American Equity Investment Life Holding Co (AEL) 2007 Q4 法說會逐字稿

Welcome to American Equity Investment Life Holding Company's fourth quarter conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Investor Relations.

Good morning. Welcome to American Equity Investment Life Holding Companies conference call to discuss fourth quarter 2007 earnings. Our earnings release and financial supplement can be found on our website at www.AmericanEquity.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 welcome, everyone. I understand from talking to a couple of you last night that American Equity probably has center stage today and we are certainly welcome for that opportunity. Operating income for 2007 was $64.9 million or $1.10 per share, that compares to $73.3 million from a year ago. And for the fourth quarter, operating income was $17 million, $0.29 diluted share, compared to $18.8 million a year ago. It goes without saying that 2007 was a challenging year for the Company but I think we came through it quite well. And as my colleague Wendy has been telling people as we have been out lately, it allows us to demonstrate our spread management capabilities in a very challenging environment.

We saw the VICs which is a measure of market volatility and having a big impact on what we pay for options grow last year from the low 12s to high 20s and occasionally into the 30s. Despite the challenges of that environment, we still managed to earn $65 million of operating income. More importantly, the rate adjustments we were implement throughout last year in response to those changes have postured us quite well for 2008 and we are very enthusiastic that we'll see spreads returning to levels that we have enjoyed in the past. The recent decline in short-term rates has kind of helped out in that regard and also should improve the appeal of our products going forward relative to other safe money alternatives. And finally, as we've said repeatedly over the past several months in pretty much every presentation we made, since the Company was formed, we have managed out our investment portfolio from the perspective of avoiding credit risk and we avoided a lot of the things you read about in the financial press concerning subprime and other risky asset classes. We don't believe we have any material asset quality problems, and we believe we are well postured for the future, don't anticipate any. So I can assure you Kevin and Wendy share my enthusiasm for our prospects for 2008, and with that, I will let Kevin talk to you about the production and marketing side.

Thanks, John, good morning, everyone. Great to be with you on the call. 2007 was a good sales year, total new sales were $2.1 billion, up 15% over 2006 at $1.9 billion. Fourth quarter sales were $533.6 million, up 27% over fourth quarter '06 at $421 million, and about even with the third quarter of '07. If we look at last year, we obviously started the year out with a flat or inverted yield curve in high short-term rates, which were causing certainly problems from a yield standpoint and a rate standpoint, as we attempted to be competitive on the rates and we saw CD rates going much higher. As the year carried out, the yield curve started to steepen. We have seen short-term rates come down. That certainly, I think, has helped us as we've started to gain some momentum, finishing out the year.

The overall trend, though, is we are seeing rates coming down. The yield curve has steepened, the rates overall have come down and we have seen an awful lot of volatility, as John said, in the marketplace which has caused caps, participation rates to come down somewhat. I think the real optimism from a production standpoint going forward, the basics of our products, our safe money, it's sleep insurance, and the volatility in the marketplace captures a lot of attention, and an awful lot of excitement over the market gyrating all over the place. I think it draws folks' attention back to principal protection which is where we fit in the marketplace. That's what our products are all about, protecting folks' retirement dollars as they get close to retirement and move into retirement. Our products do exactly what they are supposed to do. We saw some fabulous returns on our index annuities in 2007, for the consumers when the markets were doing well. As the markets started to faulter late in the year, going into the first quarter of '08, none of our customers have lost any money. I think that's the real great story behind index annuities. They got great returns last year and those returns are protected when the market goes South and like the problems we have seen this year. I think the story for index annuities and our position in the market is better than it's ever been. We are extremely excited about where we are see production moving as we move into 2008.

I would like to focus a little bit on our Gold Eagle program. As all of you know, we introduced our Gold Eagle members program to our agents in the beginning of 2007. The real goal of this program is to draw significant producers to the Company, give them an opportunity for ownership through stock options, and try to maintain those producers year in and year out with the Company, writing business on an ongoing basis. As we look at a highly competitive market, we think the stock option and the co-op marketing program called Gold Eagle will do a great job for us. 2007, we saw right at 500 agents qualify for the Gold Eagle, which was $1 million minimum of production to qualify during the calendar year, and that's paid business. Those agents accounted for about 60% of our total 2007 production or $1.2 billion. So those agents obviously did an outstanding job for us of being key producers and helping us build our numbers in 2007. Those agents will have earned approximately 577,000 of options. The options were granted on 1/16 of '08 at a market price, strike price of 791. Additionally those agents earned about $2 million in co-op marketing dollars to help them with their marketing expenses to try to help them build their business and if we can participate in building their business, we believe we'll continue that relationship and draw them closer to American Equity.

As we go into 2008, we are working hard to implement really a three-prong marketing strategy. Number one, one of the most important and probably the most important thing we can do this year is try to hang on to as many of the Gold Eagle members as we can from 2007. Kirby Wood, our Senior Field Marketing VP and his staff, the field marketers, as well as our internal marketing staff, are very focused on touching those people, keeping them close to us, continuing to develop those relationships. We have spent a lot of time on the road the first two months of year doing group agent meetings, doing group luncheons for Gold Eagle members, seeing Gold Eagle members individually, as well as getting out to key Entimodes offices, developing their marketing plan for 2008 and working those individual agents to build momentum.

Our number two strategy is we want to increase the number of Gold Eagle members that we have on board in 2008. And Ron [Garensteiner], our Chief Marketing individual in the field has taken responsibility for going out and finding the next group, the new participants in Gold Eagle for 2008. In a perfect world, you would want to go out and find 500 new Gold Eagle members. I'm not sure that that will be a number that we will hit this year. Obviously, that first group of 500 were producers that have been with us for a period of time and consistently produce. There were new additions of some guys who are already loyal to us in that group.

