American Equity Investment Life Holding Co (AEL) 2009 Q2 法說會逐字稿

Welcome to American Equity Investment Life Holding second quarter 2009 conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Director of Investor Relations. Please proceed.

Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss second quarter 2009 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com. Presenting on today's call are Wendy Carlson, President and Chief Executive Officer; John Matovina, Chief Financial Officer and Vice Chairman, and Ron Grensteiner, President of the Life Company.

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 Wendy Carlson.

Good morning, and welcome to our call for the second quarter of 2009. It's been a quarter of extraordinary activity on a whole variety of different fronts, and we have a lot to cover this morning.

As you know, operating earnings for the second quarter came in at $21.6 million. That's $0.38 per diluted share. Their earnings represent a 21% increase over the same period last year and would represent operating ROE of 11.6% for the trailing 12 months. The quarter was most notable, perhaps, for the sales growth, 77% growth, to $1.1 billion of sales for the second quarter of 2009. That's clearly a record quarter, really an extraordinary event for American Equity. And a little bill later in the call, Ron Grensteiner is going to discuss the drivers of that and some of the outlook for the rest of the year.

As you might imagine, sales at that level really affect every department in American Equity. We have an amazing home office staff here who definitely has risen to the occasion and kept pace with all of the activity. And so we feel good about being able to maintain the high levels of service that we're known for in the market and that are a key to our competitive strength.

One of the things I wanted to address initially in this call is the number of efforts that we've undertaken to support the capital of the company in light of all of the growth that we're experiencing. We are very, very attentive to the issue of maintaining our capital adequacy and have completed a number of steps and have several others in motion.

As we discussed on the last call, we were looking at three principal steps which we did complete in the second quarter. And those included infusing an additional $25 million from our line of credit. As you recall, we took down $25 million in the first quarter, an additional $25 million now in the second quarter, and we would anticipate drawing down the remaining $25 million in the third quarter of '09 as an additional capital contribution.

In addition to that, we expanded a reinsurance treaty. It's a treaty that goes back to 2005 to provide additional surplus relief. That particular treaty focuses on the reserve requirements for the penalty-free withdrawals in our contracts, our annuity contracts. All of our contracts have the 10% penalty-free withdrawal. We're required to reserve as if that's 100% utilized when, in fact, around 3% to 3.5% is utilized. And our treaty with Hanover provides reserve relief as to that excess portion that does not get utilized. We expanded that treaty to include some of our newer product forms introduced after 2005. And that, through the end of the first six months, provided a pretax surplus benefit to us of approximately $35 million or after tax, utilizing an effective tax rate of 35%, of around $22 million. For the balance of the year, we've targeted some additional surplus benefit from that treaty and may look to expand it further to cover products introduced now in 2009.

In addition to that, as we discussed on the last call, we've restructured how we pay our commissions to our sales agents. We have begun deferring 25% of those commissions which helps us support our statutory earnings and capital in the year the business is written. That program became effective June 1. Ron is going to address that also, but it seems to have been very well received by the field force.

There is a very recent development to report as well in that, within the last 24 hours, we completed the second of two binding letters of intent for additional reinsurance under which we will seed 20% of the premium on our two top selling products and 80% of the premium on a multi-year rate-guaranteed product to a newly formed Bermuda reinsurer. That reinsurer was formed by a very experienced management team, has a significant capital commitment. And they, as I said, are going to receive 20% of premium on our index products and 80% on a MYGA product. That treaty is structured as a funds-withheld reinsurance treaty where we hold the assets subject to the reinsurer -- reinsurance and on behalf of the reinsurer. Our goal with that particular program is to allow us to retain up to $3 billion in new sales and to seed off the balance of that as part of our efforts to manage our capital ratios and make sure that our growth is in line with our expectations.

In addition to that, we continue to explore additional programs to support our risk-based capital, including programs focused specifically on residential mortgage-backed securities. The ratings impact and capital requirements associated with those securities have become a very major issue for the entire life insurance industry. There's a lot of things happening on the regulatory front and in looking at transactions to manage that impact. And John will discuss that a little bit later in the call.

Finally, we continue to monitor the capital markets and will be opportunistic as the markets continue to improve in looking for opportunities to raise capital from that source.

