American Equity Investment Life Holding Co (AEL) 2015 Q2 法說會逐字稿

Welcome to American Equity Investment Life Holding Company's second-quarter 2015 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.

Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss second-quarter 2015 earnings. Our earnings release and financial supplement can be found on our website at www.American--Equity.com.

Presenting on today's call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer; 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 John Matovina.

Thank you, Julie, and good morning, everyone. Well, halfway through 2015, we are positioned for a record year at American Equity. Consistent with our performance over the past several quarters and years, we are performing quite well in the two key areas that drive our earnings and financial performance: growing our invested assets or policyholder funds under management, and then generating a high level of operating earnings on that growing earnings base.

Our second-quarter sales of $1.8 billion were up 73% from the prior year second quarter, and year to date sales of $3.1 billion position us for that record year of sales in 2015. The sales outcome fueled a 7.8% increase in policyholder funds under management for the first half of 2015, and as usual, Ron's remarks will have comments on the sales results and the competitive environment, including the factors that contributed to sales results and our market share gains.

In addition to our sales growth, we also generated a 33% increase in our operating earnings per share which were $0.64 in the second quarter of 2015, compared to $0.48 per share a year ago. On a trailing 12 months basis, our operating earnings represent a return on average equity of 13.5%.

So let me now turn the call over to Ted for more detailed comments on our second-quarter financial results.

Thank you, John. Our operating income of $50.9 million for the second quarter was 32% higher than second-quarter 2014 operating income of $38.5 million. As John mentioned, operating income per share growth was even better at 33% due to a small reduction in the diluted share count.

Our investment spread for the second quarter was 284 basis points, compared to 277 basis points last quarter and 270 basis points for the second quarter of 2014. Spread performance was impacted by average yield on investments, which increased 4 basis points to 478 from 474 in the first quarter. The increase was due to make-whole consent fees from several bond calls, which together with certain prepayment income added 7 basis points to second-quarter average yield on invested assets compared to just 1 basis point for such items in the first quarter.

Adjusting for the effect of non-trendable items, the average yield on invested assets for the quarter fell by 2 basis points from the prior quarter, as new premiums and portfolio cash flows were invested at rates below the portfolio rate. The average yield on fixed income securities purchased and commercial mortgage loans funded in the quarter was 373 compared to 384 in the first quarter, and average yields ranging from 414 to 439 in the prior-year quarters.

The 2 basis point of decline was 7 basis points better than the 9 basis points of decline we experienced in the first quarter. The improvement is generally attributable to two factors: Interest for commercial mortgage loans and commercial mortgage-backed securities is recognized on the basis of a 365-day year, whereas most fixed income securities operate off of a 12 30-day month or a 360-day year.

The second quarter had 91 days of interest for commercial mortgages and CMBS compared to 90 days in the first quarter and 92 days in the fourth quarter of 2014. We also have historically considered $4.5 million of interest from paydowns on residential mortgage-backed securities as a baseline amount for measuring excess prepayment income, which we report as non-trendable.

We've been below the $4.5 million baseline in each of the last three quarters, with the second-quarter $3 million more than the first quarter, and first quarter $1.1 million less than the fourth-quarter 2014. The actual amount for the second quarter was $4.4 million or just shy of our $4.5 million baseline.

These two items partially mitigated the impact of investing new premiums and portfolio cash flows at rates below the portfolio rate.

The aggregate cost of money for annuity liabilities was 1.94% in the quarter compared to 1.97% in the first quarter. This decrease reflected continuing reductions in crediting rates. The benefit from overhedging was 7 basis points in both the second and first quarters of 2015.

We reduced our new money rates by approximately 20 basis points in early March. We have also been actively managing our renewal rates for some time now, and most of the renewal rate reductions that were initiated in 2014 were implemented prior to the second quarter.

We initiated additional reductions in 2015, including further adjustments to policies with previous adjustments and initial reductions for policies issued between early October 2011 and early December 2012. A portion of the 2015 rate reductions occurred in the second quarter, but the majority will occur on policy anniversary dates over the next 12 months.

