American Equity Investment Life Holding Co (AEL) 2007 Q3 法說會逐字稿

Welcome to the American Equity Investment Life Holdings Company Third Quarter conference call. At this time for opening remarks and introduction I would like to turn the call over to Julie LaFollette, Investor Relations. Please proceed.

Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss third quarter 2007 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com. Presenting on today's call are John Matovina, Vice Chairman, Kevin Wingert, President of the Life Company and Wendy Carlson, Chief Financial Officer.

Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be available on our website shortly after today's call.

It is now my pleasure to introduce John Matovina.

Thank you Julie and thanks to all of you for joining us this morning. Our operating income for the third quarter of 2007 was $16.4 million, a slight increase from where we were in the second quarter, compares to $18.9 million in the third quarter of '06. Diluted EPS for the quarter was $0.28 a share, the same as second quarter of 2007.

Now for the comments on sales and production, I'll turn the call over to Kevin.

Good morning everyone. Thanks, John. Appreciate the time this morning. Third quarter '07 sales were $543.8 million, up 49% from third quarter '06 so we've continued to make some solid gains on the production side. We were down a little from second quarter '07 at $622 million but I think we've made solid ground. I think as you look at just the market, in general, in the third quarter continued volatility in the market and lack of real direction on the equity side of the market, I think, has left sales a little bit in limbo.

I think, obviously, as you look at selling safe money products, which is our primary market, a weakening equity market certainly helps sales when you're looking for principal protection and those types of things. So I think that there's a good possibility we'll continue to, as the market lacks direction and maybe drifts lower we'll maybe, see some continued gains there.

I also think that reduction in rates by the Fed will start to bring some of our fixed money competitors' rates down which will be helpful to us as we look at competition from banks, CDs and those types of alternatives.

On the pending side, I'm actually on the road today. The last pending report I saw was Tuesday, was 2,500. I compared that with a year ago where we were at 2,000 so we're up about 25% above where we were a year ago on pending. And I think as you look at pending, that number may be a little bit shaded by the fact that a week and one-half, two weeks ago, we had 170 of our top producers out of the field at our annual agents convention. So some of our biggest producers probably were out of production for at least a week and I would guess a lot of them were probably out for closer to two weeks. So with the annual agents convention as I took a little extra time off.

I looked at a year ago, according to my notes, a year ago the agents convention didn't happen until after November 1st earnings call so the numbers a year ago that we were looking at on pending would not have been affected by that same meeting and having those agents out of the field. So I think pending is in a solid position and, certainly, we're working hard to try to increase it.

The general tone at the agents convention was very, very positive. Producers seemed to be in a great mood. Both, I think, in general about the market and certainly about American Equity. Very appreciative of the service that American Equity offers and the integrity to product design that we try to build into our marketing program. So I think that those were positive. And got a lot of great comments on the Gold Eagle program which is, you folks know, is our program introduced at the beginning of 2007 where the agents can earn stock options on the AEL stock by producing business. It takes $1 million of production during the calendar year 2007 and agents are very, very excited about that and excited about the opportunity to be in an ownership position along with those of you out in the field as shareholders and, certainly, management. So I think that program is exciting.

The co-op portion of that program where we helped them with some of their marketing expenses I think has gone over very, very well. Helps them to invest back in their organization and continue to expand their opportunities in business and grow themselves. So I think that program is going to go very, very well. And I would suspect that next year will be the year when we really get, probably, maximum benefits on that program as the first group of agents goes through and gets their actual certificates and knows what their strike prices are and all of those types of things. And we start to get the feedback and the talk that will happen throughout the distribution. So I think that that will be a real positive.

We've had around 600 agents either qualified or on-time to qualify for the Gold Eagle and those agents have been over 60% of the production. So I think it will serve as well our goal as we go into 2008 to continue to increase that number. Obviously, we would love to be in a position where we could maybe even double that 600 to 1,200 agents. So we're really focusing on finding the folks that can make that difference for American Equity to get that $1 million-plus of premium in on an annual basis and hang onto them with their stock options because they are participating in an ownership opportunity in the Company.

On the marketing side we've added two new home office regionals for marketing and replaced one of our other regionals so we've put more feet on the ground. We're out there working hard, really focusing in as we look at finishing out this year is working with the NMO's to try to increase our recruiting numbers so we can sift through those recruiting numbers to find those $1 million producers. So we're out working hard and, again, we've got more feet on the ground working hard out there with the regionals.

Product happenings during the third quarter, we added our income rider to all of our new contracts at the beginning of the third quarter. So all new business is receiving the income rider. And I think the income rider is being received very, very well out in the marketplace. There's a lot of talk in the press as well as among the agents about income planning as the Baby Boomers continue to age and I think the income rider adds another level of guarantee for income purposes for a consumer to give them the piece of mind for planning their retirement and the protection of their retirement income using that income rider.

So I think that's a great benefit and I certainly believe American Equity has the right strategy for income riders and the best rider in the market with the 5% annual growth on the income side during the deferral period and the fact that we built the cost of the rider into our spread management and we have put in place re-insurance contracts for the potential tail costs on that rider. So we're very excited about where that rider and, I think, the education and the marketing development sales strategy developments that will go with that as we move through the rest of this year and into '08 will certainly help, continue to help production and sales.