In addition to looking to support our statutory capital, we've also strengthened our GAAP balance sheet. Earlier this quarter, we completed an exchange of common stock for our senior convertible debt. As I know many of you will recall, we initially issued $260 million of senior convertible debt back at the end of 2004. That debt has a put date in December of 2011. Over the course of the last year, it's traded at a deep discount, making purchases of that debt, repurchases, very attractive. We utilized cash from our line of credit earlier last year to retire a fairly significant portion of that debt. And now, since we would like to utilize the cash to support growth, the exchange of stock for debt made sense. With the debt continuing to change at a deep discount, we were able to issue the stock and realize an implied premium on the issuance of the common stock since we could retire the debt at the discount. The remaining balance of that debt is approximately $145 million. So we've not -- reduced it by not quite half, but a significant amount. And we're very conscious of the need to continue to plan for the future to refinance that obligation.

Last, but not least, we had quite a bit of activity on our 151A lawsuit and other things affecting 151A and the potential that our products will be regulated as securities. And I'm going to wait until the end of the call to comment on that and would turn it over now to John to address the components of our earnings.

Thank you, Wendy. And my welcome and thank you to everyone for joining us this morning. Couple of the key items in the earnings report for the quarter. Net investment income was at $227 million. That translates into a yield for the first six months of 6.29%, which, compared to a year ago, we were about -- year ago, we were about 6.17%. We had a lot of investment activity in the quarter. As many of you know, a cornerstone of our portfolio through the years has been government agency bonds. Those bonds are callable. The call feature is what translates into the acceptable yields we get on those bonds. And during the quarter, we had over $2.3 billion of bonds called, a small amount of sales. The call bonds had a yield of about 6.25%. And for the year, we're up to about $3.4 billion at a yield of 6.18%.

The other side of that story, then, of course, is reinvesting that money. And during the second quarter, we reinvested, or put to work, $3.2 billion at an average yield of about 6.18%. For the full six months, we're at $4.7 billion at a yield of 6.38%. So we've been investing our money at rates higher than the rates that we're losing on the called bonds. And in terms of a breakdown of where the money is going, a sizeable amount is going back into agencies; $1.7 billion in the second quarter, $791 million into high-grade corporate bonds, either class 1 or 2, and $468 million into high-grade MBS which would all be prime structures, AAA securities.

We continue to do commercial mortgages, although at a smaller scale than what we've done in the past. For the second quarter, we made $56 million in commercial mortgage loans at a 6.98% blended yield. On a year-to-date basis, we're at $102 billion for a 6.86%. And we've got commitments out there now for about $19 million at rates in the 7% to 7.25% range. The emphasis in the portfolio remains on credit quality. I mean, the comments I talked about, the securities we bought, we're -- only buying investment-grade securities has been the history of the company going back to inception. And we monitor and take serious the credit quality of the portfolio.

Commercial mortgages ended the quarter at $2.37 billion. It's just under 17% of total assets, which would be down slightly from 18% at the beginning of the year. And that would be directly attributable to the fact that the issuance of commercial mortgages is at a slower pace from prior years. We're continuing to have, I think, very excellent credit quality in the commercial mortgages. We talked last time about experiencing our first couple of foreclosures. And that's still the case. One of those foreclosures was completed. Another one is in process. And on those two loans, we expect full recovery. In the case of one that's in foreclosure now, we actually have an assignment of rents. So our interests are well protected there.

We do have a small number of loans that we would consider in workout status. Those add up to about $49 million of principal, loans that we are keeping an eye on. But at this time, have not made any provision for loan loss. We did have one loan in the quarter where we did take a $1 million loan loss provision. That represents a property that is an owner-occupied-type situation, and the -- our assessment is that a default has got a higher probability there and that the value of that property may not be up to the value of our loan, which the loan itself is about a $5 million loan.

We think the issues relative to these commercial mortgages are fairly small. As I said, $49 million is the exposure amount on the ones that we are dealing with some adjustments. And it goes back to the core characteristics of the underwriting procedures and the fact that loan-to-value ratios at the inception of those loans were very low. Our practice indicates not to go over 70%. And we've had a weighted average loan-to-value in the high 50s that provides a significant margin of error for value decline and allows us to absorb what's been happening in the market for commercial mortgages.

RMBS, all of our RMBS are performing. The new purchases that we've made have been in prime collateral, primarily '05 and prior vintages. We're buying those at a discount. And if you look at the entire portfolio of RMBS, the average discount is in the 6% to 6.5% range. And Wendy commented, and you can see from the chart we put where we indicate the ratings quality of the portfolio. There has been migration in the RMPS from the investment-grade class 1 to below-investment-grade categories. I'll remind you, though, all of the RMBS we have were all AAA at the time of purchase in the senior-most tranches, and that these rating adjustments do not reflect the expected severity of the loss. We continue to believe that the RMBS securities are going to be very good performers and that the risk of exposure is far less than what market values indicate and what these rating indicates -- rating adjustments indicate.

