American Equity Investment Life Holding Co (AEL) 2011 Q1 法說會逐字稿

Welcome to American Equity Investment Life Holding Company's First-Quarter 2011 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, ma'am.

Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss first-quarter 2011 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 Waugaman, 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 Waugaman.

Thank you, Julie, and good morning. Welcome to the call. As we announced last night, 2011 is off to a very good start with continued growth in sales, assets, and earnings for the first quarter. Sales for the first quarter were at $1.3 billion before coinsurance of $66 million. That makes it the highest first quarter ever in our history and actually it's the second highest quarter of any quarter in our history, second only to the fourth quarter of last year, where we had over $1.5 billion in new sales.

The earnings have resulted in additional book value increase to $15.20 per share excluding accumulated other comprehensive income. That makes six consecutive quarters now of quarterly increases in book value per share.

These results we believe reflect the ongoing execution of our long-term strategy which we've discussed many times, that's to continue to build assets under management through sales of fixed annuity products and to manage a consistent investment spread on this growing base of assets.

As we look to the future we continue to think that the primary driver of our future growth will be sales of our core products, fixed annuity products through our traditional distribution channel of independent insurance agents. Our market share in the indexed annuity market has grown very significantly over the last two years. It stood at 13% at the end of last year. We were number three in the market for the year of 2010, but had moved into the number two position in the fourth quarter.

We believe that to sustain our growth in sales we really don't need to continue to increase market share, although that's certainly a goal. We just need to maintain a consistent share of a growing market and we strongly believe that the market will continue to grow, even just looking to demographics alone. Increasing numbers of Americans are reaching retirement age.

If you look to census data, those 65 and older are expected to grow by 33% by 2020 and by 75% by 2030. In addition, among younger consumers, those nearing retirement age, between 55 and 65, there seems to be increasing demand for guaranteed retirement savings and so the pie is getting bigger.

We are also eager to begin sales in the broker-dealer distribution channel and we believe that the growth potential there is significant, but remains an unknown quantity. Therefore sales of annuities through independent insurance agents, which is our bread and butter, we believe will continue to be a good source of our potential future sales growth. Our strategy there is to focus on building those agents selling at least $1 million or more annually and to build the amount of sales per agent in that group, and I know Ron will discuss that in a little bit.

As you know and as we know, a rapidly growing market attracts competitors and we do expect new entrants into the indexed annuity arena. We welcome that competition for a couple of reasons. One, we think it supports our beliefs that it's a growing market. Two, we've been competing against larger companies for many years and our competitive advantages have proven to be very durable.

As a company that started from zero 15 years ago we're very accustomed to competing with larger insurance organizations. In fact when we began every insurance company we competed with was larger than we were. But despite their size none have been able to replicate our service culture, which is a key competitive advantage.

We've maintained our position in the top ranks of indexed annuity writers for many years while others have come and gone, so while we may have new competition in the market and they may be able to copy our products we think they'll have a very difficult time dislodging us from our position of leadership in our industry.

And with that I'll turn it over to John to discuss the results in detail.

Thank you, Wendy, and good morning everyone. As we reported last night first-quarter operating earnings were $30.6 million. That's $0.47 diluted per share and also as we acknowledged in the press release and the financial supplement those results did include a one-time benefit or positive adjustment of $2.7 million or $0.04 per share related to an adjustment to single premium immediate annuity reserves. That adjustment represents some excess reserves that were built up over a period of years related to the mortality element of certain of the SPIA reserves.

So excluding that item the adjusted operating earnings were $27.9 million or $0.43 per diluted share, which on an adjusted basis that would have been an 8% increase from the first quarter 2010. Those amounts resulted in ROE, return on average equity for the first quarter of 13.1% and the 13.1% is computed excluding the one-time item or one-time benefit from the reserve adjustment.

Spread for the quarter was at 3.14% and total assets grew to $20.8 billion. The spread result was roughly level with where spreads were in the first quarter of 2010, which was 3.17% and then level with our fourth-quarter spread. We've been talking in several of the past quarters about items that would be affecting spread each quarter, including the cost of holding excess cash balances and the benefit to spread from overhedging.