We've added the monthly point-to-point, and this is really going backwards onto a lot of our existing contracts. And we continue to do that trying to offer our in-force business, our current policyholders, more opportunities in terms of their interest crediting strategies. The goal there being to continue to man a solid policy retention level and maybe even improve on policy retention on a going-forward basis. We want to keep as many of these policyholders on the books and earn our spread year-in and year-out as we go forward. So that's one of the programs that's in place.

If we look to the competition, competition is kind of a mixed bag right now. A couple of the, I guess what I would consider primary competitors maybe ING, Midland, maybe even FNG, North American, have been fairly quiet here the last several months. I don't know if they are going through strategy changes or what the situation is but we haven't had as much pressure, certainly, as we did a year, year and one-half ago from some of those folks.

Allianz, as many of you know, has had a lot of pressure on them over legal issues, suitability, those types of things. I think that's kind of a mixed bag. On one side of it I think we've made some real headway with some of the Allianz producers and some of the Allianz agencies and I think we're starting to pick up some of that production as they look at the contracts and some of the headaches that they are getting because of the press Allianz is receiving.

On the other side of it, Allianz did come out with a 20% income bonus product earlier this year. Made a big push, actually it's a 15% income bonus, on their product. But they bonused it up to 20% during the third quarter so, in effect, they were using that 20% to go out and, I guess my description would be, buy business which I think that for someone looking for income only purposes is probably alright. But when it's being used to replace business with surrender charges, I think some of those particular sales from a suitability standpoint may be suspect. We've obviously been working hard to defend some of our in-force business against that type of activity but I think that they attempted to make some progress, may have made a little bit, but I'm not sure they've gotten the traction that they would have expected.

Aviva probably has picked up as much traction as anyone and I think that as you look to Aviva in the marketplace, as the new owner came in and took over Ameris, been extremely aggressive on pricing with 10-year products, 5% bonuses, very aggressive compensation on those packages. So they've picked up business that I think is going to be strained in terms of spread to maintain any kind of a competitive return over a longer period of time to policyholders. But it's certainly what we have to compete against.

Now we did introduce a product in the third quarter, a 10-year product, with a 5% bonus. Our compensation might be slightly less on that product than some of the others but we're, I think, in the ballgame. Our rates on the product, from the consumer standpoint, are a little bit less than our regular portfolios. We had to widen the spread on that business in order to accommodate the acquisition structure in that product. But I think it's a very competitive product. Our rates are still in the ballgame. The agent still gets the service, the chance to have the stock options and those types of things. So I think we're going to compete to pick up a portion of that market as time moves forward and try to do it under a strategy where we're going to have, in a stable marketplace anyway, relatively supportive of renewal rates.

Now, obviously, as volatility moves and those types of things it's going to affect renewal rates as we all know and have seen over the last number of months. But I think that some of the products in the marketplace that have already got rate reductions priced into their initial marketing strategies and then are faced in addition to these high volatilities are really going to struggle with some of their rates. And American Equity really wants to stay away from those types of strategies and put good solid consumer products that we can be proud of to our agents and still work hard to make our spread.

So all in all I think a very good third quarter, I think, positioned well for the fourth quarter and getting ready for 2008. We're out working hard with our marketing plans and then getting feet on the ground to position ourselves well going forward.

And with that, I'll turn it over to Wendy.

Good morning. Let me add my welcome to the call and this morning I'm going to start by making a few observations about our balance sheet and then move into the discussion of earnings for the quarter.

As you look at American Equity's balance sheet, it's grown by $1.2 billion in the first nine months of the year. Total assets are now at $16.2 billion, invested assets at $12.4 billion. As you look at our stockholders' equity, it's up over $34 million for the nine months excluding the AOCL. Book value of the stock is $11.89 a share excluding the AOCL. That's up $0.60 from where it was at December 31, '06. Even including the AOCL, book value is at $11.01 and that accumulated other comprehensive losses up just slightly to $49 million. So very well capitalized continued growth and assets and an RBC ratio that exceeds 430%.

We just recently were notified and it's been announced that A.M. Best affirmed our A-Excellent rating, our financial strength rating as a life company. So as we look at the financial strength of the Company and its potential, we continue to believe firmly that it is excellent as that rating implies.

Turning now to income, third quarter '07, as John reported, $16.4 million of operating earnings. That's $0.28 per diluted share. The whole story during the quarter in terms of the results really revolved around the cost of money of our index business and third quarter was an opportunity for us to demonstrate how the spreads are impacted and how we can manage the spreads in periods of extremely high index volatility.

Just to review some of the basics, we buy one year call options to fund index credits on approximately $7.9 billion of account value that's been allocated to index strategies. There's another $2.4 billion allocated to fixed rate strategies. When we purchase those options, the cost at the time of purchase is a function of a variety of factors but a very major one is the volatility in the markets and volatility is typically measured by the VIX index.

VIX reached a high of 30.83 in the third quarter compared to a low of 9.89 during the first quarter of this year. It hasn't been up above 30 for many years now, several years. It averaged, during the third quarter, 21.61 compared to just over 12 in the first quarter and 13.6 in the second quarter, so significantly higher cost of options moving really rapidly up throughout the year but particularly during the third quarter.