A couple of things are happening on the regulatory front to potentially impact how these rating adjustments are affecting the RBC calculations. Most recently, a proposal from the ACLI has been resurrected at the NAIC level that would provide some relief in the RBC calculation by allowing RMBS to be notched up from their stated ratings either by one or two notches, depending upon the characteristics of the underlying collateral and the performance of the pools. That's fairly recent, so it's difficult to speculate on whether that will ultimately go through or not.

The other area is a Re-Remic structure which would accomplish a similar result by causing the securities to be related into AAA tranches and a smaller piece then in a lower rated tranche. And the Re-Remic structures continue to be viable from a transactional standpoint. There are some accounting challenges there that are also the subject of proposed rule interpretations. And that rule interpretation, the comment period just expired last week. So there's likely to be further action out of the NAIC working group on that. And it's difficult to speculate on where that might go as well. But a couple of things happening that would provide some relief on the RBC calculation. And if they did, would very likely take us back up over a 300% level from -- which is the target we have for our A.M. Best rating.

Actual impairment losses in the quarter were relatively small at $5.6 million. That would break down into $1.3 million from RMBS, $4.2 million from corporates. Corporates were largely one security, CIT Group, which is a name that should be familiar to most everybody. And we had a $10 million principal investment in CIT with probably $9.6 million of book. And that has been impaired down to its fair value. And we're actually -- I think have now sold that security, so no further risk of impairment there. Our impairments were offset by $4.3 million in actual realized gains. So a very small amount from credit-related or impairment-related item in the portfolio -- or in the statement for the quarter.

Watch list is up a little bit from prior quarter. That primarily would be evidenced in the RMBS numbers which, as the ratings downgrades have occurred, that adds more and more securities to our list. But in the evaluation of those securities, we continue to believe the economic risk is much smaller than what's indicated by the market values. And that would be pretty clear from the fact that, you know, what we've taken in impairments in RMBS is a little more than $10 million over the first six months of the year on, say, over $500 million worth of principal value. The downgrades tend to be disproportionate. They focus on the probability of the loss and not the economic exposure that the loss might represent.

Spread was -- continued to be quite good in the quarter. I talked about the investment yield at the 6.29% level year to date. Cost of money declined to 3.31% for the first six months of '09 compared to 3.49% in '08. We continue to see very acceptable option costs. With the VIX coming down, a number of the options that were more expensive have come down in price. We continue to have a natural balance in the portfolio from the monthly point-to-point option that's moved in the opposite direction to the VIX. And of course, our cost of money has been a little bit more stable recently because of policyholder preference to put more and more funds into the fixed rate strategy where we're crediting anywhere from 3.10% to 3.35%. And that's probably 55% of the new money is going into the fixed rate strategy. We haven't had any rate adjustments in the second quarter of 2009 and really don't have any under consideration. There was nothing new in deferred sales inducements and locking in the quarter. DAC amortization was normal relative to the gross profits.

Other operating costs and expenses increased $1.9 million. The largest portion of that would be the financial statement accrual which I would look at as a one-time item for the liability created to provide for the retirement benefit that the Board of Directors approved with Dave Noble in the quarter. We did have some increase in legal expenses related to the 151A, the Wells Notice, the Minnesota Attorney General settlement and activities with Eagle Life, which is the company we formed to sell registered products if we need to do that out of 151A or if we choose an alternative distribution strategy.

GAAP net income was $9 million in the quarter. It did include about $1.5 million from the retirement of debt. It also included a negative effect of $13.9 million from the FAS 133 impact on the index annuities. We also, in terms of GAAP equity, picked up $31 million through a reduction of our valuation allowance. As you may recall last year, we put up a valuation allowance of just under $35 million against other than temporary impairments and other capital loss-type items. With the turnaround in the market in the second quarter of the year, we now have a sizeable number of gross unrealized gains in the portfolio. That allowed us to reduce the valuation allowance to zero. Unfortunately, in the accounting rules these days, it went up through earnings, and it came back to accumulate other comprehensive loss. But it is back into our book value per share, the reduction of that $31 million in the second quarter.

As I made a comment a little bit earlier, the estimated RBC is still below 300% at June 30th. And it's due principally, or entirely, to the impact on the calculation of the RMBS ratings downgrade. You know, setting aside that issue with the steps we've been taking, as Wendy described, to maintain our capital and add to our capital, we think we will have sufficient capital -- we will have sufficient capital to maintain that ratio above 300%. And as I commented, activities are occurring on the RMBS that we're optimistic would result in a resolution that will be favorable to us and others in the industry because this is not just an American Equity issue. It's affecting lots of companies in perhaps far more serious ways than it's having an impact on us.