Our active management of renewal rates will continue, should the low investment yields currently available to us persist. We continue to have flexibility in managing our cost of money and could decrease our cost of money by approximately 57 basis points, with further reductions in renewal rates to guaranteed minimum rates.

Our operating costs and expenses were $24.9 million in the second quarter compared to $21.1 million in the first quarter and $20.9 million in the second quarter of 2014. First-quarter operating expenses were lower than the second quarter, due to $1.6 million of refunds or reductions in expenses that were nonrecurring.

During the first quarter we received a reimbursement from one of our reinsurance counterparties for guaranteed fund assessments and a refund of state taxes.

During the second quarter, we had increases in salaries and benefits of approximately $1 million compared to the first quarter, due to a higher level of expense for incentive plans based on the Company's performance and general increases in salaries. Our risk-based capital ratio was estimated to be at 349%, down from 372% at the end of 2014. However, we continue to remain comfortably above the 300% threshold for our rating from A.M. Best.

Now I will turn the call over to Ron to talk about sales and production.

Thank you, Ted. Good morning, everyone. Our policyholders also had a great second quarter and continue to enjoy attractive returns compared to other safe money products such as certificates of deposits. Fixed index annuity policyholders with a policy anniversary in the second quarter earned an average annual index credit of 3.64%. The largest index credit for the quarter was 11.42%.

Approximately 36% of the annual index credits in the first half of this year were 5% or more, and approximately 67% of the annual index credits were at least 3%. So this reconfirms the value proposition of our products by helping our FIA policyholders participate in stock market advances with low risk to their fund value, offering upside potential with low risk and guaranteed income for life, are really what drives American Equity's success.

So turning to sales and marketing, as John said earlier, sales for the quarter were $1.8 billion on a consolidated basis, and that is a quarterly record for the Company. And that's up from $1.04 billion in the second quarter of 2014, or a 73% increase. And our second-quarter sales were also up 37% when compared to the first quarter of this year.

As you can probably imagine, we are very pleased with our success in the first half of this year. And when we compare ourselves to our primary competition, our sales are trending up and most competitors are trending down. I'm referring to the first-quarter statistics, the most recent data available, when I talk about that.

While our growth in sales was substantial, the ramp-up was steady and manageable. Our monthly sales increased each month this year, with June as the best month in our Company history. Our average pending business count also increased steadily each month, with an average of almost 5500 cases in June compared to 4150 in March. April's average pending count was 4872 and May's was 5130.

Looking at the competition for a moment, the competitive landscape has shifted in our favor this year, as one competitor known for the highest guaranteed income withdrew their product from the market in March. That product was a top-three selling FIA for the last three years. Another significant competitor scaled back their sales appetite for this year, giving us yet another opportunity to capture market share.

And while the actions of our competitors certainly helped us, our own doing and philosophy played the major role in our success. I believe we are being rewarded for staying with our product pricing discipline and resisting marketing strategies that were prevalent in 2014. We do expect sales to be strong going forward, but perhaps not at the same pace as the first half. Some competitors have raised their caps and rates on FIAs while we have not.

Plus there's some new resourceful competition entering our space, but it's too early to tell if they will be effective.

We are also making some adjustments to our gender-based lifetime income benefit rider, starting today. We have had this writer for one year and are simply making adjustments based on experience and the interest rate environment. Some guaranteed payout factors are increasing while others are decreasing. Regardless, we will still be competitive for guaranteed income.

One thing that we do know for certain, while that we are enjoying sales success today, we are not resting on our laurels. Our market is very competitive and we always need to keep our competitive edge sharp, backed up by our relationship-based culture and best-in-class service.

One of the foundations of our agent relationships is our Gold Eagle program, and to refresh your memory, agents who sell at least $1 million in annuity premium on a calendar year basis are part of our Gold Eagle program. They get some basic perks such as a special telephone hotline and FedEx shipping discounts at the entry or club level. Agents who produce $2 million or more in annuity premium or the elite level also receive cash compensation and restricted AEL stock, with the amount scaled higher at various production levels above $2 million.