As you look at the impact of that on our cost of money as measured in dollar terms, our cost of money was up $10 million in the third quarter compared to the second quarter of this year. It was up $17 million if you compare that to the third quarter of '06. Looking at it from a percentage standpoint, the cost of money was 3.42% on our index business for the nine months. That's up 14 basis points from where it was at the end of last year for the entire year of '06 when it was at 3.28%. Our fixed rate business had a cost of money of 3.28 compared to 3.25 for all of '06, so slightly up.

As you look at the spread earned on the index products, it was 2.67% for the nine months compared to 2.81% on our fixed rate products. The aggregate spread across all annuity product lines was 2.65%.

So I guess the take-away from that is that while earnings were essentially flat for the quarter and cost of money was up, we still are exceeding our spread target on the business and even in a time of very rampant increases in volatility it didn't cause us to fall below our basic spread target of 250 basis points.

We're, obviously, very concerned about the cost of money. We've taken a variety of steps to address it and we've been addressing it throughout the year. We've just announced recently and have begun implementing our third round of renewal rate cuts for '07. That's an unprecedented step for us. We've never cut rates three times in a year prior to this one. That's because we've had a philosophy of slow and gradual rate changes, that would be our preference. But in '07 it's been extremely difficult to keep up with the pace of increase in the option cost.

There's one distinction that I'd like to make with the cost of money in the third quarter as it compared to the first quarter of '07. We discussed at the end of the first quarter a variety of changes that we've made and implemented throughout the year to improve our hedging effectiveness. And that has primarily to do with the alignment of the receipts from the options that we've purchased at the end of the one year period to the index credits on the anniversary dates of the policies.

Those changes have been effective. We see much less volatility in our results in terms of matching up option gains with index credits. The issue in this particular quarter was predominantly the increase in the cost of purchase of the options. And our traditional response, and the response that we put into place, is to continue to look at cutting our participation rates and caps to be able to bring those costs back into line with our expectations.

As you look at other income statement line items and other factors, there was really nothing at all unusual about the quarter. It was a very solid quarter. Investment income was up and I'll discuss that a little bit further in connection with assets. Other operating costs and expenses which were high in the second quarter returned to their normal level with no excess legal costs during the quarter.

As you look at our GAAP net income you'll see a very large FAS 133 adjustment which is also a reflection of the volatility in the market and very sharp changes in the market value of options and the underlying imbedded derivatives in the indexed annuity reserves. So volatility was really the key factor in the quarter.

As you look at our invested assets, our yield was at 6.09% for the nine months which is unchanged from where it was at the end of June. Investment income was $183.7 million for the quarter which is up. It was a record quarter of investment earnings. Credit quality remains very, very high with 99% of our securities rated investment grade and no subprime mortgage exposure in any of our mortgages or negligible exposure in [of the] securities.

I'd like to spend a little time talking about our commercial mortgages since that's been such a topic of public interest in the last several months. We have $1.8 billion in our commercial mortgages and those are not pools. Those are all whole loans that we originate and underwrite here in our home office mortgage department. We have a very stringent underwriting criteria that are applied to those loans. We presently have a loan to value of 64.5%. We require the use of a very conservative valuation methodology for the underlying properties.

A third of all of our loans, approximately, have personal recourse back to the borrowers. Many of those borrowers are repeat borrowers from us. We have no interest-only loan structures. We do target fully amortizing loans. And as you look across that $1.8 billion it's comprised of 665 loans with an average loan size of well below $3 million per loan. It's $2.55 million is the average loan size.

So we've had no defaults, no delinquencies, no restructuring of troubled loans so it meets all of our criteria for asset quality and we certainly have no issues that would be akin to some of the subprime and credit problems that have been identified in the market and that are impacting other financial services companies.

As you look at new money being invested in '07, it's primarily been invested in corporate and in our mortgage portfolio. Yields on new purchases of corporate bonds are going up. In the third quarter of '07 new money was invested in our bond portfolio at an average rate of 6.45% compared to 6.36% in the second quarter of '07. New mortgages were being made at 6.39% compared to 6.19% in the second quarter. Eventually that improvement in yields should be reflected in our overall yield on our portfolio. But there is a certain amount of time lag before those higher yields are reflected.

As you look at the allocation of assets among various asset categories, you can see that the concentration of our investments in U.S. agency bonds has been reduced from 70% at the end of '06 to 65.4% in '07 with the increases going into corporate and to a lesser extent AAA rated MBO securities. And, of course, we believe in diversification as a general principle. That's what the shifts in allocations represent.

However, I do think it's worth emphasizing that we've never once realized a loss in the sale of any agency's security and those have continued to perform exactly in accordance with our expectations. Given that we're now in the second credit crisis nationally that we've experienced in the last five years, we continue to think that our emphasis on credit quality and that our concentration of agency securities has been very prudent for American Equity particularly in light of the young profile of our annuity liabilities.

As you look at asset durations and focusing on available for sale securities and mortgages, the duration was at 5.7 years at the end of September, so somewhat shorter than it was at the end of June when we reported it at 6.4 years. That's a reflection of the decline in rates in that period. Liability duration remained constant at 6.5 years. That's the actuarial calculation of our liability duration. The surrender charge protection remains very strong in excess of ten years and 13%.

As you look at outflows in terms of benefits to policy holders in the first nine months, American Equity has paid $827 million in benefits to policyholders in the first nine months compared to $1.1 billion for the same period in '06. The higher figure in '06 is related primarily to the maturing of our multi-year rate guaranteed business last year.