And with that, we'll let Ron speak about the excellent sales we had for the quarter and what's happening going forward.

Thank you, John. And good morning, everyone. Welcome to the call. As Wendy had reported earlier on, we had a record second quarter in many respects. We broke our monthly production record in every month of the quarter in June, hitting an all-time high of $409 million. Overall, the quarter was $1.1 billion, a 77% increase over the second quarter of 2008, which was $647 million. There are several reasons for this extraordinary growth.

And one reason, of course, is consumers still continue to look for principal protection on their products. While there seems to be some signs of recovery, I think the effects of this meltdown may be longer lasting in a lot of people's minds. And so offering the products that we do, we have exactly what they want, principal protection.

Another reason for great sales is a lot of companies this year have been scaling back due to the reasons that my associates have been discussing. They have been reducing bonuses, increasing fees, pulling products, a whole variety of things. And as they have pulled back, American Equity has been a benefactor of their strategies. So that's been a good factor for us.

A third one, of course, was the introduction of a new product on February 1st, our Retirement Gold. This product was our answer to many of the competitors' who had a 10% bonus on a ten-year surrender period. This particular product is not exactly like that. It has a 12% bonus, but has a vesting strategy as a part of it. But it competes very, very well with the other companies' products. And the Retirement Gold did quickly become our top selling product. The competitive environment has certainly changed substantially, though, since we've introduced it. We've always said that we wanted to be competitive with our products, but we never really want to be too competitive. And as a result, we have made the decision to lower the premium bonus on that Retirement Gold from 12% down to 10%. And we made that change effective August 1st. So we will be right in line with our competitors there.

Sales today are still very strong. Pending at the end of July was around the -- well, better than 5,200, close to 5,300. This was in part due to a flurry of activity as we made the bonus announcement on the Retirement Gold. Pending had moderated around the 43 -- 4,300 range during June and July. To try and put this into perspective for you, in 2008, we never broke 3,000 pending apps. In January of this year, we were at 1,800. We broke 4,000 in March. We broke 5,000 in April. And we peaked at the end of May at just over 6,000 applications as agents tried to get their business in ahead of the commission restructure.

Speaking in terms of the commission restructure, we did implement that program on June 1st, as Wendy indicated. This program structured commissions so that approximately 75% of the first-year commissions would be paid at issue, and then half of the remaining balance, plus interest, is to be paid in the 13th month. And the remaining balance, plus interest, is to be paid in the 25th month. From our standpoint, this obviously presents a positive impact on statutory earnings and capital. And from the marketing standpoint, our message was that it gives us a method to safely increase sales volumes and gives the agents a home and allows us to do all this without jeopardizing our financials or our ratings. So as other companies were pulling back, we, in a sense, were telling our field force that we're increasing commissions when you factor in the interest rate adjustment -- or interest rate factor.

The reaction has been very favorable. We know that we've probably lost a few agents, based on some of the emails I got. But overall, it was very well received. There is really no concrete evidence that we had a massive wave of agents leave. And I also think, by virtue of the pending count, the fact that it moderated in the 4,200, 4,300 range is certainly good evidence that it was well received. One company did follow our lead. And while I certainly don't have the inside scoop on anybody, I wouldn't be terribly surprised if some others followed with similar types of modifications by year end.

We did have some good press on our commission restructure program in the June issue of the Index Compendium. Jack Marrion wrote, "Frankly, I think staggered commissions are a better way to handle the capital strain than the market disruptions caused by pulling products or canceling agent contracts." Also, Tim Pfeiffer wrote, in the June 1st, National Underwriter, "The benefit of a multi-year spread of sales compensation and/or premium bonuses to the insurer, policyholder and even to the sales agent are strong, provided that the fixed annuity is treated as a long-term relationship." So it was very well received as you can see. And even the folks in the financial industry gave us the thumbs-up for that particular move.

Sales trends for the balance of the year, the products are still going to continue to be very strong as people look for principal protection and guarantees. I think a lot of it depends on what the competition is going to do. The competition really hasn't done much at this point. We always have to factor in summer and vacation time as we come down the homestretch before school starts. Not sure we'll see an effect from the commission structure I've already indicated. And the bonus adjust on the Retirement Gold, I think, will be minimal. So overall, it's hard to tell where we finish the year. But I think it's safe to say that our products are competitive, and we'll continue to get our fair share.

So with that, I want to turn the call back over to Wendy.

