American National Group Inc. quarterly report, Q3 FY2018

Business Context and Reporting Period

Filing identity: The submitted filing is for American Equity Investment Life Holding Company, not American National Group Inc. It is an unaudited Form 10-Q for the quarter and nine months ended September 30, 2018, filed November 6, 2018.

The company specializes in individual annuities, primarily fixed index deferred annuities. Premium collections for deferred annuities are generally recorded as deposit liabilities rather than revenue.

Key Financial Metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Total revenues	$1.194 billion	$906.0 million	$1.998 billion	$2.652 billion
Income before taxes	$207.7 million	$86.8 million	$499.5 million	$208.5 million
Net income	$169.3 million	$57.0 million	$404.2 million	$137.8 million
Diluted EPS	$1.85	$0.63	$4.42	$1.53
Non-GAAP operating income	$171.1 million	$87.2 million	$335.4 million	$210.5 million
Net investment income	$549.4 million	$500.2 million	$1.593 billion	$1.479 billion
Net cash from operating activities	—	—	$586.2 million	$1.266 billion

Net income margin was approximately 14.2% in Q3 2018 versus 6.3% in Q3 2017, and 20.2% for the first nine months versus 5.2% in the prior-year period. Revenue comparisons were materially affected by changes in derivative fair values.

Net annuity deposits increased 12% in Q3 to $934.5 million and 1% for the nine months to $2.948 billion.
Average net annuity account balances increased 6% in Q3 to $50.3 billion and 7% for the nine months to $49.5 billion.
Investment spread was $309.0 million in Q3 and $893.9 million for the nine months, versus $290.1 million and $855.6 million, respectively, in 2017.
Aggregate investment spread declined to 2.67% in Q3 and 2.62% for the nine months, versus 2.70% in both prior-year periods.
Average invested assets excluding derivatives increased 7% in Q3 to $48.5 billion and 8% for the nine months to $47.7 billion.

Financial Position, Debt and Liquidity

Total assets were $63.449 billion at September 30, 2018, up from $62.031 billion at December 31, 2017.
Total investments were $50.618 billion, including $45.822 billion of available-for-sale fixed maturity securities and $2.892 billion of commercial mortgage loans.
Cash and cash equivalents were $1.129 billion, down from $1.434 billion at year-end 2017.
Policy benefit reserves were $57.992 billion, compared with $56.143 billion at December 31, 2017.
Stockholders’ equity was $2.489 billion, down from $2.850 billion, primarily reflecting a $781.9 million decline in accumulated other comprehensive income from unrealized investment losses.
Debt included $494.5 million of senior notes due 2027 and $242.9 million of subordinated debentures. Repurchase-agreement borrowings were $116.4 million at quarter-end.
The parent company held $68.9 million of cash and had an undrawn $150 million revolving credit facility available through September 2021.
Estimated risk-based capital ratio was 386% at September 30, 2018, compared with 378% at December 31, 2017.
The company reported adequate insurance-subsidiary cash flows to meet policyholder and other obligations. Net cash from annuity deposits after policyholder returns was $952.3 million for the first nine months, down from $1.1 billion in 2017.

Material Changes Versus the Prior Comparable Period

Net income rose 197% in Q3 and 193% for the first nine months; diluted EPS increased from $0.63 to $1.85 and from $1.53 to $4.42, respectively.
Non-GAAP operating income increased 96% in Q3 and 59% for the nine months.
Net investment income grew 10% in Q3 and 8% for the nine months, driven primarily by growth in annuity business and invested assets.
Change in fair value of derivatives increased to $595.3 million in Q3 from $362.5 million, but declined to $276.4 million for the nine months from $1.016 billion.
Change in fair value of embedded derivatives was a $383.7 million expense in Q3 and a $585.5 million benefit for the nine months, compared with a $229.7 million expense and $628.8 million benefit, respectively, in 2017.
Net realized investment losses were $2.2 million in Q3 and $40.3 million for the nine months, versus gains of $1.6 million and $7.8 million in the comparable periods.
Net other-than-temporary impairment losses recognized in operations increased to $14.4 million in Q3 and $17.7 million for the nine months, versus $0.5 million and $1.6 million.
The company sold approximately $1.6 billion of securities during the first nine months to replace lower-yielding assets; related realized losses were approximately $38 million. It sold another $384 million in book value in early October and recognized approximately $12 million of OTTI based on its intent to sell at September 30.
Interest expense declined because the company replaced higher-cost 2021 notes and a $100 million term loan with 5% 2027 senior notes.
Effective tax rates fell to 18.5% in Q3 and 19.1% for the nine months from 34.4% and 33.9%, reflecting Tax Reform and a $7.4 million worthless-stock deduction.

Outlook, Commentary, Risks and Unusual Items

Management described annuity sales conditions as highly competitive, with strong equity markets and competitor pricing pressuring fixed index annuity sales. New products launched in 2018 supported sales growth.
Management continues to face a prolonged low-interest-rate and low-yield environment, although yields on new investments increased and the company is pursuing higher-yielding, less-liquid asset classes.
The company can reduce policy crediting rates toward guaranteed minimums, potentially lowering its cost of money by approximately 65 basis points, but competitive conditions may limit this flexibility.
Approximately 99% of annuity liabilities were subject to annual crediting-rate adjustment, while approximately 14% were already at minimum guaranteed rates.
The investment portfolio remained predominantly investment grade: 96.3% of fixed maturity securities were investment grade under agency ratings, and 97% under NAIC designations.
Unrealized losses on available-for-sale fixed maturity securities increased substantially, principally due to higher interest rates and somewhat wider credit spreads. Management concluded the losses were temporary, but future impairments remain possible.
Derivative and embedded-derivative fair values create significant earnings volatility. A 100-basis-point increase in the discount rate used for embedded derivatives would reduce the liability by approximately $553.9 million and increase amortization of deferred acquisition costs and sales inducements by approximately $330.2 million; a 100-basis-point decrease would have the opposite directional effects.
Key risks include interest-rate movements, investment credit deterioration, liquidity needs, policyholder lapses and withdrawals, competition, regulatory changes, tax-law changes, derivative counterparty performance, and litigation or regulatory inquiries.
Unfunded commitments at quarter-end included $47.3 million to limited partnerships and $60.0 million to privately placed corporate securities, in addition to $58.5 million of mortgage-loan funding commitments.
The company adopted accounting updates related to revenue, financial instruments, cash-flow classification and tax-effect reclassification. The tax-effect adoption reclassified approximately $128 million from accumulated other comprehensive income to retained earnings without changing total equity.
No formal earnings or sales guidance was provided in the filing. Results for the interim periods are not necessarily indicative of full-year results.

Investor Verification Checklist

Confirm the issuer identity: the filing text names American Equity Investment Life Holding Company, not American National Group Inc.
Reconcile reported GAAP net income with non-GAAP operating income and identify the effects of derivative valuation, investment losses, OTTI and assumption unlocks.
Assess whether the higher earnings are sustainable given the lower investment spread and reliance on favorable fair-value movements and tax benefits.
Review the investment portfolio’s increased unrealized losses, below-investment-grade exposure and securities sold or placed on the watch list.
Evaluate sensitivity to interest rates, policyholder lapse and withdrawal behavior, option costs and crediting-rate constraints.
Verify insurance-subsidiary statutory capital, RBC requirements, dividend capacity and restrictions on upstreaming cash to the parent.
Review the $500 million 2027 senior notes, subordinated debentures, repurchase agreements and available revolving credit capacity.
Review contingencies, regulatory inquiries, litigation disclosures and the effect of future long-duration insurance-contract accounting changes.