and the deferred tax valuation allowance release.
Reconcile GAAP net income of $805 million with operating income of $760 million and assess whether non-GAAP adjustments appropriately represent recurring earnings.
Review the assumptions underlying the $1.9 billion GLWB and GMDB liability, $5.3 billion of FIA embedded derivative liabilities and the unfavorable 2016 reserve and DAC/VOBA unlocking.
Assess asset quality using both NAIC and NRSRO classifications; the filing reports 93.2% of fixed maturity securities as NAIC 1 or 2, but 18.9% as below investment grade under NRSRO ratings.
Monitor U.S. RBC, ALRe BSCR and ALRe RBC ratios, including the effect of regulatory methodology changes and continued balance-sheet growth.
Review liquidity under severe surrender, collateral-call and market-stress scenarios, including $962 million of unfunded investment commitments and $2.507 billion of restricted assets.
Evaluate Apollo-related fees, conflicts, sub-advisory arrangements, related-party investment purchases and the proposed changes to investment-management termination rights and fee schedules.
Track the outcome of the AGER offering, DOL fiduciary-rule developments, pending litigation, IRS tax disputes and unclaimed-property examinations.