Thanks, Ron. Lastly, we wanted to comment on Rule 151A. As you know, we received the ruling of the US Court of Appeals for the DC Circuit in our lawsuit concerning that rule. The rule was remanded to the SEC for further consideration. The Court ruled that the SEC had acted in an arbitrary and capricious manner in adopting the rule without an adequate analysis of the impact on capital formation, competition and efficiency. We certainly would believe the rule that duplicates protections under state law would not be efficient. The ruling was not perfect in that it held that the term annuity contract, as used in the Securities Act, is an ambiguous term and that the SEC did not act unreasonably in concluding that fixed index annuities would not be covered by that term and not entitled to the exemption from the Securities Act and thus would have the power to adopt a rule like Rule 151A if adopted in the proper fashion.

Future steps on the litigation are uncertain at this point. Timeframes are running. There's 45 days to seek rehearing by the entire panel at the DC Circuit. There is a 60-day timeframe to seek an appeal to the United States Supreme Court, although that type of appeal is probably premature since further consideration is needed by the SEC. We don't have information yet on how the SEC intends to address the remand, whether it will, and so there is still a lot of uncertainty around this issue. We do think that there is room for dialogue between the NAIC and the SEC that might result in an acceptable resolution, and so we continue to monitor that.

In addition, as I believe you know, there are bills pending in both the House and the Senate to overturn Rule 151A by changing and clarifying the definition of annuity contract in the Securities Act. There is a fairly broad base of support, bipartisan support, in both the House and the Senate for those bills.

We had a very good event last week that was cohosted by American Equity and one of the other companies in the coalition that's fighting Rule 151A to bring to Washington a number of agents and marketing organizations. We had over 100 in attendance there. And we spent the day fanning out across Capitol Hill and calling upon the members of Congress representing the home states of the agents and marketing organizations to continue to support awareness of our efforts to overturn Rule 151A and to seek cosponsors among the senators and representatives of that legislation.

We felt that it was a very successful event. There was a lot of interest in the bills and a lot of indications of intent to support our bill. So it's hard to say at what point in time those bills might be voted on. Representative Price of Georgia, who is the co-lead sponsor of the bill in the House, commented that year end was a good timeframe to focus on for getting those bills passed. Whether that will happen, of course, is uncertain at this point.

Because we don't know what's going to happen with 151A, we continue our preparations to develop our broker-dealer channel and to be able to sell registered products into that channel. We did recently, in the second quarter, file a registration statement for our first registered product, so that was an exciting event. We hope that that will be a product that can be sold in addition to our existing inventory of indexed products and that the broker-dealer channel will supplement our traditional channel of the independent insurance agent and not replace it.

And with that, I'll turn it back to the operator for questions.

(Operator instructions.) Your first question comes from the line of Randy Binner with FBR. Please proceed.

Hi. Good morning. Thank you. Thank you for the very in-depth comments on RBC. I think at this point, pretty familiar with all the workings there. But maybe just at a higher level, I mean, it sounds like it's clearly a priority to manage to the 300% RBC level. I just wanted to get a sense from you on that, if that's an absolute line in the sand, if there's any flexibility that A.M. Best might view around absolutely managing to that, in light of everything that's going on from a macro perspective.

It's hard to comment on what they would do. You know, we have used that as our internal target. It's not the only measure of capital adequacy. And so given the issues that we're dealing with are industry issues, I have to think that there's some flexibility there. You know, as you look at the other measures of capital adequacy such as A.M. Best's own capital model, which is the BCAR model -- and John's got the exact numbers here. But we've got a very strong capital adequacy ratio. And it would certainly indicate that our -- that we have adequate capital for our rating using that measure. In addition, we look to just the basic ratio of liabilities to capital. And that has remained very strong. John's got the specific numbers. He can add to my comments.

Well, yeah, the BCAR ratio, A.M. Best level has been 175 for their highest rating. We've been up above 250 for a number of years now. And the A-minus rating is at 130. So we would continue to be above that even with the RMBS downgrades. On the statutory capital and surplus to liabilities, our ratio is sitting at about 8%, which is comfortably above a threshold of 7% for where we would view the cutoff for our rating.

Yeah. So in a sense, maybe whereas I'm asking the wrong question about focusing on RBC. It seems like -- I mean, if BCAR kind of has a better response to all of these issues than RBC, I mean, is it really the RMBS piece, et cetera? Are there any other pieces that impact RBC more, where BCAR has less of an effect?

They're totally different models, so it would be hard to assess that. And you know, A.M. Best would say that no one measure controls their ratings. They look at all the factors, both quantitative and qualitative. And so there's no way to draw a bright line around what their requirements are. So all those things get thrown into the mix.