During the first quarter the cost of the excess cash benefits -- or cash balances was about 5 basis points. The benefit from overhedging was 7 basis points, so that would translate into an adjusted spread of 3.12% compared to 3.17% for the first quarter of last year and 3.16% for the fourth quarter. And those still represent, at 3.12% a spread in excess of where our target levels would be.

Looking at the components of spread, investment yield, the aggregate yield on invested assets was 5.96%, so adjusting for the cost of the excess liquidity we were at 6.01%. Yields -- or investment yield has been coming down for a number of quarters now because we've been investing money at lower rates than what we had in the overall portfolio, say a year ago.

Purchases of assets in this quarter continue to reflect our strategy of diversifying the asset mix with a continuing emphasis on minimizing credit risk. We've said that from our inception as a public company that we don't like credit risk. We want to achieve acceptable overall asset duration relative to liabilities with minimization of credit risk.

In the first quarter we purchased fixed income securities, bonds, about $2.5 billion of those with an aggregate yield of 5.37% and that would have been split among the following asset classes -- government agency bonds, $1.8 billion at 5.34%, corporate bonds with just under $500 million at 5.38% and then taxable municipal bonds, $136 million at 5.75%.

We also did have ongoing calls in the quarter. Calls or sales of fixed maturity securities were about $1.5 billion. The yield on those called securities was 5.80% so the combination of having securities called away at higher yields and the reinvestment would have also contributed slightly to the decline in investment yield.

Cash balances during the quarter were significantly reduced from prior quarters and our call risk going forward is probably the smallest we've seen in a while. We've got $1.4 billion that's potentially callable in Q2 and then for the balance of the year it's about $250 million in each of the third and fourth quarters.

We have now returned to a net borrow position through repurchase agreements which is our preference. As we've talked about in the past our objective in managing the business is to have the expected premiums invested prior to their receipt so that we start earning our spread immediately upon crediting the fixed -- or interest to the annuities. And once we get through the second-quarter calls we ought to be firmly back into that net borrow position for the second half of the year.

Commercial mortgage loans, we funded $192 million of new commercial mortgage loans in the quarter at an average yield of 5.72%. Reiterating my comments earlier about minimizing credit risk, asset quality, as we said, has been paramount management goal for -- since the company was formed. It remains very, very high with 98% of the bond portfolio rated in NAIC, National Association of Insurance Commissioners, classes one or two. Those are equivalent to investment grade ratings from the Standard & Poor's, Moody's agencies.

And of that 98.2% just under 75% is in class one, which would represent bonds single A or above. On a rating agency basis 92.5% of the portfolio is rated investment grade and the difference between the 98% and the 92% is going to be the ratings for residential mortgage backed securities where NAIC ratings reflect severity of losses and the price that you're carrying the security, whereas rating agency evaluations give no recognition to those factors so it's based entirely upon whether or not a security will lose as much as -- or as little as a single dollar.

Impairments in the quarter on an after tax basis after adjustment for DAC amortization were at $2.5 million. That number would represent about $7.8 million on a pre-tax basis, so a rather manageable number in terms of impairments. The $7.8 million included $2.7 million from commercial mortgage loans. That would have been five loans with an aggregate balance of $11.2 million.

We also had impairments on the RMBS of about $6.6 million. That would have been on five securities. The RMBS impairments continually evolve from adjustments from other parties, primarily rating agencies reevaluating expected losses. When those events happen our evaluation process says to consider all available evidence, including information from rating agencies and other parties and that becomes a significant factor in our ongoing assessments of the residential mortgage-backed securities.

Our cost of money declined to 2.82%, so after adjustment for the overhedging benefit it was at 2.89%. That compares very favorably to the 3.8% we had in first quarter 2010 and 2.94% fourth quarter 2010. And those declines are principally reflecting that fact that as new money investment yields have come down we've adjusted crediting rates on our policies. We've done that twice within the last 12 months, last summer in July and then most recently in January of this year. And we've also I think overall had slightly lower option costs as market volatility continues to come down, although not as much as it did probably a year ago.

