Business Context and Reporting Period
Filing discrepancy: The supplied Form 10-K is for American Equity Investment Life Holding Company, not American National Group Inc. It covers the fiscal year ended December 31, 2018; the filing is not a quarterly report, although it includes unaudited fourth-quarter information.
The company operates one segment focused primarily on fixed index and fixed rate annuities, distributed through independent agents, broker/dealers, banks and registered investment advisors. Products emphasize principal protection, tax-deferred accumulation and guaranteed lifetime income.
Financial Performance and Key Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenues | $1.547 billion | $3.892 billion | Down 60% |
| Net income | $458.0 million | $174.6 million | Up 162% |
| Diluted EPS | $5.01 | $1.93 | Up 160% |
| Non-GAAP operating income | $425.7 million | $285.1 million | Up 49% |
| Net investment income | $2.148 billion | $1.992 billion | Up 8% |
| Operating cash flow | $43.2 million | $1.924 billion | Down materially |
Reported revenue declined primarily because 2018 included a $777.8 million loss from changes in derivative fair values, compared with a $1.678 billion gain in 2017. Changes in embedded derivative fair values also shifted to a $1.389 billion benefit in 2018 from a $919.7 million expense in 2017. These accounting effects make reported revenue and net income volatile and reduce period-to-period comparability.
- Annuity deposits: $4.405 billion before coinsurance and $3.992 billion after coinsurance, up 5% from 2017. Fixed index annuities represented 96% of deposits before coinsurance.
- Investment spread: 2.60%, down from 2.72%; average investment yield was 4.47% and aggregate cost of money was 1.87%.
- Annuity account value: $51.1 billion at year-end, up from $48.4 billion.
- Investments: $49.4 billion, down from $50.3 billion; 96.5% of fixed maturity securities were investment grade by NRSRO ratings.
- Policy benefit reserves: $57.6 billion, up from $56.1 billion.
- Stockholders’ equity: $2.399 billion, down from $2.850 billion, primarily reflecting a $904.6 million other comprehensive loss caused by lower unrealized investment values.
- Debt: Notes and loan payable were $494.6 million and subordinated debentures were $243.0 million. The company had no borrowings under its $150 million revolving credit facility.
- Liquidity: Parent-company cash and cash equivalents were $68.9 million. American Equity Life could distribute up to $325.2 million in dividends without prior regulatory approval, subject to applicable restrictions.
- Capital: American Equity Life’s risk-based capital ratio was 360%, compared with 378% in 2017.
- Dividend: Annual dividend increased to $0.28 per share from $0.26.
Material Changes Versus the Prior Comparable Period
- Net income and diluted EPS increased sharply, supported by higher investment income, growth in business in force, favorable assumption revisions and the lower federal corporate tax rate.
- Non-GAAP operating income increased 49%, providing a less volatile view of underlying performance than GAAP net income.
- The aggregate investment spread narrowed by 12 basis points as option costs for certain index strategies increased.
- Net operating cash flow fell to $43.2 million from $1.924 billion, partly because of changes in derivative collateral and other working-capital-related items.
- Unrealized investment losses increased substantially as interest rates and credit spreads rose. Accumulated other comprehensive income declined from a $724.6 million gain to a $52.4 million loss.
- Net other-than-temporary impairment losses increased to $36.7 million from $4.6 million.
- The company sold approximately $2.1 billion of lower-yielding securities, recognizing approximately $38 million of realized losses and $12 million of OTTI, to obtain an estimated 170-basis-point yield improvement on replacement investments.
- Interest expense declined following the 2017 refinancing of $400 million of 6.625% notes and repayment of a $100 million term loan, replaced with $500 million of 5.0% senior notes due 2027.
- Fourth-quarter 2018 net income was $53.8 million, compared with $36.8 million in the fourth quarter of 2017. Fourth-quarter revenue was negative $451.0 million, primarily because of derivative fair-value movements.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal earnings guidance. Management expects to continue growing invested assets and operating income while maintaining a predominantly investment-grade portfolio and managing investment spreads.
- Interest-rate and spread risk: Prolonged low rates may reduce investment yields and compress spreads; rising rates may increase surrenders, liquidity demands and realized losses on securities sold before maturity.
- Derivative and accounting volatility: Fair-value changes in call options and embedded derivatives can materially distort GAAP revenue and earnings. A 100-basis-point increase in the embedded-derivative discount rate would reduce the related reserve by approximately $504.5 million, while a 100-basis-point decrease would increase it by approximately $559.9 million.
- Investment and credit risk: Unrealized losses totaled approximately $1.351 billion at year-end, and future credit deterioration could produce additional impairments. Commercial mortgage loans totaled $2.943 billion; no loans were delinquent by 60 days or more at year-end.
- Reinsurance risk: The company remains liable to policyholders if Athene or EquiTrust fail to perform. Coinsurance deposits were approximately $4.4 billion with Athene and $0.6 billion with EquiTrust.
- Lifetime income benefit riders: The rider liability was $808.2 million. A 10% increase in the assumed election rate for the fee-based rider would increase the liability by approximately $102 million.
- Capital and regulatory risk: Dividend capacity depends on statutory surplus, risk-based capital requirements, ratings objectives and insurance-regulator approval thresholds.
- Competition and distribution: The company reported continued pressure from competing annuity products and a decline in overall fixed index annuity market rank from second in 2016 to sixth based on information available through September 2018.
- Other unusual items: The 2018 effective tax rate was 19.0%, benefiting from Tax Reform and a $7.4 million worthless-stock deduction. The company also recognized favorable assumption revisions that increased 2018 net income by approximately $82.8 million.
Important Facts for Investors to Verify
- Confirm that the intended issuer is American Equity Investment Life Holding Company rather than American National Group Inc.
- Reconcile GAAP net income with non-GAAP operating income and isolate derivative fair-value effects, realized investment losses and OTTI.
- Review the sharp decline in operating cash flow and the year-end cash and derivative-collateral balances.
- Assess whether the 2.60% investment spread can be maintained as option costs rise and investment yields remain sensitive to interest rates.
- Review unrealized losses, below-investment-grade exposure, watch-list securities and potential future impairments.
- Evaluate sensitivity of embedded derivative, lifetime income rider and deferred acquisition cost balances to discount rates, persistency, investment spreads and rider elections.
- Confirm reinsurance counterparty strength, trust collateral arrangements and the company’s continuing liability for ceded policy obligations.
- Review statutory capital, the 360% risk-based capital ratio, dividend restrictions and compliance with credit-facility covenants.
- Review pending or future litigation, regulatory examinations, annuity sales-practice requirements and evolving insurance regulation.