Business Context and Reporting Period
The provided filing is a Form 10-K for American Equity Investment Life Holding Company, not American National Group Inc. It covers the fiscal year ended December 31, 2012, with quarterly information for the quarter ended December 31, 2012. The company operates primarily through insurance subsidiaries selling fixed index and fixed rate annuities, with a smaller life insurance business, through approximately 60 national marketing organizations and more than 20,000 independent agents.
Key Financial Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Total revenues | $1.589 billion | $1.140 billion | +39% |
| Income before taxes | $86.0 million | $132.9 million | -35% |
| Net income | $57.8 million | $86.2 million | -33% |
| Diluted EPS | $0.89 | $1.37 | -35% |
| Operating income | $110.2 million | $133.7 million | -18% |
| Investment spread | 2.70% | 3.03% | -33 basis points |
| Net cash from operating activities | $784.3 million | $277.8 million | +182% |
Reported net income margin was approximately 3.6% of revenue, compared with approximately 7.6% in 2011. Operating income margin was approximately 6.9%, compared with approximately 11.7% in 2011. The filing presents operating income as a non-GAAP measure that excludes, among other items, investment gains and losses, derivative fair-value changes, and litigation reserves.
- Annuity deposits before coinsurance ceded were $3.947 billion, down 22% from $5.090 billion in 2011; net deposits after coinsurance ceded were $3.743 billion.
- Net investment income increased 6% to $1.287 billion, primarily because of growth in invested assets, while average investment yield declined to 5.28% from 5.80%.
- Total investments increased to $27.537 billion from $24.383 billion, and total assets increased to $35.133 billion from $30.875 billion.
- Policy benefit reserves increased to $31.774 billion from $28.119 billion.
- Total stockholders’ equity increased to $1.720 billion from $1.409 billion, aided by $229.6 million of other comprehensive income.
- Cash and cash equivalents were $1.269 billion at year-end, compared with $405.0 million at year-end 2011. The company also reported approximately $2.2 billion of excess cash and short-term investments during its liquidity discussion.
- Notes payable were $309.9 million and subordinated debentures were $245.9 million at December 31, 2012. No borrowings were outstanding under the $160 million revolving credit facility.
- For the fourth quarter, total revenues were $291.9 million and net income was $36.4 million, or $0.58 diluted EPS. Quarterly results were affected by volatile derivative fair-value changes and $9.4 million of fourth-quarter OTTI losses.
Material Changes Versus the Prior Comparable Period
- Sales declined materially because of the prolonged low-interest-rate environment, more aggressive competitor pricing, and policyholder purchases made ahead of rate reductions in 2011.
- The average amount of annuity liabilities outstanding increased 16% to $26.0 billion, supporting higher investment income and a $596.7 million dollar investment spread. However, the percentage spread narrowed from 3.03% to 2.70% as investment yields fell and excess liquidity earned low returns.
- The company received $4.6 billion of net redemption proceeds from callable U.S. government-sponsored agency securities and reinvested less aggressively because of low available yields. It purchased $948.9 million of such securities versus $4.3 billion of calls during 2012.
- Change in fair value of derivatives shifted to a $221.1 million gain from a $114.7 million loss in 2011, while change in fair value of embedded derivatives shifted to a $286.9 million expense from a $105.2 million benefit. These items materially increased reported revenue and expense volatility.
- Operating expenses included a $17.5 million estimated litigation liability, or approximately $9.6 million after tax and related offsets, associated with a purported class action concerning annuity sales practices.
- Effective January 1, 2012, the company adopted ASU 2010-26, which reduced the types of acquisition costs eligible for deferral. The change caused $9.1 million of additional costs to be expensed in 2012 and reduced net income by $5.8 million, or $0.09 per share.
- The company redeemed approximately $22 million of 8% convertible junior subordinated debentures; $20.6 million of principal was converted into common stock and the remaining securities were settled or scheduled to be settled in cash.
- Investment portfolio unrealized losses declined to $83.9 million from $178.9 million, while net OTTI losses recognized in operations declined to $14.9 million from $34.0 million.
Guidance, Outlook, Risks and Unusual Items
- Management expected the low-interest-rate environment to continue at least through 2014 and expected average excess cash and short-term investment balances to decline during 2013 as funds were reinvested into longer-term securities.
- Management reduced crediting rates on new and existing annuities and reduced rates on new sales by approximately 0.25% beginning with applications received after December 5, 2012.
- Key risks include further spread compression, reinvestment at lower yields, rising-rate disintermediation and policy surrenders, credit losses and OTTI, commercial mortgage loan defaults, derivative-counterparty exposure, adverse rating actions, reinsurance counterparty failure, regulatory changes, litigation, and limitations on access to capital.
- At December 31, 2012, 94.1% of fixed maturity securities were investment grade under NRSRO ratings; the filing also states that approximately 98% were investment grade under NAIC designations. The portfolio included $2.624 billion of commercial mortgage loans, with a $34.2 million loan-loss allowance.
- Approximately 96% of annuity liabilities were subject to surrender penalties, with a weighted-average remaining surrender-charge period of 9.9 years and a weighted-average surrender-charge rate of 15.4%.
- American Equity Life’s risk-based capital ratio was 332%, above the 275% covenant threshold. Up to $99.2 million could be distributed by American Equity Life in 2013 without prior regulatory approval, subject to statutory and contractual restrictions.
- Reinsurance exposure remains material: policy benefit reserves ceded were approximately $1.0 billion to EquiTrust and $1.9 billion to Athene. The company remains liable to policyholders if the reinsurers fail to perform.
- The filing states that management and the independent auditor concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2012.
Most Important Facts to Verify
- Verify the issuer identity: the source filing is for American Equity Investment Life Holding Company, while the request identifies American National Group Inc.
- Reconcile annual net income and operating income with the underlying derivative fair-value changes, OTTI, litigation accrual, and accounting-change effects.
- Assess whether the 2.70% investment spread can be maintained as legacy assets mature or are called and reinvested at lower yields.
- Review the composition, credit quality, unrealized losses, and impairment assumptions for corporate securities, residential mortgage-backed securities, and commercial mortgage loans.
- Evaluate liquidity under rising-interest-rate scenarios, including potential surrender activity and the need to sell investments at losses.
- Review the status and ultimate exposure of the purported class action and whether the $17.5 million accrual is sufficient.
- Assess reinsurance collectability and the company’s continuing liability for ceded policy obligations, particularly with respect to Athene.
- Confirm debt maturities, conversion features, covenant compliance, and the effect of potential dilution from convertible notes and warrants.