The next group, we are really going outside and finding new individuals either through production groups that we know the bulk of the individuals are $1 million plus producers or through referrals from our Entimodes or other Gold Eagle members to try to develop that list and then Ron is personally inviting these individuals to learn more about American Equity and our Gold Eagle program and trying to increase that number of Gold Eagle members. The third thing we are doing is we are really trying to focus our M&O's this year and their marketing plans on recruiting. We want them to focus their recruiting on both bringing us Gold Eagle potential-type individuals, as well as generally spreading the word on American Equity so we can develop our overall recruiting program and bringing new potential producers to the Company.

To help move those processes along, we have done a couple of things to start the year here to try to generate excitement, enthusiasm, help the recruiting process, both for new Gold Eagle members, as well as just generally new agents to the Company. One of those is on February 1, we announced a commission increase running through June 30, on three of our products. The commission increase is really in lieu of the contest that we have run in the past. You guys are probably aware that in 2007, we ran three production contests, we felt at this time that probably the production contests had started to lose some of their sizzle so we were looking for a different approach.

We decided that by putting together a program where we could increase commission on some top-selling products for this five-month period, it would put us on solider ground competing with a couple of our top competitors, Allianz and Aviva from a compensation standpoint. It runs the increase through our commission grid so we get commission reductions on older age business, which we wouldn't normally would not have done, or gotten under our commission bonus programs and it also allows a new agent coming to the Company to know that this program is available to them, and it's got some teeth to it for a period of time. When you run a contest and try to recruit a new big producer to the Company, if you're two or three weeks into your contest and it's only a six-week contest, by the time you get them on board, there's a good chance they may not qualify any or a significant amount of their production into the new contest. And we believe with this approach, it will give us a better chance of bringing these new Gold Eagle members into the fold as well as just recruiting generally in the market place.

As we move into May and June, we will certainly evaluate the effectiveness of this, and when you -- you probably are aware that we price incentives and we price some of these types of expenses into our price product modeling, our pricing, so we do have the cost of this figured into our models. So we -- we are prepared for this, and obviously we'll continue to manage our spreads accordingly.

Additionally, today we are announcing to the field that we are going to be introducing a new enhanced income rider. What that means is the agents will still be able to market American Equity's premier income rider, I believe our income writer is the best on the market. It's a 5% growth on their income account with no fee for that income rider. And the way the income account works is it grows out here for five or ten or 15 years. We look at the income account and we have based on their age, we have a payout factor. We will take that account base and apply the payout factor, and guarantee them a lifetime income, no matter how long they live without annuitizing their contract.

Now, the value -- the underlying accumulation of their account is drawn down at the same time the income account draws down, so that if we pay out income for a long enough period of time, we have drawn down the underlying value of their annuity, but during that period of time, it allows them to still control their account value and if something in your life changes, a health problem, income no longer is important to the them, any funds left in the annuity, can still be drawn, if at their death, there's any account balance left in their account, it still goes to their beneficiaries. It guarantees them income but still allows them to have some control, as long as there are funds still in that account.

The enhancement to this benefit is we are going to offer the consumers via the agent an option. And the option is that they can now have a 7% growth crediting rate but there will be a 40 basis point annual fee for the higher rate. So they can get a 5% growth on their income account at no fee or 7% growth on their income account at a 40 basis point annual fee. So if income is important, particularly I think as we look at moving into and see more business from baby boomers, as they look at their 401K, maybe as their prime income account for them in their retirement, this type of benefit is going to be extremely important to them, because they can maintain control of their funds, while knowing that they've got a guaranteed income for the rest of their life.

So we think that this option, where everybody, if they don't want the 7% paying the 40 basis point for it, they automatically get the 5% with no fee but they have got the option of a higher crediting rate, which you pay for if they think that the income and the growth of that account is going to be extremely important to them. Our pricing on this benefit anticipates a positive economic results from the rider, so we can use those positive economic results from this rider in several different ways as we look at developing business in the future.

As we look to the competition, I think competition right now, it's interesting. Allianz is retooling their business plan. They looked to me like tried to sell some of their losses. They have introduced their newest product, which if you look at it, and didn't see that it had Allianz on it it probably could be an American Equity product. It's a walk away product, which is unusual for them. As you know, they generally sell two tier (inaudible) with prior products. It's a walk away product that looks very similar to our products and I think from our point of view -- the good news is that they have brought their pricing in line and brought the compensation on that product down to 8% which puts us on very favorable grounds as we look at product competition going forward. So I think that we are very solid in our marketing position against Allianz.

Aviva has been very aggressive as they are attempting to take over Allianz's number one spot. Aviva is really focusing their benefits on -- somewhat shifting to conditioned bonuses, where the customer may be told they are getting a bonus up front but the bonus is recovered if the contract is surrendered. It's another form of surrender charges. So they are really taking a different tact, and I think with the income rider and the compensation structure that we have set up, we compete very, very well against them, and I would see them as our two prime competitors. As we look at where we stand right now, pending is right at 2100. When you look at the beginning of 2008, business was really pretty soft for the first couple of weeks. It's picked up very, very nicely since then. We've had two of our best app count weeks the last two weeks. I think we have averaged about 750 apps a week and the app counts have been going up.