Through the first half of this year we have had or have 664 producers representing $1.5 billion in premium who have qualified compared to 432 during the same time last year. So that's a 54% increase in Gold Eagle membership, which coincides with the 51% increase in our independent agent production during the same time.

Our second-quarter recruitment was also very strong for agents. We contracted almost 2900 agents compared to just under 2400 agents in the first quarter. And when compared to the second quarter of 2014, that number was 1600, so recruiting is up very nicely, too.

Turning to Eagle Life, we had $75 million in sales in the second quarter compared to $122 million in the first quarter. The second-quarter product mix was roughly 89% FIA premium and 11% multi-year guaranteed annuity; whereas the first-quarter mix was roughly 50-50. Eagle's second-quarter FIAs sales are up 10% over the first quarter, and a substantial portion of our FIAs sales in the first half of this year came from a broker-dealer relationship that we've had in place for several years.

As we commented last quarter, we had a multiyear guaranteed annuity rate special for much of the first quarter, and those sales have withered when the rate special ended at the end of February. However, our objective was to use that rate special to establish relationships with two financial institutions that we hoped would subsequently begin promoting our FIA products.

In our judgment this effort was successful, in that we began receiving FIA applications in April from one of the financial institutions, and sales from that institution have been building momentum since then. And we are still optimistic that the other relationship will follow with FIAs sales as well.

We also began receiving FIA applications from another financial institution late in the quarter, and momentum with that institution is building into the third quarter. We are also in the early stages of forming two new wholesaler relationships that have very good connections with broker-dealers and financial institutions that currently don't have selling agreements with Eagle Life. We anticipate having more positive news to share with you in the next quarter.

Finally, we are holding our 100th client appreciation event next week. This is a very important and rewarding milestone for us. It's a program that we've been doing for five years now. It's an opportunity for us to connect with our policyholders and producers. But our most important mission is to tell our policyholders thank you for entrusting us with their money. It makes our work a whole lot more meaningful when we see and visit with the people who are depending on us to keep their retirement money safe. To date, we have hosted 20,487 policyholders and 1244 producers.

With that, I'll turn the call back over to John.

Thank you, Ron and Ted. To kind of bring the call to a conclusion, a few final comments. Of course, one natural question you have when sales are accelerating is do you have the operational capacity to handle the higher volumes. And the answer, as Ron I think commented about, is our staff has been up to the task and met the challenge. They've continued to deliver best-in-class service to our policyholders and independent agents each and every day, and we are confident they will continue to shine in the months and years ahead.

However, we do need to acknowledge that the higher volume in second quarter has put a little stress on the operations. Overtime is up, so we will be planning to add some additional employees, perhaps 20 to 25 employees in our key service areas during the next few months to get operations back to a less stressful situation.

Of course, the second natural question when sales are accelerating is do you have the capital to support higher sales. As Ted said earlier, our estimated risk-based capital ratio at June 30 was 349%, and that's comfortably above the 300% threshold for our A.M. Best rating.

Our current capital projections show that our risk-based capital ratio would be slightly above 300% at the end of the third projection year of a three-year projection period if our sales were $6 billion in the first year of that projection period and increased 10% per year in projection years two and three. However, as we've said on previous occasions, we are looking for a ratings upgrade from Standard & Poor's. That's likely to move the bar higher in terms of RBC to something in the 325% to 350% range based upon S&P's capital model and ratings criteria.

So to the extent that we do have sales levels that cannot be supported by internally-generated capital, we would intend to obtain capital from external sources to facilitate such growth.

As Ron commented, we are optimistic about the outlook for the remainder of the year. While low interest rates remain a headwind to our spread management, we remain proactive in managing our liability rates and have much flexibility to continue to do so. And of course, naturally our job would be less challenging if we could get some higher rates.

We are expecting a record year for sales, but the first-half surge may settle down somewhat. Our product offerings remain competitive and we expect producers to continue to favor us, especially in situations where guaranteed lifetime income is important to the consumers' fixed index annuity purchase.

So with that, we will open up the call to questions.

(Operator Instructions). Mark Hughes, SunTrust.