Okay. And, I guess -- I mean, again, the comments were very comprehensive on 151A. But, I mean, is there any -- the issue of a compromise, or the potential of a compromise with the SEC and the NAIC seems to be a very reasonable and logical solution. It's just less disruptive to everyone involved. And so any color you could provide on that avenue and kind of, you know, how seriously you think the SEC may want to take this would be interesting. Thanks.

Well, I couldn't agree more that it would be reasonable, logical and less disruptive. Whether that's the road that we'll go down here is hard to say. I think there is interest on the part of the regulators to approach the -- the insurance regulators to approach the SEC. Everybody wants to think carefully about the best ways to do that. And to what extent the SEC would be receptive to that type of dialogue, it's just very difficult to know. You know, the rule arose under the Chairman Cox administration of the SEC. We don't have a good feel for whether the rule is as important to Mary Schapiro now as chairman of the SEC. So it would just be impossible to try to predict what direction they will go.

Fair enough. I know that they're difficult questions, but I appreciate the color.

Your next question comes from the line of Paul Sarran with FPK. Please proceed.

Good morning.

Hi, Paul.

On the reinsurance deal that you announced today, did you say if that covers existing business, or is that only new business going forward?

It's '09 business. It's '09 premium in our top two index products and in a multi-year rate guaranteed product.

Okay. So what's the best way to think about the impact on capital? Is it essentially you can write just 25% more business for the same amount of capital? Are there any intricacies in there that make it more complicated than that?

We think of it a little differently. We think of it as capping the liabilities that we are going to assume during the year at $3 billion so that we don't have the additional capital required to support production over that level.

So you could go -- okay. I think I understand what direction you're going with. All right, on another topic, can you talk about persistency trends in the block? Have those been moving either positively or negatively recently? Are you seeing the normal rate of lapses?

Yeah, there's nothing happening on the persistency front that's either -- that's abnormal or that much different than what we've seen in the past.

Okay. And then just lastly, and I'm sorry if I missed it, do you have any update on the Wells Notice that you can share?

Yeah, there is not a lot to report. There has been some discussion with the SEC. We have filed written submissions responsive to what we believe the underlying issues are. And we anticipate that there will be further discussion.

Okay. And thanks. That's all I had.

Your next question comes from the line of Bill Dezellem with Tieton Capital Management. Please proceed.

Thank you. I actually wanted to follow up on a prior questioner's question about the new reinsurance agreement. Are you implying that the reinsurance agreement essentially kicks in once you've reached that $3 billion monthly annual run rate, or does it apply to every single contract that you're writing of those three policy types that you described?

Thank you, Bill. That's a good clarification that's needed. It does apply to every policy. It's at 20% of premium in those two index products, and 80% of the multi-year rate guaranteed product will be reinsured through this transaction. So it functions, I think, about like a coinsurance arrangement except it's funds withheld. And the $3 billion is not an absolute. It's a target. And so in arriving at those percentages, the 20% and the 80%, that was our best estimate of how to manage new production to that $3 billion limit.

So, in essence, kind of using the prior question's point, is it in fact -- it does allow you to write roughly 20% more business. But that's essentially the estimate. And I'm using the two contracts. That's essentially the estimate of what you felt you would need, kind of coming back to your comment, to cap your growth at the $3 billion run rate.

Correct.

Okay. Thank you. And thinking about your commissions with the agents, have you considered -- and if not, why have you not considered -- lowering your commissions with the agents as one route to actually limit your growth?

Well, we don't really want to limit our growth. We want to continue our growth and be able to accommodate the production that the agents want to send us. Because once you start limiting your growth by turning agents away through whatever means, then it's very difficult to turn it back on again in the future. So we'd like to be able to continue accepting all the business they want to send us and to manage our capital through a variety of means to be able to do that.

Ron, I don't know if you have other comments on that.

No, I think that's very well said, Wendy. And I think Jack Marrion said it pretty good, too, in his quote that when you start reducing commissions, it causes disruptions in the field force out there. And it takes us a lot of time and effort to get the momentum gathered up. And when they start to throw cold water on it, it seems like you have to work twice as hard to get it back where it was before. So Wendy hit it right on the head.

Thanks. And then two additional, completely different questions. The first one is, given that you're having discussions with the SEC relative to your Wells Notice, and given that you're, on the other hand, having discussions with the SEC relative to Rule 151A, does that create any sort of a conflict or maybe more of a jaundiced eye that the SEC would look at American Equity with?

It would be impossible for me to comment on that. The issues are arising in different areas of the SEC, different divisions of the SEC. And so to the extent that there's some crossover there and one affecting the other, we just really don't have any basis to know that.