So I'm very, very optimistic that we are seeing some positive movement, and that -- that pending moving up to 2100 it dropped in mid- to late January quite a bit. So we have had a big gain in the pending in just the last three or four weeks. So, I think we're gaining some momentum on the production side and expect to continue to gain momentum as we're out here working hard and we're getting this income rider out and the compensation package that we introduced is just a couple of weeks old. So I think we are moving forward very, very well. I'm excited about 2008, and looking forward to a good year. With that, I will turn it over to Wendy Carlson.

Thank you very much, Kevin and good morning, everyone. I would like to turn back now to the discussion of the financial results and I will begin my comments with our spreads for the year. As John indicated, volatility was really the watch word for us in '07. And in that very volatile environment, our aggregate spread on all of our business was 261 basis points for the year, which was down from 273 in '06. '06 had a been a record high for us in terms of spread results. So some slippage but still quite strong, relative to our peer group and above our minimum target. The primary factor in the spreads this year was the cost of money on our index business. That came in at 260 basis points for the year, compared to 286 in the year of '06. So a higher degree of spread compression in that block of business. That was certainly primarily affected by volatility in the markets. They impacted us in a couple of different ways.

One, we watched option costs go dramatically up during the course of the year, which we responded to with rate cuts but to a certain extent each time we put a rate cut in place, the volatility would continue to go up. So we chased the volatility up all year long. It also impacted our hedging effectiveness, which we talked about on or prior calls, it made it a challenging environment, but one we feel we came through in a good shape. The cost of money did remain high in the fourth quarter. Our last rate cut was put into effect in November, and we really didn't begin to feel the improvements from that prior to year-end. Our cost of money on index business in '07 was $3.51, compared to $3.26 in '06. So that reflects the overall increase in option costs and hedging issues during the course of the year.

As we move into the first quarter of '08, we are seeing some notable improvement in overall option costs and it signals to me that the cuts we put into place last year, and the improvements we made in our hedging process are now starting to be felt in terms of a lower cost of money. As we look at January and early February, our costs on our index business appear to be averaging around $3.35. No idea whether that will be sustained now on into the future, but we're off to a good start, we think, in this year. I saw one of the analyst comments this morning that the fourth quarter might have been an inflection point for us in spread management and I personally think that's a good way to look at it. As we think now about '08, and we think about what we hope will be continued lower cost of money into it, it is important to remember that in any given quarter, the option costs and the expenses of option costs reflect a portion of the current quarter and a portion of purchases made in the prior three quarters because we're amortizing that over a 12-month period. So the improvement we hope to see will be gradual over the course of '08.

Spreads on our annually adjustable fixed and multi year rate guarantees products remained quite high, 283 basis points on the adjustable fixed and 197 on the multi year. So those were as good, if not better than '06. They do represent a smaller percentage of overall fund values coming in at about 14% and as you know the bulk of our fund values or annuity reserves are in our index products which represent approximately 84%.

I would like to spend a couple of minutes talking about the FAS 133 impact on our GAAP net income in the fourth quarter and in '07. Normally I would not spend much time on this and instead refer you to the financial supplement, which contains a very detailed reconciliation of GAAP to operating income. This quarter, the FAS 133 adjustment to our index business was unusually high and that relates to the volatility of market. Since it is a larger impact on our GAAP numbers, I wanted to spend more time on it this morning. The FAS 133 adjustments affect the asset, as well as the liability side.

On the asset side, we have the one-year call options, which we mark-to-market under FAS 133. It's the change in value during the year that we adjust out of operating income. That change in the fourth quarter was a decline of $132 million. So much higher than we had ever seen a movement up or down in any given quarter. And that flows through GAAP revenues as a negative. That decline is not significant to us from a spread management standpoint, because it signals that those options may expire with no gain. In that situation, the policyholders get a zero return on their contract for the current contract year.

From the Company's perspective, we've already included the cost of the option in our operating earnings and so the fact that it expires without a gain is not something that's -- that's meaningful to us in terms of spread management. From a policyholders perspective, the policy holder may receive no income credit for the year, however, the beauty of a fixed annuity product is that account values never decline, market value decreases are never flowed through, and so they -- they begin the next contract year with the same level of contract value and with an index reset at the lower level, which allows them to participate to a greater extent than we increased in the current contract year. On the liability side we are valuing the annuity reserves in the index business. The basis of valuation under FAS 133 is different on the liability side than the asset side and that's part of what creates our issues. We had a change in fair value net of derivatives in that liability of a little over $56 million and, when you take into account the related stack and the deferred sales inducements, line items that came up to $101.4 million of offsets on the expense side.

When we look at the annuity reserves, under FAS 133, they are considered to include a series of embedded derivatives, therefore it's a long-term liability in contrast to our one-year options on the asset side. We are required to project forward future option costs and then discount them back to present value, and that's what goes into the calculation of that change in value. There were a number of things going into that this quarter that were different, and among those, one of the principal ones was the changes in discount rate, as we discount to present value. That had a very large impact on the calculation and was one of the reasons that the mismatch between the -- the asset adjustment and the liability adjustment was larger than normal. That mismatch was a negative $31.9 million pretax, $19.7 million after-tax, and so that's the reason the GAAP results looked the way they do, which was a net loss of $5 million. But we can't emphasize enough that the FAS 133 adjustments have no real impact on our operating income, on our spread results and that as we move forward, we are likely to see positive FAS 133 results, but those positive results won't affect our GAAP earnings or rather our operating earnings either.

