Business context and reporting period
Filing identity: The supplied 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, 2014, filed November 10, 2014.
The company primarily sells individual deferred annuities, with a smaller life insurance business. Deferred annuity deposits are generally recorded as policyholder account liabilities rather than revenue; key earnings drivers are investment income, investment spreads, policy charges, derivative results and policyholder benefits.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total revenues | $460.4 million | $580.3 million | $1.577 billion | $1.773 billion |
| Income before taxes | $104.3 million | $85.7 million | $145.3 million | $310.0 million |
| Net income | $67.8 million | $56.2 million | $94.8 million | $202.3 million |
| Diluted EPS | $0.85 | $0.75 | $1.19 | $2.79 |
| Operating income | $64.0 million | $59.8 million | $139.9 million | $123.6 million |
| Net cash from operations | Not separately reported | Not separately reported | $487.4 million | $604.4 million |
Calculated net-income margins were approximately 14.7% for Q3 2014 and 6.0% for the first nine months of 2014. Operating income, a non-GAAP measure, increased 7% year over year in the quarter and 13% year to date.
- Net investment income increased 9% to $386.9 million in Q3 and 11% to $1.128 billion for nine months, reflecting growth in invested assets. Average invested assets excluding derivatives increased 12% in Q3 and 13% year to date.
- Aggregate investment spread increased to 2.82% in Q3 and 2.77% year to date, versus 2.80% and 2.73%, respectively, in 2013. The company’s stated target is a 3.00% spread.
- Net annuity deposits after coinsurance were $1.035 billion in Q3 and $2.916 billion year to date. Deposits before coinsurance increased 2% in Q3 but declined 3% year to date.
- Total assets were $42.954 billion at September 30, 2014, versus $39.621 billion at December 31, 2013. Stockholders’ equity increased to $1.975 billion from $1.385 billion, primarily reflecting $499.7 million of other comprehensive income and $94.8 million of net income.
- Cash and cash equivalents were $788.8 million, compared with $897.5 million at year-end 2013. Total investments were $34.610 billion, including $31.024 billion of available-for-sale fixed maturity securities.
- Total liabilities were $40.978 billion. Notes payable were $475.3 million, subordinated debentures were $246.2 million and repurchase-agreement borrowings were $81.2 million. The $140 million revolving credit facility had no borrowings outstanding.
Material changes versus the prior comparable period
- Q3 net income rose 21% and diluted EPS rose 13%, despite lower total revenue, primarily due to improved operating performance and favorable quarterly changes in embedded-derivative values.
- Nine-month net income fell 53% and diluted EPS fell 57%, largely because 2013 benefited from substantially more favorable derivative and investment-related results. Nine-month 2014 operating income nevertheless increased 13%.
- Interest-sensitive and index-product benefits increased 32% in Q3 and 26% year to date, driven mainly by higher index credits and growth in annuity liabilities. Average net annuity liabilities increased 13% in both comparable periods.
- Premiums and other considerations declined 39% in Q3 and 35% year to date, primarily because life-contingent immediate-annuity premiums decreased after pricing became less competitive in the low-rate environment.
- Accumulated other comprehensive income increased to $545.9 million from $46.2 million at year-end 2013. Net unrealized losses on fixed maturity securities fell to $212.1 million from $861.4 million.
- The company extinguished $36.2 million of 2029 notes and $46.5 million of 2015 notes during the first nine months, recognizing a $10.6 million pre-tax loss on debt extinguishment. It issued common shares in connection with portions of those transactions.
Guidance, outlook, risks and unusual items
- Management did not provide formal earnings guidance. It expects continued growth in invested assets and operating income, but noted that low investment yields are a significant headwind to reaching the 3.00% investment-spread target.
- Management reduced renewal crediting rates for certain older policies over a 15-month period and implemented modest new-money rate reductions in October 2014. Approximately $15 billion of policyholder funds were expected to experience a 0.20% cost-of-money reduction when fully implemented.
- Approximately 98% of annuity liabilities were subject to annual discretionary crediting-rate adjustments, subject to minimum guarantees. Competitive pressure, guaranteed rates, persistency, surrender activity and reinvestment yields could limit this flexibility.
- Q3 and year-to-date results benefited from assumption unlocking that increased net income by $31.0 million. The revisions reduced amortization of deferred sales inducements and deferred policy acquisition costs, while revisions to living-income-benefit-rider assumptions reduced net income by $8.0 million.
- A second-quarter 2014 revision to lapse-rate and future option-cost assumptions increased nine-month net income by $14.8 million after related offsets and taxes. The fair value of fixed-index-annuity embedded derivatives was $5.262 billion and is highly sensitive to discount-rate assumptions.
- The investment portfolio was predominantly investment grade: 98% of fixed maturity securities under NAIC designations were Class 1 or 2. However, the portfolio remains exposed to interest rates, credit spreads, impairments, mortgage-backed securities and reinvestment risk.
- Commercial mortgage loans totaled $2.503 billion of principal, with $8.5 million past due and $12.6 million in non-accrual status. The company held $17.4 million of specific allowances and $10.5 million of general allowances.
- The Los Angeles annuity-sales litigation remained subject to appeal. The estimated litigation liability was $11.1 million at September 30, 2014, and the company stated that ultimate claims-related liabilities remain uncertain.
- Subsequent to quarter-end, the company extinguished an additional $23.1 million of 2015 notes for cash and shares and expected $6.2 million from related hedge unwinds. The remaining 2015 notes were scheduled to mature in September 2015.
- Principal market risk is interest-rate risk. Management estimated that a 10% increase in rates, defined as 32 basis points at quarter-end, would reduce fixed-maturity fair value by approximately $882.1 million and reduce stockholders’ equity by approximately $261.4 million after stated offsets.
Important facts for investors to verify
- Confirm the issuer identity because the request names American National Group Inc., while the filing identifies American Equity Investment Life Holding Company.
- Reconcile GAAP net income with non-GAAP operating income and assess how much of reported earnings came from assumption unlocking and derivative fair-value changes.
- Review the sustainability of the 2.77% year-to-date investment spread against the 3.00% target under continued low yields and future crediting-rate reductions.
- Evaluate fixed-index-annuity embedded-derivative sensitivity, including the filing’s disclosed 100-basis-point discount-rate sensitivities.
- Assess liquidity, statutory capital, the 275% risk-based-capital covenant, debt maturities and the company’s capacity to retire the remaining 2015 notes.
- Monitor investment-grade and below-investment-grade exposures, unrealized losses, mortgage-loan delinquencies and potential OTTI or credit-loss charges.
- Follow the appeal and claims process in the Los Angeles litigation and any changes to the $11.1 million estimated liability.