As you look at the portion of those benefits paid that were subject to a surrender charge, it was $225.6 million for the first nine months compared to $200.9 million a year ago. A product charge income for the three months increased to $12.6 million compared to $10.6 million in the second quarter of '06. That's a reflection of a couple things. It's a reflection of the normal aging of the business as well as some of the aggressive competitive activity that Kevin described a little earlier.

We continue to have approximately 98% of our annuity account values protected by a surrender charge and our surrender charge protection has increased slightly to 103% of our combined balance of deferred acquisition costs and deferred sales inducement.

And I'd like to conclude just by commenting that we are, obviously, very concerned that our stock is trading below book value. We are aggressively evaluating strategies to address that. It's hard for us to understand where the stock is trading given that we have no material asset quality exposure. Our book value has been consistently growing, assets and annuity account values have been consistently growing and so things remain very strong on all fronts. Nevertheless, we recognize that with the stock trading below book that we need to be looking at all alternatives and we are. And with that I'll turn it over for questions.

(OPERATOR INSTRUCTIONS) Tom Van Buskirk, McMahan Securities.

I appreciate the additional disclosure in the supplement about the watchlist credits but I think it kind of maybe goes a little bit to the concerns some people have had in the marketplace about any company that's ever lent a dollar to anyone else or has ever had any exposure in anything mortgage related. And with that I think it's only fair to ask that above and beyond what's listed in there as watch list credits, is there any other exposure throughout your portfolio to issuers in related sectors that, I think, we're all sort of wondering if there are other shoes that are going to drop. Not that any shoes have dropped at your doorstep but just based on what's been disclosed. And then I have a follow-up.

Absolutely. And as you look at what's on the watch list there's one mortgage-backed security. It's got a $2.8 million amortized cost and a net unrealized loss at the moment of $700,000, so not a very big security. And, obviously, this quarter with all of the concerns about any type of mortgage-related or real estate-related investment, there was a very high level of scrutiny on all of our securities.

As you look at our MBS portfolio, the great majority of it is AAA rated securities and in any of those securities that have any degree at all of subprime mortgage investments, which is very, very small, we have a super senior tranche. So it's all rated AAA, we're super senior in virtually all of it and so we've looked hard at it, we really don't think we have any exposure.

Nothing CDO related or --?

We haven't purchased any new CDO products since, I think, the year 2000 and that the balance of those assets on our balance sheet is very, very small. It's $33.8 million.

What are the criteria for something making the watch list?

It has to decline by either 20% in value or $1 million, whichever is the greater.

Is that a market price?

Well, it's market relative to the purchase price. Yes.

And then I had just a quick follow-up. There were a couple of things that had been mentioned in A.M. Best's affirmation. I think they had a couple of concerns in there that they had mentioned as potential negatives. I think one of them was just related to interest rate risk still being high and then the other one was an increasing DAC-to-equity ratio. And I was wondering if you had a comment on those?

Yes. I mean you either have interest rate risk or you have credit risk. And given our discussion about the mortgage debacle and some of the credit quality problems others are having, we continue to think that by emphasizing credit quality and taking the extension risk and the assets, that that's been the right thing for American Equity.

We do have a high concentration in callable agency bonds. We do see the value of those bonds move around as interest rates move around. That's market value adjustments only. We've never realized a loss in any of that portfolio and where the -- where interest rate risk becomes important is when you've got a large portion of your annuity reserves out of surrender charge because in that situation when interest rates move, you're likely to see policyholders move and it may trigger a liquidation of assets.

In our case, with 98% of the fund value protected by a surrender charge, average surrender charge over 10% remaining on that book of business, there's the idea that our bonds are going to move around in value is really primarily a cosmetic issue to us. Since we don't believe that there will be any need in our modeling as A.M. Best points out would suggest that there's no need for us to think that we would have to liquidate one of those bonds at a loss.

I can appreciate that. And then just as a follow-up. And I apologize if you've touched on this. We had some furniture movers upstairs and there was a part of the call I couldn't hear. So I apologize if you went over this already but I know you typically don't give much in the way of forward guidance, but given that we've been through a month of Q4 and the VIX has been up at still averaging, I think, at about 19 for the first month of the quarter, any thoughts on what the impact is likely to be on earnings for Q4 if we kind of stay at this level?

I can't really comment on earnings for Q4 but I can comment on cost of money to the extent that as we discussed, we will have yet another round of rate cuts being implemented here very shortly. It's been announced and goes into effect within the next couple of weeks. So policies renewing will have lower rates. That's designed to bring our option costs back down to the level that it was at -- roughly the level that it was at earlier this year and last year. So we do expect our cost of money to be lower in the fourth quarter than it was in the third quarter. But, as you point out, volatility is changing, increasing, and it would be hard for us to make any hard and fast predictions about that.

Fair enough. Thanks very much.

Steven Schwartz, Raymond James & Associates.

I know it's never been in your corporate DNA, but from your comments vis a vis book value, it sounds as if you might be considering a buyback which I think would be roundly cheered by everybody. In your discussions with A.M. Best, as part of the affirmation, was that topic brought up and, if so, how was it treated by Best?

We did not specifically discuss a buyback with them. Obviously, if we were going to take a step like that we would want to be talking with A.M. Best as well as the other rating agencies. Our modeling continues to suggest that we are well capitalized, adequately capitalized, and so were we to take the step of a buyback it would be in the context of also reassuring ourselves and them that we have more than sufficient capital to support our future growth.

