Business Context and Reporting Period
The provided filing is American Equity Investment Life Holding Company’s Form 10-K for the fiscal year ended December 31, 2011, filed February 29, 2012. The request metadata identifies American National Group Inc.; that does not match the registrant named in the filing and should be verified.
The company operates primarily as an insurer and underwriter of fixed index and fixed rate annuities, with a smaller life insurance business. It sells through approximately 60 national marketing organizations and 22,000 independent agents in all 50 states and the District of Columbia. The filing includes unaudited fourth-quarter 2011 results.
Financial Performance and Key Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total revenues | $1.140 billion | $1.286 billion | Down 11% |
| Income before income taxes | $132.9 million | $65.3 million | Up 104% |
| Net income | $86.2 million | $42.9 million | Up 101% |
| Diluted earnings per share | $1.37 | $0.68 | Up 101% |
| Operating income | $133.7 million | $108.9 million | Up 23% |
| Operating income per diluted share | $2.12 | $1.70 | Up 25% |
| Net cash provided by operating activities | $277.8 million | $420.5 million | Down 34% |
- Annuity deposits before coinsurance ceded were $5.090 billion, up 9% from $4.669 billion; net deposits after coinsurance ceded were $4.764 billion, up 14%.
- Net investment income increased 18% to $1.219 billion, driven by growth in invested assets and the annuity portfolio.
- The aggregate investment spread was 3.03%, compared with 3.15% in 2010. Average invested-asset yield declined to 5.80% from 6.06%, while aggregate cost of money declined to 2.77% from 2.91%.
- Total assets increased to $30.875 billion from $26.427 billion. Total investments increased to $24.383 billion from $19.817 billion.
- Policy benefit reserves increased to $28.119 billion from $23.656 billion, primarily reflecting additional annuity sales.
- Stockholders’ equity increased to $1.409 billion from $938.0 million, substantially aided by higher unrealized investment gains. Accumulated other comprehensive income increased to $457.2 million from $81.8 million.
- Cash and cash equivalents were $405.0 million at year-end, compared with $597.8 million at year-end 2010. Cash used in investing activities was $3.606 billion, while financing activities provided $3.135 billion.
Fourth-Quarter 2011 Results
| Metric | Q4 2011 | Q4 2010 |
|---|---|---|
| Total revenues | $422.7 million | $484.4 million |
| Net income | $49.7 million | $9.0 million |
| Diluted earnings per share | $0.79 | $0.14 |
| Net investment income | $324.3 million | $277.9 million |
Fourth-quarter revenue was affected by volatile fair-value changes in derivatives and embedded derivatives, as well as investment impairment and realized investment results. The filing does not provide a separate fourth-quarter operating-income measure.
Material Changes Versus Prior Comparable Period
- Net income more than doubled, while operating income rose 23%, reflecting growth in annuity account values, higher investment spread dollars, lower operating expenses and the absence of the $48 million class-action settlement accrual recorded in 2010.
- Investment spread dollars increased to $585.9 million from $502.9 million, despite percentage spread compression.
- Derivative fair-value results reversed from a $168.9 million gain in 2010 to a $114.7 million loss in 2011. The corresponding embedded-derivative result changed from a $131.0 million expense to a $105.2 million benefit.
- Net other-than-temporary impairment losses recognized in operations increased to $34.0 million from $23.9 million, primarily from residential mortgage-backed securities.
- Net realized investment results changed from a $23.7 million gain to an $18.6 million loss, including a $30.8 million increase in mortgage-loan credit-loss allowances.
- Other operating costs declined 41% to $67.5 million, principally because 2010 included the class-action settlement accrual.
- The company reduced crediting rates for new and existing annuities in the fourth quarter in response to low interest rates. New-sale rates were reduced by approximately 0.40% to 0.50%; renewal reductions began in November 2011 and were expected to benefit 2012 spreads progressively.
Debt, Liquidity, Capital and Outlook
- Notes payable were $297.6 million and subordinated debentures were $268.6 million at December 31, 2011. The company repurchased $46.3 million principal amount of 2024 notes in December 2011.