And then with limited exceptions our renewal rates have been constant since 2007, so managing the cost of money has been quite effective.

Operating costs and expenses for the quarter were $17.5 million. That's up from $16 million in the first quarter 2010, slightly down from the fourth quarter of 2010. Our legal expenses did remain somewhat elevated, but we're down a fair amount from where they were in the fourth quarter when we had expenses related to the trial of the Stephens case which we talked about in the last call as being one that we had reached a settlement on. That settlement is proceeding and if all goes according to plan will be implemented this quarter and that one will be behind us.

Offsetting the decrease in legal expenses would have been some increases from reinsurance costs and insurance taxes. Reinsurance costs up primarily from a new reinsurance agreement that we entered into in the first quarter that will provide -- provided a $32 million after tax surplus benefit. And then our insurance taxes, they fluctuate from quarter to quarter in a fairly unpredictable pattern and first quarter often sees some higher levels relative to the fourth quarter in insurance taxes

So I think expenses overall line in good shape and we would expect perhaps some decline in future quarters as expenses related to the litigation ultimately move away, in particular the Stephens case.

And with that I'll turn the mic over to Ron for commentary on sales and production.

Thank you, John. Good morning, everyone. As Wendy reported, we achieved a record first quarter of production with $1.3 billion, a 58% increase over the first quarter of 2010. Also the second biggest quarter in the company's 15 year history.

We had some excellent momentum in the fourth quarter of 2010 which certainly helped us get off to a good start in the first quarter, plus the rate reduction that John referred to was implemented in January and certainly caused a temporary spike of sales in advance of that reduction.

After the reduction, however, our sales -- our rates were more in line with our competitors, yet sales continued at a very good pace for the duration of the quarter. Our pending count did get as high as 6,800, but has moderated in the 3,500 range which happens to be about where we were this same time in 2010, of course our best year ever.

Wendy also mentioned that there were some newcomers in the indexed annuity market this year. So far some of the competition has catered more to the bank and broker-dealer channels with somewhat vanilla products, with no bonuses, shorter terms, lower commissions. And some companies have come with products so overpriced they possibly can't sustain any substantial sales volume.

These products -- very high bonuses, 10% bonuses, very short surrender durations, very high roll-up rates on their lifetime income riders. These are companies that seem to be really trying to make a splash and get some attention and are also companies that have some ratings that are less than A.

As Wendy mentioned we certainly welcome new entrants into the market and it gives our products the validity and certainly the respect that they deserve. It's interesting, though, that our primary competitors in the independent channel are about as aggressive as they've been in a long time. They seem to want their producers and their production back. That's fine. They're running some special promotions trying to get some increased premium bonuses out there, some special commission bonuses. We've countered with our own commission incentive for April and May to try and hold our agents' attention.

Unfortunately there is some distractions out there as companies make new moves and introduce new products, but we really feel like we're holding our own. Our message to our producers and our marketing companies is that when many of our competitors struggled in 2008, 2009, and 2010, we really kept going strong and we did not reduce renewal rates and we did not cut commissions.

We did not cut agents. We did not cut home office staff. We did not turn away new business, but we did have record sales, asset growth and earnings. So we remind them of that consistently, that we were there for them back then and we're still here for them going forward.

We had a very successful $1 million producer forum in March. This was our fifth event and the biggest one and the best one to date. We had over 800 attendees, which includes the marketing companies and guests of the attendees. That compares to over 600 in 2010. To refresh your memory, these attendees need to prove that they wrote at least $1 million in fixed annuity premiums the previous year, whether it was with our company or with one of our competitors.

This year we had 475 agents attend who had the -- who had to prove their qualifications. Just over 200 of those did their production with someone other than American Equity. So we have a huge incentive ahead of us to convert those agents to sell for American Equity rather than who they were selling for before.

Since the event we've been able to get business from 109 of those 200 agents that have written business with us since the event, so we're making good strides. We still have a big chunk of agents to work on. It's still very early in the process, however, we have a very specific follow-up plan to reach out to those agents that we want to convert. We're committed to having personal one-on-one visits with 178 of those who qualified to attend through somebody else and we want to have that done by June 1. Our marketing team is very motivated, myself included, to get out there and call on these people and tell them the American Equity story.