Turning to investment income, the total for '07 was $719.9 million up from the prior year, where it was $677.6 million. Invested assets were up 11% for the year at $12.6 billion, so despite market volatility, despite some spread compression, we continue to build assets at a double digit rate. Our aggregate yield for '07 was at 6.11%. That compares to 6.14% in '06, however, we did see improvements in yields throughout the year. If you look at the fourth quarter on a stand alone basis, I believe it was 6.14%, and that reflects a couple of things, one, it reflects some prepayment income in the fourth quarter, but as we move into '08, we will also begin to benefit from the higher yields on new investments purchased with new annuity sales proceeds in '07. We were buying bonds at 6.52% in the fourth quarter, commercial loans remained strong at 6.31%, which was slightly less than the high for the year, which was the third quarter when we made new loans at 6.39%. The average on commercial mortgage loans was 6.30 for the year.

As we move now into '08, and into and a possibly lower rate environment, we're very focused on the issues of calls in our callable bond portfolio and making sure that that money gets put back to use in investments that meet our credit quality standards, as well as our yield targets. So far in '08, we have had $484 million worth of bonds, either called or sold at a gain. Those bonds had a yield of 5.30%. We've reinvested that money now in new investments that are earning approximately 6.50%. So an improvement there as well. One of the big themes for American Equity has always been high asset quality and avoidance of credit risk as a principal tenant of our philosophy of investing. That remains as true today as it was a year ago or five years ago. We still have over 99% of our fixed income securities rated investment grade or above and over 90% carry A ratings. Government agencies are at 65% of the total portfolio. So it's still a concentration and still a perfect credit quality. Our commercial mortgage portfolio is at 15.5% of total invested assets. As we have said so many times before and it remains true today, we have no delinquencies, no losses, no restructurings or write-downs on our special mortgages and we continue to think that this is a very strong asset class for us.

As you look at our MBS securities which represents 5.7% of our overall invested assets, we had no losses. No write-downs on our MBS securities so no issues there in the fourth quarter. We added one to our watch list that particular security had a cost of $2.8 million. It's down in market -- excuse me, down in market value by $1.2 million, so very, very small relative to our total block of invested assets. Our investments in corporate bonds which includes public utilities and redeemable preferred stocks was at 11.2% of total invested assets. The average rating on those securities is BBB plus. We did take a write-down and had a couple of very small sales at a loss for a total realized loss of $4.8 million in the quarter. After tax and back adjustments that nets to $2.3 million or a very tiny percentage of our total invested assets. The write-down relates principally to our investment in the Chicago Tribune" bond. We have got a $10 million face value bond that was written down. We have some reason to think that the value of that bond will recover, but accounting rules require us to write it down and take the loss in any event, but we will continue to watch the value of that asset. Several other bonds were added to our watch list, but in total, it still is an immaterial amount of the overall.

Turning for just a moment, to asset liability management. As you look at our available for sale of commercial bonds and commercial mortgages they had an effective duration of 5.1 years. That matches up to an actuarial at 6.4 years. So very acceptable match of duration. In today's low interest rate environment, as you look at the duration of all of the assets, including held for investment, they are at 6.4 years so, no reason to think that the matching of asset liability durations is not appropriate.

Looking to DAC and deferred sales inducements, our aggregate surrender charges remained at 102% of the combined value of those two assets, so no issues with the recoverability of DAC. That's been a very steady number for a number of quarters now. Our experience with actual surrenders continues to be very positive. During '07, the total amount surrendered was 4.5% of total fund values, compared to our expectation which was at 5.9%, based upon the pricing of the products. Penalty-free withdrawals ran at 3.4% of total fund value compared to our pricing of 2.8%. So slightly higher. That's a trend we have seen now for a couple of years, and that we are cognizant of in pricing new products.

Our capitalization remained at a total $1.2 billion at the end of '07. Book value per share excluding the other comprehensive losses, 11.63 at year end. If you include the mark-to-market on available for sale bonds, it's 10.94. When you look in the supplement, you will see a new calculation for this quarter also, which adjusts not already for AOPL, but also there's the FAS 133 adjustment since that was such a large adjustment this quarter and the book value, excluding both of those items was at 12.22. Our statutory capital remains very strong. Our real estate capital ratio is at approximately 400%, on a preliminary basis. It has not been finalized yet, but still well above the minimum level for our rating which is 300%.

I wanted to give you an update on our repurchase program of our common stock. Through February the 19th, we had a total of 1.5 million shares repurchased at a weighted average cost of $8 a quarter. That -- a purchase represents 2.6% of our shares outstanding at the end of September. 300,000 of the shares were purchased prior to 12/31. So it had a very small impact on our EPS calculations for year end and then the bulk was purchased in January. Purchases through year end were made at a weighted average cost of $8.83.

We're funding these purchases, as you know, by drawing down on our line of credit which we had not drawn down on before. We are benefiting from the decline in rates by using that line of credit at this point. We've had two draws now in connection with our repurchase program, one in December and one in January. The December draw was at 5.6%, and in January it was at 3.8%. So a very sharp drop in interest costs. As we look to the future on our repurchases, those levels will depend upon a variety of factors. It will depend upon stock price, depend upon sales volumes, and also will keep an eye on our leverage ratios as we draw down on our line of credit.

Last, but not least, I would like to make a few comments about the settlement we recently announced with the Minnesota Attorney General. We were very pleased to reach a settlement. The terms were very favorable to us from a financial perspective. The settlement really consisted of two parts, one is a modification to our existing suitability review program. We've had in place a very robust suitability program for a couple of years now. We began reviewing all sales in all states regardless of the age of the purchaser and regardless of whether the state required it in March of '06. We have a process of moving to elevated reviews certain sales that have red flags that we have defined. In Minnesota, we will be tweaking that process slightly by adding some liquidity-oriented questions to our suitability form and by tweaking, the parameters for elevated review. These are not significant changes, and so we -- it will not be a major event to make that change for us in Minnesota.