- A new $160 million revolving credit facility was entered into during 2011 and was fully available at year-end; no borrowings were outstanding.
- American Equity Life had statutory capital and surplus plus asset valuation reserve of approximately $1.597 billion and an NAIC risk-based capital ratio of 346%, above the 275% covenant threshold.
- American Equity Life could distribute up to $195.5 million in dividends to the parent in 2012 without prior approval, subject to statutory and regulatory restrictions.
- Management expected to maintain an investment spread of 2.90% or more and continue growing invested assets and operating income, subject to sales, capital, rating and market conditions.
- Approximately 96% of annuity liabilities were subject to surrender penalties, with a weighted-average remaining surrender-charge period of 10.2 years and a weighted-average surrender-charge rate of 15.5%.
- Approximately 93.4% of fixed-maturity securities were investment grade based on NRSRO ratings; the filing also reports 98% investment grade based on NAIC designations. Total fixed-maturity securities were $21.108 billion at year-end.
Risks, Contingencies and Unusual Items
- Low interest rates and callable securities create reinvestment risk and may compress investment spreads. Management reported that 22% of fixed-income securities, approximately $4.3 billion, would become callable during 2012.
- Interest-rate sensitivity is material: a modeled 10% increase in market interest rates, equivalent to 29 basis points, was estimated to reduce fixed-maturity fair value by approximately $540 million and stockholders’ equity by approximately $154.9 million.
- The investment portfolio remains exposed to credit deterioration, residential mortgage-backed securities, commercial mortgage loans, impairments and valuation uncertainty. Commercial mortgage loans totaled $2.823 billion, with a $33.0 million allowance for credit losses.
- The company remains liable to policyholders for ceded business if reinsurers default. Coinsurance deposits were approximately $1.1 billion with EquiTrust and $1.7 billion with Athene, an unauthorized Bermuda reinsurer whose obligations are supported by a funds-withheld trust structure.
- Derivative and embedded-derivative fair-value accounting can cause substantial volatility in reported GAAP earnings. Fixed-index-annuity embedded-derivative liabilities were $2.530 billion at year-end.
- A purported class-action lawsuit alleges improper sales practices involving deferred annuities sold to individuals over age 65. No class had been certified, and management could not estimate a probable loss or range of loss.
- A prior-period error involving single-premium immediate-annuity reserves was corrected in 2011, increasing 2011 net income by $2.7 million; management concluded the error was not material to prior periods.
- Beginning January 1, 2012, new accounting guidance on deferred policy acquisition costs was to be applied prospectively. Management estimated that 2011 net income would have been $80.1 million, rather than $86.2 million, under the new definition.
- Financial-strength ratings were A- with a stable outlook from A.M. Best and BBB+ with a stable outlook from Standard & Poor’s. A downgrade could reduce sales, increase surrenders and raise capital or reinsurance costs.
Important Facts for Investors to Verify
- Verify the registrant identity: the supplied filing is for American Equity Investment Life Holding Company, not American National Group Inc.
- Reconcile GAAP net income of $86.2 million with operating income of $133.7 million and review the recurring versus nonrecurring derivative, impairment and investment adjustments.
- Assess whether the 3.03% investment spread and management’s 2.90% or greater target can be sustained as portfolio yields decline and callable securities are reinvested.
- Review statutory capital, RBC requirements, dividend capacity and the effect of continued annuity growth on capital needs and ratings.
- Evaluate credit exposure in residential mortgage-backed securities and commercial mortgage loans, including the increase in mortgage-loan allowances and impaired or workout loans.
- Review reinsurance counterparty exposure and the company’s continuing liability to policyholders for ceded obligations.
- Monitor the pending annuity sales-practices litigation because the filing provides no estimable loss range.
- Consider the sensitivity of earnings, equity and reserves to interest rates, credit spreads, persistency, surrender behavior, index performance and fair-value assumptions.