Ron, did you give the pending count for July, the most recent pending count number?

I did not. As I mentioned in my comments, we changed the terms to our lifetime income benefit rider and they are effective today. So the number's inflated perhaps a little bit. I can give you an average for July was 5585, so that was the average for July. Today, which is the first day of the change -- as I said, it is inflated, but this morning it was 5733.

And then last year if I recall, it was at 2800, I think was the number. Do you agree with that?

Yes, just a little bit less than 2800.

Right, okay. The regulatory picture, John, if you wouldn't mind touching on that. Anything -- we read the comments from, I guess, the group that you contributed to. I wonder if you could make any comments or any updates on developments as you see them, kind of how yours and the industry efforts are going to try to shape the DOL rule.

Well, of course, everybody's comments are now in. And at this point in time, I wouldn't say there's been any development since the end of the comment period last week. The next thing on the schedule is the hearings that the DOL is going to conduct, I think the week after next. So that might provide some insight into their reactions to the comments based upon how those hearings go.

As you saw in our comment letter, we try to make suggestions to help the rule be more workable. The original proposal was pretty vague, and oftentimes the question was, well, what you have to do to make sure you are compliant with this. So it was framed around that type of thing. I know there are comment letters out there that were more vocal in their opposition to the rule, think it shouldn't happen at all.

There was one comment letter from a very well-established lawyer who questioned the legal precedent or the legal authority for the DOL to do what they are proposing to do. So it's still kind of open as to see where it does head.

Just pondering this pending count, Ron, you are doing quite well, maybe even better on a year-over-year basis than you did in the second quarter, and we can adjust for the change in rate. But it doesn't seem like the competition has increased from -- is that a fair assessment? Are they making noise but not really having an impact on your sales trends? How should we think about that?

Well, I think your thinking is probably pretty good. We have seen some of the competition raise caps, for example, on their indexing strategies, not huge amounts. I think it's probably in response to some of the uptick in the 10-year treasury and a little bit of relief there.

Our big-play mark is the guaranteed income, which John spoke about. We have one of the most competitive guaranteed income options for our indexed annuities. So when that is in the retirement plan, American Equity is one of the first companies that they go to. And it's a simple strategy that we have compared to some of the competitors out there that are a little bit more complicated, so they like us for that, too.

So other than some interest rate changes from the competition, we really haven't seen anybody really poke their head up that would be a serious threat at this point. But it's only July.

Right, yes. And then final question, any update on your expectations for sales out of Eagle Life for the full year?

Well, we finished the first half of the year right a little bit shy of $200 million, and that is a result of a pretty good boost for some multiyear guaranteed premium in the first quarter. We are increasing our MYGA rates, or multi-year guaranteed annuity rates, coming up here in early August which might spur on a little bit more production in that product for the third quarter.

So we will be competitive in that product, but that doesn't mean that our competition won't also increase their MYGA rates as well. So we are optimistic for Eagle Life, the two new wholesalers that are fairly new in our relationship with them this year. They hopefully get some access to some new financial institutions and broker-dealers for us. But as we've learned, though, with our Eagle Life project here that things move a lot slower in the broker-dealer and the financial institution channel than they do in the independent channel, but we'll keep after them.

Thank you.

Steven Schwartz, Raymond James.

Ron, you just pointed out, to Mark's question, that you thought pending might be inflated because of the LIBR changes, which says to me that you've got a bunch of agents, a bunch of NMOs, who are trying to get their sales in before the change. And the reason why they would do that is because they would find the change unattractive.

While you are making -- I guess the question is you're making a lot of different changes, but overall will the change increase the return on the product to you?

No. When you say increase the return, do you mean increase production; will the change increase production for us or demand?

No, the IRR on the product or the return on capital invested. Possibly, that's better for Ted.

This is Ted. The changes we are making to the product is to keep us at the same IRR that we want to be at. So it's not increasing the profit or the return back to us on those products.

Okay. Preventing it from decreasing, I guess is the way to look at it?

Yes.

Okay, all right. Ted, while you are there, the incentive comp that you noted in the quarter, was there any catch-up accrual from Q1?