We also continue to have our producer forums. We've done this for probably about five years, too, where we invite producers and prospective producers to our headquarters. They hear our story, learn about our products, but more importantly they meet our people who really make it happen around here and witness our culture first hand.

As a matter of fact, next week we have a producer forum where 23 of the 42 producers that will be in our offices are from that $1 million producer forum that qualified with other competitors. So we will certainly have on our game face and we will have our best foot forward to get our message across to those 23 producers that American Equity should be their number one choice.

We have a total of 14 producer forums scheduled in 2011. Our goal this year is to increase our Gold Eagle membership by 10%. We'd like to get at 1,100 Gold Eagle members. As a refresher, those are producers that write at least $1 million in fixed annuity sales for the calendar year. In the first quarter we are ahead of schedule. We have 1,257 agents who have either qualified or are on schedule to qualify, so we are on our way. So good things there.

We continue to have our policy holder appreciation events with great accolades from the policy holders and the producers as well. We were in Louisville and St. Louis this week and hosted nearly 600 people. To -- as a refresher for that our primary purpose with these is to really to say thank you, thank you for entrusting us with their money. We, of course, want to give them a little bit of history on American Equity, what our philosophies are, how we think about running our business.

We give them a financial overview of the company, certainly, and we also reinforce the ABCs, the 123s of fixed annuities. And every time, I mean every time we do one of these, people come up to us at the end. They want to shake our hands and they give us those sound bites which reinforce the reason we do them in the first place. And they say things like -- we wish we knew about you before we lost money in the market, or they say -- we'll sleep better knowing that you are protecting our retirement money.

And I also know that we get as much benefit from these events as our attendees because now that we've met them, we've broken bread together, we come home and recognize that they are depending on us and that we're more committed than ever to run the best insurance company possible. We have 21 of these events scheduled in 2011.

Wendy said in her opening comments that we want to maintain a consistent share of a growing market and we certainly believe that's going to be the case. I have some additional statistics for you. The Baby Boomers have $10.7 trillion in mutual funds and that's from a USA Today article. The Baby Boomers also will inherit $11.6 trillion. That's from an ABC Money news article. So they are going to be looking for safety and guarantees and, by golly, we're going to give it to them with our fixed annuities.

As we look at our long-term strategy, it certainly has served us well and it's going to continue to serve us well. Just a couple of more statistics for you. In the first quarter of this year we recruited fewer agents than we did in the first quarter of 2010, but those agents wrote more business than the agents we recorded in the first quarter of 2010.

We're also writing more annuities today with 34,000 agents than we wrote when we had 50,000 agents. We were ranked number three last year in total indexed annuity sales with $4.1 billion. Number four was a distant number four at $2 billion. We've been ranked in the top five for 44 out of 50 consecutive quarters through last year. So consistency certainly is the key at American Equity.

And I think Dave Noble summed it up best in this quote in our press release. He says, quote, "American Equity is well positioned to capitalize on growth trends in the fixed annuity market. With our reputation for best in class service we seek to be the carrier of choice for policy holders and producers. New entrants into our market will need to run hard to match our product expertise, service culture, and strong commitment to distribution," end quote.

So with that, thank you, and I'm going to turn it back over to the operator.

Yes, sir. (Operator instructions). And your first question comes from the line of Paul Sarran with Macquarie.

Hi, good morning.

Hi, Paul.

I guess just to start can you give an update on efforts at Eagle Life? Do you still expect to sell registered products by the end of this year?

Yes, we certainly do expect to be selling by the end of this year. Now, in what volumes, I have no idea, but the goal is, and we think it's realistic, to begin selling in the second half of this year. As we've talked about before we have a national sales director at Eagle. His name is Kirk Anderson.

He came over from the American Equity side and he's working very hard to continue to build relationships and get marketing materials finalized and all of the groundwork that needs to be laid to enter that channel. And so we feel that we're on schedule to begin sales in the latter half of this year.