The other component of the settlement is a claims process. We do already have at American Equity a market conduct department that's very good, handles inquiries and policyholder problems. They review cases in some instances, make refunds to policyholders if something went wrong in the sales process. Historically, less than 0.2 of 1% of all policyholders have filed any type of complaint with us and a much, much smaller percentage would have been refunded. As we look in Minnesota, in particular, prior to the lawsuit by the Attorney General, our complaints averaged three per year in that state. After the lawsuit was filed, we had seven complaints which, again, represented less than 0.2 of 1% of all active contracts in Minnesota. As a part of the settlement, we'll send letters to some 1400 households advising them that they may submit their case for review to determine whether the sale was suitable, and whether the product was properly represented to them. We would expect a very small percentage of that -- those 1400 households, policyholders to submit claims to us and that's consistent with the discussions that we had with the Minnesota Attorney General on -- in connection with our settlement. So as we look to that settlement and the financial impact, we expect the overall financial impact to be less than the cost of defense would have been moving forward. So that's -- that's a win in my book.

And with, that I will conclude my remarks and turn it over for questions.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Keith Walsh with Citigroup. Please proceed.

Hey, good morning, everybody.

Hi, Keith.

A couple of quick questions. I guess first, Wendy, it seals like the regulatory environment, I guess, has improved over the last several months. Maybe if you could just talk a little bit on the margin how that is going to help maybe public perception of a product and maybe sales as well. And then, secondly, I think Kevin alluded to this in his comments. Maybe if you could just touch on the number of producers that have contracts to sell with AEL. How many have produced business in the last 12 months and maybe any thoughts on focusing that list down to a smaller number? Thanks.

I will answer the first one and I will let Kevin answer the second one. Certainly the improvement in the regulatory environment is very, very helpful and ought to be helpful from a sales perspective. Both industry and regulators, I think have worked very hard to define standards and to make sure that we were adhering to standards in market conduct and in sales that were very robust. We think American Equity has been a leader in that regard, both in terms of our internal processes and programs, as well as our efforts to work with regulators on that issue. So I really think that '08 will be a year where a lot of legal and regulatory issues settled down, and they have been a drag on sales, I believe, and so that should be very helpful to us, as we move forward.

As it relates to the agents, we've still got about 52,000 agents under contract, and last year, we would have had about 7500 agents write a piece of business. And as I said, about 500 of the agents accounted for 60% of production. And we're very conscious of carrying that big of a group of agents out there with production being so concentrated, what we are attempting to do now is weed down that list and try to identify as best we can folks that maybe don't have potential, versus the ones that do have potential. Give the ones that do have the -- that are in the business more than on a part-time basis and try to give those folks a chance to become significant producers with American Equity and become Gold Eagle members. Yes, we are very conscious of it and I would anticipate as we move through 2008 and into 2009, the overall agents under contract will come down and what we really need to do is try to increase that 7500 agent number as well as the 500 agent number. So we are focused on identifying those producers and trying to make as many as we can significant to American Equity.

We think that if we can get them to have a taste of our service, our products, our culture, as it relates to renewal rates and how we treat consumers, we just believe that as well as the Gold Eagle, where they have the opportunity for stock option ownership, and pull out marketing, we take over the next -- I would say 18 to 24 months, we can really hone down that group of key agents. Now you are probably always going to have -- you can't get rid of every, down towards 100% producing agents because year-to-year, you have different agents produce and you never know which one going into the next year is going to be the producer, but I do think we need to draw that number down.

Great. Thank you.

And your next question comes from the line of Randy Binner with Friedman, Billings, Ramsey. Please proceed.

Hi. Thanks. Just a question on the investments. Wendy, had you mentioned in the press release and your comments that there's a yield of around 6.5% on some newer securities that you are buying.

Yes.

What are you buying that gets that you kind of attractive yield? Can we get more color on that?

Yes, it's a mixture of agency securities. It's a -- it's got some corporate bonds in it. There is some mortgage-backed securities in it and some preferred stock. And the weighted average yield on those four groupings comes in at 6.50%.

Okay. And what -- I mean, I know that you've always had a focus on credit quality, so in -- I guess on the corporates, where would that fall, if there was a middle point?

Well, everything we purchased would have been investment grade at the time of purchase. We certainly haven't purchased anything below investment grade. I don't have the actual ratings in those bonds right in front of me, so I can't answer that specifically, other than to tell you that it wouldn't be below investment grade.

And the MBS, as you alluded to is all agencies?

The MBS may not be all agency, but it certainly all would be prime collateral, and super senior tranches.

It would all fit in the grid that we published in the past in our presentations of where our exposure to mortgage-backed securities were, all in that prime or Alt A super senior tranche with no subprime purchases in there at all.

Okay. But there could be some new Alt A purchases there?

There Would be additional Alt A and there would be additional prime mortgage backed securities and the grid we have on our investor presentation, the numbers would grow in size some, but the complexion would not vary.

Okay. And with the -- with Alt A, is that something that is selling at a discount right now in the market?

Absolutely.

Those are -- I would say one of the advantages of us having a 5, to just under 6% allocation to that asset class at the end of the year, the current distress in the market that has presented some excellent opportunities to buy securities at very high quality and incredibly low risk of default at attractive yields.

Great. And I guess dovetailing with that, is I have heard anecdotally about the opportunities that insurers had with commercial mortgage origination. Could you give us color on how opportunistic you are being there and if you are seeing special opportunities, or unique opportunities because of the currently constrained capital environment?