And then the last question is relative to your commercial mortgages. What have you seen in terms of the trends with whether it be 30 days past due delinquent or problem loans, however you want to define them, can you walk us through trends over the last couple three quarters? And I'm, in part, asking because we've had a couple of companies imply that second quarter, things improved.

I would kind of concur with that, Bill. I think the -- we might have had a fewer number of loans that came up for discussion analysis in the second quarter than we did in the first. It's still a relatively small number, so I don't draw any trend conclusions out of it, but when we've got 10, 15, 20 loans that are in situations where we're paying closer attention to than normal review and analysis.

Did your delinquent or past due loans increase or decrease in Q2 versus Q1?

I don't know specifically because it's such a small number. I don't think it did much of anything, though.

Great. Thank you. Appreciate all of your comments.

Your next question comes from the line of Steven Schwartz with Raymond Jones. Please proceed.

Hey, everybody.

Hi, Steve.

To go back to the reinsurance agreement, so it sounds like it's retroactive to the beginning of the year. How much premium -- well, first, what are the two top products you've got: Retirement Gold, and what's the other one?

Bonus Gold.

And Bonus Gold?

Mm-hmm.

And how much was written in those two products through the first six months?

Well, total was $1.8 billion of all sales, and that would represent the majority of it.

Those products were probably $1.5 billion.

$1.5 billion, okay. And that's -- it's about 80% of sales going forward?

Yep.

Okay. All right.

Might be a little bit higher going forward.

Little bit higher, okay. And then, John, how much you got in -- maybe you said this. You were going pretty fast. But how much -- what's the amortized cost of the Alt-A RMBS that you've got on the books?

Alt-A is $562 million amortized cost.

Okay. And is that tanked down at all?

Pardon me?

Is that tanked down? I mean, is that coming down?

Yes, it would be coming down. Slowly, but it's coming down. Obviously, we're not buying any new ones. And there are some paydowns in there. But looks like amortized cost was about the same -- well, it's about the same amount in December.

Okay. And then, Wendy, going back to SEC Rule 151A, they have to prove that the rule -- the most efficiency capital formation and competition. Do you know, as a lawyer, how the SEC goes about doing this?

As a lawyer, I have not had an opportunity to look into that kind of a study, and so I would be speculating to answer that. But it's my understanding, from talking to our lawyers on this, that data is needed. Facts and figures are needed. It's our belief that they would need to dig into the state insurance regulation in the various states to determine what actually is covered and what the level of disclosure, required disclosure, is, what suitability requirements are. And so it could be a burdensome task to compile all of the state insurance regulation on this issue and determine what the most efficient way to regulate the products is.

New registered product that you have, is the disclosure very different?

There -- you can look at the registration statement which would include a draft of the prospectus. It's filed under Eagle Life Insurance Company, which is our newly formed subsidiary for this purpose, licensed in, I believe, 23 states and applications pending in the remainder. That registration statement is in excess of 150 pages long, so it certainly would be a longer document than our normal disclosure. I think we would argue pretty strongly that it certainly isn't a better disclosure, and it in some ways obscures a lot of the important issues just because it's so prolix.

All right. Well, maybe when I've got nothing better to do, I'll read it. Thank you.

Your next question comes from the line of Greg Eissen with ICM Asset Management. Please proceed.

Thanks. Good morning. Going back to your risk-based capital, you had previously been over your 300% target. You're saying now that your RBC comes to less than 300%. And that's essentially because of rating agency downgrades?

Of the RMBS securities, that's correct.

Of the RMBS securities.

Right.

And the RMBS are located in line item of the mortgage and asset-backed securities on your schedule of investments. As I look at the year-to-date progress, you've seen a steady growth in that whole line item of mortgage-backed securities, $1.8 billion at December to $2.2 billion in March, now $2 billion -- almost $2.6 billion in June. I guess I'm trying to understand what seems like a -- for someone who is looking on the outside looking in and doesn't know the details, a contradiction that this category of asset class is causing a problem. But you're investing money into that asset class at a very healthy clip, you know, so far on a year-to-date basis. And it seems to be causing some problems, whereas on the flip side, you're not really originating much growth in whole loan mortgages this quarter, or last quarter for that matter, yet they're yielding much higher yields, and they seem to be showing a better risk profile than the RMBS product. Can you explain why you're growing the mortgage-backed securities portfolio at a time when it's causing you risk-based capital problems, I guess, is my question.

Well, the risk-based capital problems would be in the securities we bought prior to this year. The newer purchases, one, no further Alt-A collateral, only prime collateral. We've also been buying earlier vintages, 2005 and prior, where underwriting standards were more conservative or more -- protected the buyer of the securities more.