And is that -- have you signed up any broker-dealers that aren't affiliated with marketing organizations that you already do business with?

Not yet, but we're working on it.

Are you finding your A minus rating to be a hurdle at all?

No. Prior to the financial crisis we would have thought that the A minus rating might be a hurdle, but post financial crisis there have been so many downgrades that just across the financial services industry generally that we're finding there's less sensitivity to that, at least in the BD channel. I'm not sure it would be true in the bank channel.

Okay. Can you comment on how sales have trended through March and April after the sort of fire sale effect from January wore off?

Well, as I mentioned, the pending count has moderated in the 3,500 range, so we're at least on par where we were last year. We're ahead of where we were last year. So we're feeling good about the balance of the year. As I mentioned there are some distractions out there where agents are looking at different things that other companies are doing, but we're certainly continuing to get out message out and want to make sure that they stay focused on us.

Okay. And then have you looked at the Department of Labor's proposed changes to what defines a fiduciary with respect to IRAs and if that could have any impact on the agents that sell your annuities?

Paul, are you talking about registered reps at broker-dealers or you're talking about independent insurance agents?

Knowing that a decent minority of the agents that sell your products are dually registered, I'm wondering if they could be impacted by this?

Insurance agents, and for even those who are registered, today sales of unregistered products are still considered outside business activities for most of the BDs that the agents are associated with. The whole insurance industry and insurance distribution was excluded from the issue of looking to imposing fiduciary standards on sales of financial products, so we don't expect it to be an issue in the independent insurance agent channel. It is an issue potentially for registered reps at broker-dealers.

We look at fiduciary standards in conjunction with our suitability standards. Those have come a long way. While going through suitability review is not quite the same from a legal standpoint as a fiduciary duty, it gets pretty close to that same concept. So we feel really good about our suitability process and how we look at every potential sale that comes in the door and whether or not that's suitable for the individual. So even if the fiduciary standards do come about with respect to registered reps, I think we can handle that development.

Okay, thanks.

And your next question comes from the line of Mark Hughes with Sun Trust.

Thank you very much. Ron, when you do get new competitors that are out there that are offering aggressive products like that, how many of the folks that you work with where you've got a long-standing relationship, is it just too tempting to not direct some business in the -- towards that appealing of an offer, or do they -- do they assume that these folks aren't going to be around for very long and so they're more cautious? Could you give just some sense of the dynamic there?

Well, I think even our best relationships aren't going to completely ignore the competition when they come out with products because if they don't at least visit with their producers about the products and give them some education about the products they're going to go someplace else who will give it to them. And so I think our long-standing relationships will perhaps talk about them.

I think they'll also go through an educational process with them in that, okay, you're going to have this policy benefit or this feature, but it's also got a market value adjustment on it, or know that this bonus is pretty high out there, so maybe you want to sell it now knowing that if they can't possibly sustain that for very long.

So I think that they do talk about it and as I talk about our marketing companies, though, they always consider it's our long-standing relationships. They know to say you guys are still number one with us. I think what ends up happening a lot of times is they'll talk to the agents about those other products, but at the end of the day they still eventually get redirected back to American Equity just because we're the consistent one in the bunch and they know they're going to get good service from us and that we're not going to embarrass them with horrible renewal rates.

So, it is interesting and it's a process that needs to work itself out and it just takes some time and sometimes it takes a quarter or maybe takes two quarters for that education process and discovery process, but eventually, hopefully it turns back to us again.

Right. Wendy, did you mention Solvency II? I was on a little bit late. I know you had mentioned it briefly at -- in Florida. Any update or expanded thoughts you care to share there?

No, I really haven't heard any updates beyond what I commented on in our meeting in April. There's -- most of the focus now is on a couple of things. One is the implementation dates and to the best of my knowledge that's still 2013, so quite close, although there's a big long transition period of 10 years. So sometimes we hear people say that it isn't going to be effective until 2023. That's not really true. People have to start implementing in 2013, but they've got a long time to get the process in place over that 10 year period.

