Business Context and Reporting Period
This Form 10-Q covers American Equity Investment Life Holding Company and subsidiaries for the three months ended March 31, 2015. The filing describes a life insurance and annuity business focused primarily on individual deferred annuities, including fixed index annuities. The request metadata identifies American National Group Inc., but the filing registrant is American Equity Investment Life Holding Company.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 or prior period | Change |
|---|---|---|---|
| Total revenues | $409.0 million | $445.5 million | Down 8% |
| Net income (loss) | $5.9 million | $(9.8) million | Returned to profitability |
| Diluted EPS | $0.07 | $(0.13) | Improved |
| Operating income, non-GAAP | $48.8 million | $37.5 million | Up 30% |
| Net investment income | $399.7 million | $370.0 million | Up 8% |
| Aggregate investment spread | 2.77% | 2.77% | Flat |
| Operating cash flow | $(140.2) million | $48.2 million | Decreased |
| Total assets at period end | $45.4 billion | $44.0 billion at Dec. 31, 2014 | Up 3% |
| Stockholders’ equity at period end | $2.33 billion | $2.14 billion at Dec. 31, 2014 | Up 9% |
Reported revenue and earnings were materially affected by mark-to-market changes. The change in fair value of derivatives was a $(31.1) million loss in Q1 2015 versus a $48.5 million gain in Q1 2014. The change in fair value of embedded derivatives was a $51.2 million expense in Q1 2015 versus $92.6 million in Q1 2014. Net income margin was approximately 1.4% of reported revenue, compared with a negative margin in the prior-year quarter.
- Annuity deposits before coinsurance increased 43% to $1.32 billion; net deposits after coinsurance were $1.21 billion versus $870.7 million.
- Average net annuity liabilities increased 12% to $35.9 billion, and dollar investment spread increased to $217.7 million from $190.2 million.
- Invested assets totaled $37.6 billion, including $34.3 billion of fixed maturity securities and $2.4 billion of mortgage loans.
- Approximately 96% of fixed maturity securities were investment grade under the NRSRO rating presentation; 98% were NAIC Class 1 or 2.
- Cash and cash equivalents were $293.8 million at March 31, 2015, compared with $701.5 million at December 31, 2014.
- Notes payable were $421.9 million and subordinated debentures were $246.3 million. The $140 million revolving credit facility had no borrowings outstanding.
Material Changes Versus the Prior Comparable Period
- Net income improved from a $9.8 million loss to $5.9 million of income, while operating income increased 30% to $48.8 million.
- Sales growth was concentrated in fixed index annuities, whose deposits increased to $1.23 billion from $845.8 million.
- Net investment income increased because of growth in invested assets, but average invested-asset yield declined to 4.74% from 4.95%.
- Interest sensitive and index product benefits declined 11% to $282.8 million, primarily because of lower index credits and lower average fixed crediting rates.
- Interest expense on notes payable decreased 28% to $7.3 million, primarily following the 2014 extinguishment of convertible notes.
- Operating cash flow shifted to a $140.2 million use, driven in part by a $326.2 million increase in collateral held for derivatives and higher policy acquisition costs. Financing cash flow of $792.4 million, principally from policyholder deposits, partially offset investing cash outflows of $1.06 billion.
- Accumulated other comprehensive income increased to $893.7 million from $721.4 million, primarily due to net unrealized investment gains.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management did not provide formal earnings guidance in the filing. Management expects continued growth in invested assets and operating income, but notes that growth must be supported by statutory capital and rating-agency requirements. Management stated that sales capacity is not unlimited and that external capital could be required if growth exceeds internally generated capital.
- Persistent low interest rates are pressuring investment yields and make restoration of the company’s 3.00% target investment spread difficult. Management reduced new-money crediting rates by approximately 0.20% in early March 2015 and began additional renewal-rate reductions.
- Approximately 99% of annuity liabilities were subject to annual discretionary crediting-rate adjustments, although contractual minimum guarantees limit further reductions. Management estimated average remaining reduction capacity of 0.55% across the in-force book.
- Derivative and embedded-derivative valuations create significant earnings volatility. A 100-basis-point increase in the discount rate used for fixed index annuity embedded derivatives would have reduced the liability by an estimated $405.6 million, with related offsets to deferred acquisition and sales-inducement balances; a 100-basis-point decrease would have increased the liability by an estimated $454.2 million.
- The investment portfolio had $109.7 million of unrealized losses at March 31, 2015, down from $156.0 million at year-end. Management considered the losses temporary, but recognized $132,000 of net OTTI losses on one residential mortgage-backed security.
- Commercial mortgage loans totaled $2.45 billion, including $9.9 million in workout loans and $2.3 million that was 60 or more days past due. The loan-loss allowance was $19.5 million.
- The company carried an estimated $11.1 million litigation liability related to the Los Angeles annuity-practices settlement litigation. The claims process remained affected by an appeal, and the ultimate liability was described as uncertain.
- The company had $87.0 million of unfunded commercial mortgage loan commitments, $28.6 million of limited-partnership commitments and $11.2 million of secured-bank-loan commitments.
- A proposed U.S. Department of Labor fiduciary rule could increase requirements for agents selling annuities to retirement accounts. Management warned that substantially similar final rules could adversely affect IRA and 401(k) annuity sales.
- Interest-rate risk is the primary market risk. A modeled 25-basis-point increase in rates was estimated to reduce fixed maturity securities’ fair value by $760.3 million and stockholders’ equity by $254.2 million, although actual results could differ materially.
Important Facts for Investors to Verify
- Confirm the correct issuer: the filing is for American Equity Investment Life Holding Company, not American National Group Inc.
- Reconcile GAAP net income with non-GAAP operating income and assess the recurring investment-spread performance separately from derivative mark-to-market effects.
- Review the sustainability of the 43% increase in annuity deposits, associated capital requirements and the effect of sales incentives and reduced crediting rates.
- Evaluate liquidity after the $407.8 million quarterly decrease in cash and the $140.2 million operating cash outflow, including policyholder surrender and withdrawal trends.
- Monitor investment yields, unrealized losses, OTTI exposure, below-investment-grade securities and commercial mortgage loan workouts.
- Assess the September 2015 maturity of the remaining convertible notes, related hedges and warrants, and the company’s refinancing or settlement plans.
- Track the Los Angeles litigation appeal and the potential effect of the proposed Department of Labor fiduciary regulations on annuity distribution.