One of the things that I've thought about and maybe, actually, you can give us an update on timing and how it's all going to work because I don't really remember but one of the issues that I've always thought that the stock has had with its trading is the very, very large convert that you had out there. A significant participation in your stock trading that doesn't give a damn about fundamentals, really, and is just more interested in volatility and hedging. Given where the stock is, what's the thought on how you're going to deal with that? I think that's just been a couple of years. Right?

Yes. We did that transaction in '04. The first call date on that security, unless we were to restructure it in some way, is 2011. We've had numerous conversations with outside advisors about the impact of that security and, in general, the advice we've gotten is that when you look at the short position in our stock you can think of it in two tranches. There's the shorts that are related to the convertible debt that are simply hedging their position in the ordinary course and then there's everybody else. And it's -- so it's everybody else that we worry more about in looking at that short position. So, yes, it has an impact. We've talked about various strategies with that and we'll continue to look at that.

And then I guess another kind of legal theoretical thing that you may talk about, any new thinking on AEL's part with regards to introducing a product that might have an MVA associated with it?

Not an index product.

Not an index product. Okay. Thanks.

Richard Sbaschnig, Oppenheimer.

I just want to know, again, just in terms of the rate cuts, do you have a sense for how well sales will hold up after those rate cuts?

Well, that's a key issue and we do try to look at where our rates will be relative to the market after the cut is implemented and we prefer to be in the middle of the pack, neither the highest nor the lowest and we believe that's where we will be following the rates cuts.

The other thing, Richard, is the rate cuts, most of which we've been referring to are renewal rates. We have been discussing our new money rates but there's been no announcement of any new money rate changes at this point.

Richard, I think it's important -- as you look at some of our competition as it relates to renewal rates, some of these folks have built these products with widening spread expectations. Some of their renewal rates, my best description of them would be miserable, so I think our renewal rates are still going to be solid, competitive and certainly not embarrassing from an agent's standpoint given the market volatility and the Fed-reducing rates as it relates to new money, we're somewhat in the, as Wendy said, we're in the middle of the pack.

And I think as you look at rates over the last year and some of the challenges that go with rates, we didn't get our A.M. Best rating back until late summer last year. And as we went into the late summer and after 05-50 and all the noise in the industry at that point in time we probably had to be a little more aggressive on new money rates than we would have preferred to just to kind of get the rating back on the street and jump the production. And as we made rate adjustments over the last year, I think that some of the things that we probably couldn't predict on a going forward basis were the continuation of the flat or inverted yield curve which had an effect on option prices and then the spike in volatility. So, despite the fact that we were bringing rates down to manage the spreads, we were also seeing -- having events on the outside that were probably tempering somewhat those adjustments in terms of their net effect on the spread.

Now as we look at where we are today, I think that we feel like we're in today's market we're getting where we want to be with the rate cuts and I think we're still, both on a renewal and a new money basis, going to be in the ballgame.

And just a question for John. The economic value of the cuts, roughly, has been kind of a 10 to 15 basis point type impact?

I don't know I can necessarily say that. I'd say that the cuts are designed to bring the cost of money down into the 330 range.

So down roughly 10 to 15 basis points?

Well, if you're looking at 345 or so, yes. It will bring it down, yes, 10 to 15 basis points from there.

The other question I have, the other issue -- one issue that seems to be kind of dead right now is the whole securities versus insurance debate and I'm just wondering, do you have any update on that and have you seen any change in behavior? I mean, perhaps, any change in kind of the 05-50 adjustments in the market that we saw?

It is, certainly, a lot quieter this year and it might be even too that the issue is pretty much dead from a legal standpoint. There's been no indication that we're going to see a dramatic change in the legal status of the products to being securities as opposed to insurance products. So that part of the discussion has quieted down even though the SEC has never come out and clarified the issue to put it to rest once and for all.

Notice to members, 05-50 is still out there. I think in general the agents have sort of learned to deal with it and adjust those of whom have series 6 or series 7 licenses and are working with broker/dealers. We do hear some complaints and problems from agents who have a difficult time working with their broker/dealers because of notice to members 05-50. But it's much lesser this year than it was last year.

We continue to look at strategies for doing what we can to help those agents and facilitating their move, if they need to, from a broker/dealer who has taken a very stringent position to one that understands the product better.

Richard, I think if you look at what's going on to some extent on the market side, NESD [FINROW] really accomplished what they wanted to with 05-50 at this point. They, in most cases, got control of this insurance, these annuities, back through the broker/dealers on the agents that are contracted to sell securities and what I see a lot of out in the field, and I think we're going to continue to see more of, is for the real, I guess what I would describe, high end agency agents where this type of business is their primary business. Looking at opportunities possibly to expand their business through more of an investment advisor, an insurance practice coupled with an investment advisor business, whereby they are going to provide a more complete planning type profile. And some of that's being driven by the state regulators as you get into this investment advice issue. So I see a lot more guys looking at those types of things.