I don't know that I would characterize the things we've seen as special as unique. I guess the things I've heard from our people is the fact that some of the more -- I can't think of the right adjective now, but the more aggressive competitors and the one thing that Bob spoke to us about regularly throughout the first part of last year was the activity of the conduits and being very aggressive in terms of this their pricing and we wouldn't compete with those. I think what happened in the latter part of the years is the conduits disappeared from the landscape, so to speak, in terms of being competitive. So that's somewhat, -- brought the market back to us, but I would also understand that we've been fairly disciplined and stable in what we have been willing to do in terms of underwriting discipline, and rates we offer.

Great. And then one other investment asset question. I noticed that the -- the schedule of watch list securities it looks like it got rolled -- it appears it got rolled up in the more generic categories than previously.

Right.

Can you just walk us through kind of your mind-set with that?

Sure. First of all, we wanted to make it more consistent with what we saw out there in other filings. There wasn't anybody else out there who was identifying individual securities and so it seemed to us that it made a lot more sense to identify them by classification. And so that was the main reason for that as opposed to identifying the individual securities. As we looked at '07, we saw a number of securities that if you just had a bright line percentage test, would wind up on the watch list. For example, if you said if it declines in value by 20%, that goes on my watch list. That might have resulted in a larger watch list at various points in time in '07, without any real rational basis for that because there hasn't been rationality in a lot of the price movement that we have seen in different securities. So in part of developing the watch list for this year, we exercised judgment in determining which securities actually had some credit concerns that we thought we ought to keep our eye on and put on the watch list.

Okay. So something -- you go to like $0.80 on the $1, but if you don't perceive it as having long-term credit issues then it may not go on the watch list?

Well, that's a pretty big decline in value. If it was that big of a decline in value, it would go on the watch list.

But maybe $0.85 or a higher number? I guess that's the distinction you are making, right?

I think of it more if something has declined 20 or 30% and we can't see any reason for it in terms of the credit quality then we don't think it ought to be on the watch list.

Okay. Fair enough. One other quick set of questions on the share repurchase. Wendy, could you review what the rates were on your two draws, December and January?

Yes. And they were draws of $5 million a piece each time. And the first one was at 5.6% and the second one was at 3.8%.

So okay. So that got a lot more favorable. And then--?

And actually, those are borrowed under LIBOR, plus 20 basis points mechanisms. So the 5.6 will reset at some point in time. I don't remember if we used a six-month borrowing time frame on that or three months, but that one will reprice and assuming that rates don't move from here, it will reprice at a lower rate.

Okay. And so that's helpful. And then so on the balance sheet, that will slowly -- I guess that part of your payables will increase and so you -- at what -- I guess is there a debt cap threshold that would get passed when you have to step back on that?

No. Absolutely not. Our maximum adjusted debt-to-cap level that we will accept is 40% before we implemented this repurchase program, we ran projections of where our leverage would be if we exercised the full, -- purchased back the full 10 million shares that were authorized, and even at that level, it didn't push us above 40%.

Okay. And then -- I mean, finally, I guess, just maybe more color on sales. For me, the sales outlook seems good from all the comments, but to get sales to $3 billion seems very optimistic. I mean, is that really -- how realistic is that in the context of the buyback and continuing?

Well, in terms of buying a $3 billion number, I don't think the Company has put out any guidance on sales for the year, but I -- I could probably tell you in the third quarter, we are -- whether that's a realistic number, I think that -- I guess my optimism for this year is that if we have -- if we maintained volatility in the first half of the year, in the stock market, I think you are going to see more push to save money in alternatives and I think that's where our sweet spot in the market is. The challenge in the market is the high volatility does cause participation rates and caps to come down in the low interest rate environment. It has got fixed interest rates depressed, but on the short-term rates have come down and so the CD alternative is not as attractive as it used to be. I think where we are at is our product is continuing to become more attractive. I think our product has performed exactly the way it was supposed to, based on the last two or three years of performance. So with good crediting rates when the indexes were up, and protection of the principal and gains in the indexes went down here again at the beginning of the year.

So I think from a general standpoint that the market is positive. Then what we have to do is from a competitive standpoint, position ourselves against the Allianz's and Aviva's. The decision we made early on was to be extremely competitive. We know we have been a little bit with our hand tied behind our back on compensation against a couple of them. Let's be agressive, let's take a different approach with this compensation adjustment for the first five months of the year. Try to recruit agents to American Equity and get them to understand American Equity, our products, services, and so forth. I think you are starting to see a big shift in the agents' minds towards this income issue. I don't think they fully have grasped how to use it on a sales standpoint but we want the leading edge there. I think we were leading edge with a 5% income rider. And no fee now with the 7% income rider with a 40 basis point fee, we give them a high accumulation, income accumulation and opportunity with -- with the fee and I think that's 7% is something that is going to draw attention both from agents, as well as policyholders. And you are starting to see sales, and I think you will over the next five years, see sales shift to maybe some younger ages as the baby boomers get close to retirement and start looking at protecting their funds.

I'm optimistic that we are well positioned this year for a great year. Obviously, as we have all seen, things can change in the market very, very quickly. Things could get worse on the volatility side, and production could skyrocket like it did back around 9/11. On the other side of it is, the market could settle down and see it trickle up in interest rates. That could slow things a little bit. But I'm optimistic we are well positioned. We are focused on -- we want to grow production and part of growing production is going to be taking it away from the competition. We are very, very focused on it and probably 60% of the business written in a year is written in the first six months of the year. So we are going to make a hard push here at the beginning of the year.