The other issue that's still up in the air is the issue of US equivalence of solvency standards with the European standard. Today they are certainly not equivalent in terms of the amount of capital that would be required. I believe that the approach of the NAIC is to try to show equivalence based upon outcomes.

In other words, we've had very few insolvencies in the United States, so it must be a good system, but whether that argument will fly for equivalence, which I believe would have the impact of excluding the US subsidiaries from the Solvency II requirements, but it's going to be, I think, a tough road to get that equivalence established.

Okay. And then final question, any technology initiatives internally? Kind of where do you stand? Where do you think you stack up relative to competitors? Any thoughts about new investments over the next couple of years?

Well, we're always looking at technology. We've expanded some of our website capabilities to allow policy holder access to account values, which was a newer step for us. We're in the process of looking to refresh and upgrade our public website as well as the agent and consumer parts of it. Certainly Eagle has some new technology requirements and we've already made some investments in that area.

So that's, in my mind that's part of an ongoing process, ongoing expense that we have quarter in, quarter out, in trying to make sure we stay up to date.

Thank you.

And your next question is from the line of Steven Schwartz with Raymond James.

Hey, good morning, everybody. I'd like to follow up the -- Ron, a lot of -- you pointed to companies that -- below A minus. These companies are getting into the business, it seems, through exclusive relationships with wholesalers to NMOs, whether it be -- I don't know for sure whether it would be a Nexus or somebody like that. This is something -- exclusive products that these guys market. This is something you've never done. I just -- would you address that, why you don't like this model?

Well, Steven, that's a very good question. I guess when we get asked, and we have been asked from different marketing companies, why don't you guys form an agent group like the ones you mentioned? And the people that are asking are obviously people who are not members of the other groups and I ask them a very simple question -- how did you feel when you didn't get included in those groups? And they say, well, it didn't feel very good. So I said -- well, I rest my case.

We have a lot of marketing companies that have supported us in the last 15 years and the day we start excluding certain marketing companies who helped us get to where we are today is not going to be a good day for us. That's when we lose sight of our true partners and who helped us get here.

The other unique thing about that is when these producer groups or special products come out, they always -- and I guess it's marketing, but they always say stuff like -- this is going to be the best product ever. And I guess my question is what's making it the best product ever? I think all the companies who are responsible, anyway, always put their toes up to the line and try and get maximum bonuses, maximum commissions, the shortest surrender charges they can. We all get the best that we can and still be responsible.

So if it's the best thing over, in my opinion, they're putting their toes over that line and somebody's going to pay for it in the long run, and usually it's the policy holders. And we're not going to put our position -- put our company in a position where somebody's going to pay for it just because we want to be a little bit more aggressive or have the best product ever.

So I'm getting on my soapbox here.

No, That's all right. And if I may, just [Aliance] a couple of things. They had put in I believe it was a bonus as opposed to a extra commission to get them -- to get themselves started. That was supposed to be a one month -- you know back in the day Aliance used to always extend those things. Did that happen?

Well, they went from a 7% bonus up to a 10% bonus back down to an 8% bonus the last I heard. I don't know what their future is. So yes, that's what they did.

Okay. And then John, if I may, you talk about the cost of money all in being in the mid-280s, it sounded like to me. I'm not looking back at my notes. What's the -- spread is ultimately going to depend on your new business. What's the cost of new money?

We have two principal products that capture 80% to 85% of our indexed sales. One of them has a fixed rate of 2% which would also be the option cost and the other one has 2.25%. And so the one at the 2% actually seems to generate a little higher sales. So I would think of our blended cost of money for new business at about 2.15%.

Okay, and then if I heard you right you're investing around 5.35%, 5.40%?

Right.

Okay. All right, great.

Also keep in mind -- well, okay, never mind. That 2.15% is cost.

Okay. Great, thank you, guys.

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

Thank you. That's Tieton Capital Management. Where did the reversal of the $2.7 million in reserve adjustment show up in the P&L?

Intrasensitive Product Benefits.

Great. Thank you.

And at this time there are not further questions in queue so that concludes the Q and A portion of today's call. I would like to turn the call back over to Ms. Julie LaFollette for closing remarks.

Thank you for your interest in American Equity and 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.