I think one of the possibilities that really we haven't totally have been the beneficiary of, and goes back to one of Steven's earlier questions as it relates to MVA's, I'm not sure the market has recognized this MVA issue on these index annuities properly, at this point. I think it's going to recognize it and I think when it does recognize this MVA as putting a backhanded approach to market risk in a lot of these index annuities, that you're going to see companies scrambling to make adjustments and you may see some of these broker/dealers that have allowed their agents to sell "safe money products" with these MVA's getting some egg on their face. And American Equity is well positioned with no MVA's in its index annuity portfolio to maybe step into some of these places and become the true safe money alternative. So I think there's some opportunities.

We've seen situations where MVA's have caused surrender charges on certain products go from our competitors where we've seen surrender charges up at 30% or more and so I think that has the potential to cause some heartburn out for some people in the marketplace and American Equity has solidly been the alternative to market risk in your index annuity, which is what we've always sold.

Just one last question before I jump in queue. In terms of the opportunity that's maybe left on the broker/dealer front, earlier I remember last year you gave some data points where, on some very large producers, you had that couldn't do any business because they weren't -- that AEL was not an approved -- didn't have approved products on their broker/dealer list. Is there still a large percentage of broker/dealers out there that you feel you need to penetrate or pretty much the larger producers taking care of?

I would describe it as a large -- probably a relatively (inaudible) group of the larger MVD's that we would certainly like to penetrate. I think we've seen a number of the producers who are more top-end producers and particularly where they are weighted towards the fixed index business or the fixed business in their practices, find broker/dealers that are willing to be not only friendly to their business but friendly to American Equity's business. So I think we've seen the producers start to handle the issue within their own business practices.

Now one of the things that I do think has been an overall challenge for the index annuity market, in general, we've made some solid ground this year in terms of production and growing the production but the industry overall is probably pretty flat and a lot of the carriers are down. And I think that's been driven by the fact that we've seen a stock market that's been continuously up and a lot of guys have gone to selling variable annuities.

And I think the fact of the matter is, is when the market does have a significant correction, these variable annuities are still going to have to stand up and open up to what the underlying values of what those accounts are. And I think you're going to see a lot of agents probably take heat that these secondary guarantees aren't guaranteeing the underlying assets And I think that's where an opportunity is going to present itself because you're going to see some of these producers that went back to selling variable annuities say, "Why am I doing this? And let's get back to selling some fixed products." And they are going to either look for broker/dealers that are friendly, push their broker/dealer to be friendly or totally change their business practice.

So I think there is an opportunity out there in the market that hasn't matured to the point where we've been able to take significant advantage of it. But I do think that's there and I think it's going to come over the next couple of years. I wish I knew when the market was going to have that big correction but one of these days it will.

So do I.

We could market that, also.

Well, thank you very much.

Michael Levy, [Quarto].

Just sort of as a follow-up on some of Steven's questions, you talked a lot about a potential -- or you talked a little bit about a potential for a stock buyback. You talked a little bit about the convertible bonds impact on your share trading. I was wondering if you could sort of elaborate on some of the other things you guys are looking at to improve the stock price.

At this point, Michael, it would be premature to be discussing those things in this call. There are a variety of things that are under consideration. Certainly the thing that leads to everybody's mind when you've got a stock trading like ours is a buyback. So that would be no big secret. But it's premature for us to speak on this call about other strategies that we've been considering.

That's fair. And to just change direction and I might be going all over the place here, the tone of the call and what you're talking about in terms of how the Company has been doing seems very, very positive. I am fully on board with that and I understand everything that you guys are saying and it all seems very, very great. But, still, diluted earnings from the continuing operations doesn't seem to have really moved in the last few years. If anything it seems to have gone down a bit. Is that something you guys are looking at carefully in terms of improving the earnings and growth profile of the Company?

Sure. And as you look at the absolute earnings, they've increased through '06 pretty dramatically. I forget what the exact cumulative growth rate in the earnings has been but it's been very, very strong. The EPS has not moved much principally because of capital raising activities that we did, both the IPO and then the follow-on equity offering at the end of '05. And through the issuance of additional shares that has the effect of bringing that EPS number back to more of a level position. But raising that capital has been critical to us to support the new business and to work with our rating agencies, principally A.M. Best, and to get that A-Excellent rating back which was our highest priority for a number of years.

So even though you don't see the earnings growth as much in the EPS, certainly there's been very significant earnings growth. But to answer your question, yes, we talk about it, yes, we're concerned with it and yes, we're looking at strategies that would help us show both absolute earnings growth and EPS growth.

Thank you. And then the final question, I'm not asking you to make a call on what's going to happen with the VIX or interest rates in general because that's not really your business but could we, as investors, expect lumpiness in the earnings whenever there's a dramatic increase in the VIX or if the VIX stays at markedly higher rates -- levels than it has been in the past few years?

Was lumpiness the term that you used?

I was trying to be somewhat polite.

In a general sense, yes, you could see more ups and downs in earnings in periods of high volatility and that's, in fact, what we have seen in '07 with spreads being compressed in the first quarter coming back to where they were expected in the second quarter and now compressed again in the third quarter. So that's a pretty lumpy profile for the year.

At the same time, we look at that and we have the same kinds of concerns as you are expressing about that pattern of earnings. And so we continue to look at our hedging process. We continue to look at refining that. We've just hired a new actuary whose area of expertise is, in fact, the hedging process for the index product and so it's certainly our long-term strategy to make the volatility in earnings as minimal as possible by continuing to improve how we're hedging those products.