Excellent. Thank you very much.

Thank you.

And your next question comes from the line of Bill Dezellem with Tieton Capital Management.

Thank you. A couple of questions here. To begin with, relative to your multi year rate guaranteed products, would you please update us on the rolloff that's taking place and the benefit to spreads that you would anticipate in 2008, please?

Bill, that benefit really is a prior period event. We had products that were sold principally in '01 and early '02 that guaranteed rates for a three and a five-year period. Those rolled off -- the three-year product rolled off in '04, the five-year product rolled off in '06, and so the higher rate that we were experiencing on those products gave us a significant bump in our spreads as that higher costing money matured. We still offer those products, but when they were sold, they were repriced into the lower rate environment, so that the rates offered on our newer generation of multi year rate guaranteed products are significantly lower than those early products. So I wouldn't anticipate to see a significant impact on spreads as a result of maturing of multi rate guarantee business.

So that process is essentially behind us now?

Yes.

Thank you. The second question is relative to what we're hearing you say, that you see sales rebounding and spreads are expected to -- to widen going forward, does this imply that during the first quarter you should see your operating income to be up versus the first quarter of 2007, and then theoretically, 2008 also should see increases. So essentially coming back to this concept that the fourth quarter was an inflection point where you had been seeing negative comparisons but starting in the first quarter, those comparisons turned positive?

The first quarter of '07 was the worst quarter in the year for us. So I certainly hope and believe that the first quarter of '08 will be an improvement. And yes, I think you are right on that -- that, assuming things remain as they are today, and that may or may not prove to be the case, but based on what we are seeing today, we would expect to see spreads gradually improve throughout the year and we would expect that would translate into improved operating income over '07 throughout the current year.

That's helpful. Thank you.

And your next question comes from the line of Steven Schwartz with Raymond James and Associates. Please proceed.

Hi, good morning.

Good morning.

Hi, Steve.

Wendy, maybe you could talk to the new rider and the return on that new rider. Kevin mentioned that it was economically positive. I know your products are priced with 15% ROE. Is the new rider in line with that?

Absolutely. Our current rider, that we offer that's a guaranteed income rider, we don't charge anything for. And we've got it reinsured. It has got an estimated 10 basis point cost, and so that's taken into account in managing the spread. The new rider is looking at different kinds of cost structures, and so that -- I think that's the basis for Kevin's comment. He can clear it up if that's not the case. But, yes, that would -- that would add to our estimated price target of 15% within the product.

Okay. And then maybe we can go over some legal things. First, what was -- do you know vis-a-vis Minnesota, what was the -- for lack of a better term, I guess turnover rate for Allianz, get back, return, whatever you want to call it. Do you know what that was?

Yes, I have some information about that. I believe that Allianz had approximately 7,000 policyholders in the state of Minnesota who received the claims letters as a part of the settlement. It's my understanding that as of a couple of weeks ago, there were approximately 200 of those 7,000 that had submitted claims and of those, it's my understanding that refunds were made in a large percentage of those 200 cases.

Okay. And you had -- you had 14 -- 1400 cases in Minnesota, is that what you said?

That's correct? That's households. The policy count is a little bit higher than that. Policy count is about 2,000. That reflects that certain policyholders have more than one contract with us. So the letters will go out per household and it's 1,400 households.

Okay. And then could we -- can we simply touch on some other legal things and how things are developing? In particular, I was thinking about your California, what's going on vis-a-vis you in California, as well as if there's anything new on Midland that you might be aware of and anything else out there that has surfaced over the last quarter.

Sure. Well, let me answer the last one first, which is the ninth circuit has not yet ruled on Midland's appeal of the denial of class -- or rather the plaintiff's appeal of the denial of class certification in Midland's Hawaii case. So we are still waiting on that. For us, we've got a big court case and a federal action. There's really not much going on in the federal action today. There's -- at some point, we will move towards the class certification process, but that's been kind of dragging along and postponed on several occasions by the plaintiffs. So when that will actually ripen into a hearing on certification, I don't know for sure, but at this point, it would not be sooner than the second quarter and more likely the third quarter. In the state court case, there is a certification hearing upcoming in March. The briefing has been done, and all the paperwork filed. I'm real pleased with the work that's been done for American Equity in that case, and so I think we go into that hearing with an extremely strong position.

Both the federal and the state are in California?

Yes. The state case is pending in the San Francisco area. The federal case is pending in the L.A. area.

Okay. Anything else out there nationwide affecting anybody else that you are aware of, one way or another?

Affecting anybody else?

I mean, anything new? Did somebody file something in Virginia against Allianz that you are aware of? Or something like that.

Not that I'm aware of. The two new things that have come up in the last month have been the Minnesota Attorney General sued Aviva.

Yes.

So, they were next on the list for that process. And Allianz paid a fine in the state of California based upon a review by the insurance department. Those are the two most recent things.

Okay. And then just one other question looking back at Minnesota. The tweaks that they made you make with regards to liquidity questions, is there any reason not just to roll that out nationally and get ahead of that?

We are talking about that. And that's very likely the direction we will go, Steven. It's not going to happen at the same time as we roll out of the Minnesota process, but at some point, within a reasonable time after that, we will be addressing that very issue.

Okay. Great. Thank you.

On a lot of these cases, we look at this -- we're looking at these types of things anyway as we go through the suitability process, and we've got a heightened review process already. So it is not unusual for us to be looking at this stuff. We do think that we can roll out a similar -- a similar type materials. It is just that doing it on a national basis, changing your procedures with that many agents is going to take a little bit of time to get the process complete. But we've already got pretty -- pretty detailed aggressive suitability program. I wish some of my competitors did as much.