So I've heard, yes.

Pardon me?

I've heard to that to be true --

Yeah. So -- and in particular in the second quarter, the large increase there was concentrated in a Re-Remic structure where we were able to have significant influence in the development of that structure. You know, and in a typical RMBS on a prime, you might have subordination of say 5% to 10% below your AAA top tier. In this particular structure, we were able to accomplish, I think, in the 20% to 25% range of subordination. So that security is -- you can't ever say anything's bulletproof, but we've got substantially greater protection of the triple rating on that security than we did in some of the earlier purchases that go back into last year when we were buying Alt-A.

Contrasting that to the commercial mortgages, the mortgage-backed securities as AAA have a much lower risk-based capital requirement than a commercial mortgage does. The AAA securities are going to have like .004% required capital at the company action level. A commercial mortgage is going to start out at a 2.6% required capital as the baseline. And you are able to adjust that level depending upon your own company experience. American Equity has always been able to adjust down to the lowest level, which is a 50% reduction. But even still, a commercial mortgage then acts like a class 2 bond as opposed to a class 1 bond at the best RBC level.

The other element in our consideration there is -- in terms of not growing commercial mortgages as great, is an acknowledgment of the fact that the portfolio got up to 18%. Kind of our upper threshold is 20% of invested assets. Another measure that A.M. Best advises us of is the size of commercial mortgages relative to statutory capital and surplus. And they have a framework of two times statutory capital and surplus. And we were over that level at year end. So actually with the slowdown in originations, we're gravitating back to that measurement. So those are a number of the factors that would result in fewer commercial mortgages this year and more RMBS.

I get it. I get it. Totally different question, if I could go back to the 151A problem, I'm trying to kind of understand kind of the end game of this. Assuming you can't get law changed in Congress, and you have to sell a registered product, right now, you're selling unregistered product, and it's selling fabulously well, I mean, $1.1 billion in sale this quarter. You have an impediment that the agents that sell the product would have to be registered with the SEC. Well, it sounds like, to me, that the people that are selling this product are selling an awful lot of it, they're making probably very good money selling it. But they have every incentive in the world to take whatever test they have to take to get registered and jump through those hoops. Other than the agents getting registered themselves and you creating a new entity with essentially creating a registered product that would look similar to your existing product but essentially be registered, what other major impediments are there to selling what you're selling now, wearing the clothing of a registered product versus an unregistered product?

Sure. It's a great question. The things you just described, registering the products and the agents getting securities licenses, are probably the easiest part of the change that would be required. You know, today, an independent insurance agent can run his or her own business, can be affiliated with multiple marketing organizations and have multiple revenue streams. If 151A becomes final, that agent not only will have to get a securities license but have to become affiliated with one broker-dealer. And in order for him or her to sell our products through that broker-dealer, we have to have a selling agreement with that broker-dealer and have to get shelf space with an entirely new group. And of course, there isn't just going to be one broker-dealer, there's going to be hundreds of broker-dealers that the agents potentially become affiliated with, which means that we have to have selling agreements with all of those firms.

Traditionally, we've managed our distribution channel through the national marketing organization. That's been a very effective way for us to grow and manage the agents. One of the changes that this would represent is that the role of the national marketing organization in a broker-dealer channel is very unclear in how you build that organization in. So changing that whole structure is a pretty tall mountain to climb.

Then you look at it from the standpoint of that independent agent who is running his or her own business, have made a career out of selling sleep insurance and advising people that avoiding the risk represented by the market is a good idea. You're asking them to basically give up their status as a small business person, affiliate with a broker-dealer in a world that they've never really wanted to be a part of, or a lot of them. And the compensation they receive on the sales of the products in that channel is going to be lesser than it is in the independent agent channel because there's more elements to build in, in terms of compensation. We've got to build in a concession for the broker-dealer in that system. So if I'm our typical agent, I'm probably going to say it's not worth the effort, and I think I'll just focus my time and efforts on selling traditional fixed-rate products where I can earn a comparable commission and not have to go through all them.

I see. There will be more hands in the pie asking for a cut.

Exactly.

So their income would go down at the same time the sales pitch that they've been making all along would appear to have to change because it isn't just selling sleep insurance now. The customer realizes they're buying a securities product. Even if it's the same type of product as before, it suddenly sounds different to the customer.

Correct.

Gotcha. Gotcha. Okay. I appreciate the answer. Thank you very much.

There's no further questions in the queue. I would now like to turn the call back over to Julie LaFollette for closing remarks. You may proceed.

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.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.