And just one final question. Obviously, if you just looked at the classic price-to-book to ROE regression line, AEL's probably well below the line relative to other life insurers which is sort of a good thing, I would think. You're the only life insurance company with a 10% ROE or greater that is trading below book value. And I know that Dave has talked about how he would never sell the Company and how he did that once before and he never wanted to do that again -- or would prefer not to do that again. But at what point do you have to start considering looking towards strategic partners in terms of aligning yourselves more strategically just to get greater value for shareholders, becomes a priority?

I think it's an overstatement to say that Dave would never consider selling the Company. I think what he said is that opportunities that come along, we will look at, but we do feel very positively about the Company. We feel very positively about its present strength and its future prospects and so as we think about considering offers from potential acquirers we want to negotiate in that scenario the best possible price for us as shareholders, as well as the entire shareholder group. So we're going to be very bullish about our own Company and about its value in those kinds of settings. But if and when those offers come along, we have a fiduciary obligation to look at them, for one thing, and it's not just a flat - no.

Great. Well, I hope the success continues then.

Mark Finkelstein, FPK.

It's getting late so I'll just ask two brief questions. I guess historically AEL has always prided itself on being very -- not moving around the rate very much on the index of products whereas others have kind of been a little bit more active in moving that around. And, I guess, you are now putting in place a third rate increase or --

Decrease.

Decrease, sorry, this year. And my first question is, I guess, can you just describe the dynamic of what you've kind of prided yourself on historically versus what's happened this year. And then secondly, how has this impacted or been embraced by the agents and the IMO's?

Managing a company like ours is a process of balancing the interests of the policyholders and the shareholders and the agents. And so you're always dealing with all three things. And you can't neglect the interests of any one of them.

Our philosophy of being slow to move rates has been part of our philosophy of being fair and showing a high level of integrity to our policyholder base because that is critical in our long-term relationship with our policyholders and our agents and critical to our position and reputation in the industry.

At the same time, in years like this where you've got unprecedented, or at least unprecedented recent times, volatility and cost increases you have no choice but to take affirmative action and to move rates where they need to be to try to contain those costs in order to manage the profitability and continue to be concerned about the profitability for the benefit of the shareholders. So in a year like this, you really have to take action to continue to reduce rates.

In terms of how that's been received? I guess, I don't -- I guess I'd let Kevin comment on that. I don't think that it's created ill will out there or that policyholders or agents are holding that against us. We start with a pretty good record relative to some of our competitors in that area so I -- it's my perception that that's not harming our standing in the industry with policyholders because we've taken those steps.

Mark, I think part of what you have to look at is our position, historically as a carrier has been, is we want to try and start out as we issue contracts with a rate that everything being equal is reasonably supportable in the future. We don't want to go into these contracts with the strategy being that in the third or fourth year we've got to widen the spread and reduce the rates in order to make the product work. There are carriers that will do that. So I think, first, we start with the fact that we try to be solid at the beginning and the initial rate is key from a renewal rate standpoint.

Now that's -- my discourse with the field has always been, that's assuming that everything remains relatively equal. Well, in the environment that we've been here in the last couple of years things haven't remained equal. We've had an inverted yield curve; we've had periods of high volatility. So things haven't gone -- worked to where you could maintain a stable rate and we've had to make rate adjustments but the rate adjustments that we've made have been driven by market conditions, not by pricing conditions. And I think we can explain those to the field and the field is reasonable. And our rate cuts in most cases are -- look very, very good compared to what a number of the competitors are doing out there in the market. So I think we've been pretty solid in delivering on the strategy that we said we would deliver on from the very beginning. And, obviously, consumers always want more and that's human nature.

The other thing to remember is we've got these multi-strategy index annuities. If one strategy has a significantly lower rate in a given year, there may be an alternative strategy that has a little better opportunity for that next year so the customer can reallocate their funds and, again, we're looking at costs of each of the strategies. So if we can offer one strategy with a little better cap or better participation rate and give the customer an opportunity to go there and still hone in on trying to get ourselves in order with spread, I think it does work.

I really think part of the challenge over the last year has been we've had to overcome that rating issue with A.M. Best. And, again, it would have helped if we would have got it three or four months earlier than we did because of the 05-50 issues and the fact that we made rate cuts over the last year. Events in the marketplace have, in some instances, negated those rate cuts because the market was moving more rapidly than the rate cut and, obviously you can say, "Well, why didn't you cut rates quicker or cut them more or cut them again?" Well, we are cutting them again. It's just I don't think -- it's very hard to cut rates every week.

Mark, one thing. We've talked about three rate cuts, but each policyholder never sees but one rate adjustment per contract year. It's not like one guy has had his rate adjusted a couple of times in the current year. It's adjusted at renewal and that rate or index term is then locked in until we reach his next anniversary.

And I guess I would ask just one follow-up and you've kind of alluded to it throughout the call and in the answer to the last question. But at what point when you are going down participation rates and costs of 35% range, caps -- I guess caps are staying where they are but the monthly point-to-point is coming down again, at what point does this product not become attractive to the consumer?