Thanks, Kevin.

I have my persistency, Steve.

Steven, one more comment on the legal front I forgot to mention that there was a positive development in the state of Massachusetts in the federal district court case where there was a potential class action filled against Sun Life and it was dismissed on a motion to dismiss by the federal court in Massachusetts, so that was a win for the industry.

Okay. Thank you.

Yes.

And your next question comes from the line of Beth Malone with KeyBanc. Please proceed.

Thank you. Just a couple of questions. When you look at 2008 and the changes you have made in 2007, in terms of your -- with the rate changes and where the volatility is in the market, I would assume that the intent was to get the product priced for the current environment so that you can achieve your goals. And my question is, if the market volatility were to move back to what would be more normal, would that put you in a position to have a better spread? I mean, are you comfortable that if the market doesn't change, and interest rates don't change that you are still going to be able to make a superior spread to your target?

Right. And I think your comments are right on point, that if volatility does settle back down again, to the levels that we saw pre-'07, we've got our products now priced for that higher volatility environment. So one would expect to see option costs go down further if volatility calms down which would be helpful to our spreads. At some point, if that happens, we will bring rates back up, but just as we have always been slow to take them down, we will also be slow to bring them up.

But the changes you made in your option program, does that limit the benefit you could get from the volatility going down, since you kind of hedged yourself against that?

No. There's two different issues. The -- as volatility goes down, the basic option costs will go down. And that -- that is a major driver of our overall cost of money, if not the major driver. The ineffectiveness that arose from some mismatches between strike prices at time of purchase and at expiration date, the improvements we have made to minimize those mismatches, that will simply be positive because it will mean we will have a more effective hedging program overall.

Okay. And then a question on the -- on the competitiveness of the equity index product. Typically it's always been one of the biggest challenges is what the CD rates are. And with the recent changes in the yield curve, how would you describe the market conditions now as you compete against CD rates? Are they improved and is there some kind of metric we could see that when interest rates, short term go to a certain point, that means you are going to be more competitive and if they change, it will be less?

Yes, Beth. I think what you are looking at is -- and some areas it's more of a gut feeling than you are actually going to be able to place your finger on numbers. When the CD rates were pretty much nationally across the board up at 5% or better, I think what you're seeing is a lot of consumers saying well, I can get 5%, I'm guaranteed the 5% for three years, four years, five years. They are looking at the index annuities. And base rates on our products the last couple of years have ranged between, probably 3.75, or maybe 3.60. Now with tax deferral arm, the effective return you would have to get would probably 5 for most of them after taxes because given our rates but that still makes it a tougher sale. And then as you saw over the course of last year, volatility trick up, you start to see taxes coming down to the 6% range. So they are getting 5% on their CDs and their cap on their index is 6, but they might not get anything. So that becomes a tougher sale and a tougher (inaudible). I think the income riders have helped to offset that a lot because part of what people have to be concerned with is some growth in their funds for income purposes because they are probably going to need more income as inflation eats away into buying power.

The other thing is you see CD rates start to come down and they start to move down to 4 and then move under 4, I think that that probably is -- my gut tells me that once you are down under 4, CDs become much less exciting for your average consumer and I think the opportunities offered in our products and with the income riders, with the bonuses and with the up side on the indexes -- last year, if you think about it, as our products become understood better, it wasn't unusual last year on the indexing side of our products to see consumers get 16% returns inside of these -- these index annuities. Well, in a product if you get 10 or 15 or 16% return, and then the market goes down the next year and you don't get it back, that starts to draw some excitement and some attention to the products. And I think that the baby boomers are going to get this probably better than their parents did because they have tended to be in the market via their 401ks if no place else for most of their life. So they understand the need for protection, but they also understand and want the opportunity for upside.

Okay. Well, that's certainly helpful. Thank you.

And your next question comes from the line of Daniel Baransky with Fox-Pitt Kelton. Please proceed.

Hi. I just had one follow-up question and one clarification. I guess dovetailing on what Beth asked, if we think about how you have changed the pricing of the products and sort of the volatility of the market, what does the -- what does the average consumer -- what is their behavior today towards their product? Are they finding it more attractive or less attractive in this environment with the rates where they are?

Well, they ought to find it more attractive, because with the volatility in the markets and the declines in values, safe money alternatives become very attractive. With short-term interest rates declining, that -- as Kevin commented, that will make CD products less attractive. So even with rates where they are today, it's still a better alternative than -- than for people who want safe money investments, it's still a better alternative to most competing products.

Okay. And the numbers thrown out before the $3 billion sales, I know that wasn't guidance, but was that number that you felt could be attainable in 2008 if you sort of stay on the present trajectory and everything goes right for the Company this year, or is that a number we should think about more distant in the future or how should we think about that?

That's a number we've talked about in terms of the capital management in that when we instituted the stock repurchase program, we said, as long as we are writing business at the $2 billion range, or the low $2 billion range, we can buy back shares, because our capital needs are self-funded at that growth level. If we get to a $3 billion level, which is where we would certainly like to get to and beyond, then we have to start thinking hard about capital again, if we happen to get on pace for that at some point in time this year, we would consider, you know, what that pace meant to the stock repurchase program.

So, John is exactly right. Said another way, when we start getting $250 million a month, which translates into a run rate of $3 billion a year, then that will be a factor in how we think about repurchases.

Okay. Great. Thanks. That's all I have. Thank you.

There are no additional questions at this time. I would now like to turn the call over to Julie LaFollette for last and final remarks.

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.