I think, Mark, that's the beauty of these multi-strategy products is the fact that you do have alternative strategies. I would say out of 35% participation rate, the annual point-to-point at that participation rate, that particular strategy, probably is not attractive in this market. But, there is still a capped annual point-to-point with a 6 1/4% cap. You've got a monthly point-to-point, you've still got a fixed interest rate, you've got a monthly average. So you've got alternatives there and when one particular strategy may not be attractive, I think the beauty of our products and our product design has always been that there are other opportunities within the product to take advantage of the next year going forward and then do it again the following year. A number of our competitors that have only one or two strategies, I don't think have the same competitive advantage that we do.

Now, obviously, we've got to shell into that and we've got to get the agents to understand it but I do think that we're extremely well positioned in the market. It's a matter of education and continuing to find the right group of agents out there which we're working hard to do.

But the -- we also have all got to remember that the agents have got a lot of noise in their heads right now because of the market movements and interest rate movements and 05-50 and state securities regulators and suitability and all those types of things. So we're working through a process with these guys at this point.

That's what I have. Thank you.

Randy Binner, Friedman, Billings, Ramsey.

Most of my questions have already been answered but just real quick on a legal front, the -- I know that we had issues last quarter and apparently those costs are more on a run rate level but is there anything coming down the pike from California, Iowa or Minnesota? I know Allianz did a settlement in Minnesota where they are essentially giving refunds. Is there any color or update that we should be thinking about in regard to that?

There's not a lot of new developments to report there, Randy. Basically the discovery process leading into the spring round of motions that will be filed spring of '08 has been completed and so costs have been back down to normal levels this quarter and I would expect them to be at normal levels in the fourth quarter.

Allianz has settled a couple of lawsuits. They settled one of their class actions that related to their two-tier product. They did settle with the Minnesota attorney general. American Equity sells different kinds of products. We've always had a different attitude about market conduct than Allianz so part of our litigation strategy there is to make sure that we're not lumped into the same boat with that. So we've watched those developments with interest but we don't see them as being directly applicable to our situation.

In California, those cases plug along. There's been nothing that's happened that would tilt the scales one way or the other. There is an interesting development in that the Ninth Circuit Court of Appeals will be reviewing a decision that came out of the State of Hawaii that denied class certification in a case against another carrier for lack of commonality which we feel strongly is the right and correct conclusion. That conclusion will be reviewed by the Ninth Circuit. If that decision comes down before the dates of the certification hearing in our case then that will be a major thing.

So just to clarify, you had hoped for a favorable verdict would essentially --

We would hope that the Ninth Circuit would affirm what the Federal District Court in Hawaii did.

Got it. Thank you.

Beth Malone, KeyBanc.

I guess just one last question for me. I just -- when you talk about the A-minus rating upgrade, do you see that as delivering what you expected at this point in terms of getting into new sales offices and getting sales as what you had anticipated and does it also -- has it given you some more flexibility when it comes time to make these rate changes in your product line? Do you think it's easier having an A-minus rating than it would have been otherwise?

Beth, at this point in terms of making rate changes I don't think it has a particular effect. With that said, if we had to be [double] plus, I think we would have had other issues to deal with in terms of some of the places where we are able to do business today.

I think it probably has opened up some doors, maybe not as many doors as I would have anticipated. I think the restatement of the rating late last summer was somewhat tempered by the fact that 05-50 had been on the street and May was really a critical decision making date for a number of the broker/dealers and had put a lot of noise into the marketplace. And to some extent -- we know there are certain broker/dealers - a couple of them are competitors that won't let us in and use the A-minus rating, for example, as the reason but - so they use the A-minus rating today even as a reason not to put us on their shelf.

But I just think with everything that happened last year through the first seven, eight months of the year prior to the rating change, had caused so much noise in the marketplace that, unfortunately, I think the ratings adjustment, I won't say it was -- it became a non-event, but it became a much less driving event in the marketplace than it probably would have been a year or year and one-half earlier.

So now do you think that some of the sales benefit you're seeing today is actually just a catch-up?

I don't know if it's so much a catch up. It has opened some doors for us. It has gotten us in some places where we probably wouldn't have gotten with the B-double-plus. So I think that, yes, there are places where it has helped production. On the other side of it, I think the production drive today would just be the overall marketing strategy that we've implemented this year and just plain hard work. This is a market you just got to work hard.

I mean a new portfolio that we've introduced -- we've just introduced a new income rider; we introduced the new agent incentive program with the stock option opportunity and the co-op dollars. We've ran a couple of additional incentives during the year, so -- and we've been on the street a lot doing a ton of agent meetings. We've brought agents to Des Moines. So we've just been out -- it's got to be a combination of a lot of things that I think have helped move us forward. And the fact that we've got great service and I think one of the other things that's been a help to us is if you look at most of -- I'm not going to say most, but certainly a number of the primary competitors in the market, they are offshore-owned organizations. This is U.S.-based company and I think there are producers with the opportunity that have the stock option program and a U.S.-based managed company find that to be attractive. So we've just -- I think it's hard work and some good products as much as anything.

Thank you.

Richard Sbaschnig, Oppenheimer.

One quick question. Have you seen any effect on options pricing beyond the increase in volatility?

Richard, my understanding is option volatility is by far the most significant driver of what happens to option prices. There's some element of the risk-free interest rate in that equation but VIX or volatility is by far the most significant influence on how prices move.

Thanks a lot.

I show no further questions in the queue.

Thank you for your interest in American Equity and for participating in today's call. Should you have any follow-up questions, please feel free to contact us.

This concludes the presentation. You may all now disconnect. Good day.