There's a little bit of catch-up because when we look at where the Company's performance is, it pushed it up. So there's probably about maybe $400,000 of expense in this quarter that's really catch-up from last quarter.

Okay, all right. And then a couple of DOL questions as well, I guess. Ron, any change in the percentage of sales that went to IRA accounts in the quarter? I think you are somewhere around 70% -- 68%, 70%, something like that.

That's a good question, Steve, and I didn't specifically look at that. But I haven't heard of any trends that our percentage changed from the first quarter. So you are accurate; our qualified money or IRA money would be in the 65% to 70% range.

Okay. And then one more on this if I could. At the Iowa Investor Day, Ron, you stated that you believe the product and the Company would get treatment under PTE 84-24. Do you still think that's an accurate statement?

Yes.

Okay, all right. That's what I had. Thanks, guys.

John Barnidge, Sandler O'Neill.

What is your investment strategy for overhedging gains? You've had 7 basis points of excess for two quarters in a row. Should that pattern continue, accelerate or decelerate?

It's always been the philosophy here to manage to an overhedge. However, what we would like to manage to is more like a 2 to 3 basis point return. Now, obviously, the amount of overhedging also depends on market performance, and we happen to be at a point in time where we are little bit more overhedged than what we would like and the market is performing.

How long that will persist is dependent on policyholder behavior, but we meet as a hedging group on a monthly basis and we have people looking at it on a daily basis. And when we see trends in overhedging, we make adjustments to the amounts of options that we are purchasing on a daily basis.

You don't want to have a knee-jerk reaction to that and pull back too much on your decrements of what you are doing, so we try to have a very disciplined policy. But 7 is a little high for us, but in the future it really does depend on market performance and policy behavior. But we do make adjustments here to start to reflect that in our decrements when we're making purchases.

This is John, Just to remind everybody, the overhedging comes from the standpoint of estimates of policyholder behavior as opposed to other actions. The options that we buy match up in terms very closely to the obligations to the policyholder. If the policyholder has gotten an opportunity for a 4% cap, we buy a 4% cap.

But where the hedging inefficiency comes in is that we have to estimate is how much money is going to be withdrawn over the course of the next 12 months at the time we are doing the hedging, whether it be deaths, full lapses, partial withdrawals and all that. Because any money that's not there a year later does not receive the index credit.

So that group that Ted referred to is regularly looking at where the trends are at in those withdrawals and the outcomes, and adjusting the amount of options we buy to reflect those trends. But as you can imagine, we are always in probably a catch-up mode on that process, although you try and stay on top of it as much as you can.

All right, great. Do you perhaps have some visibility on bond prepayment fee income in the third quarter?

We don't have any comments on that at this point in time.

Okay.

That's going to depend on behavior of the holders or the issuers themselves.

Yes, there's $30-some-billion of investments. Who knows what the managements of those corporate entities are thinking. A lot of that prepayment income or consent fees comes from situations where the management teams of companies come to the bondholders asking for consent, and pay fees to accomplish whatever they want to get done. So you just have no idea when those might happen.

All right, great. My last question, if there was one thing you could change about the DOL role, what would it be and why?

John, we haven't condensed that down.

Too much to know.

Yes.

Randy Binner, FBR Capital Markets.

This is Alex Combs on for Randy Binner. My first question is on your sales growth. With pending counts above 5000, it seems sales of $67 billion are achievable for 2015. What level of sales can you support this year and next year with your current capital base in order to meet the NAIC and S&P requirements in that 325% range? And can you provide some more color on your thoughts on sources of additional capital?

Well, the comments I made earlier, Alex, the high projection scenario we have is $6 billion this year, $6.6 billion next year, and $7.2 billion the year after. And that takes us down to a 300% RBC at the end of the third year. And you could actually look at those in the level of aggregate, they don't necessarily have to emerge in that pattern.

So that's an average of $6.6 billion over the next three years, would take us down to that level. Pulling 300% three years out up to 325% is -- I'm trying to do the math in my head.

Is it linear?

No, they'd have to look at the required capital, obviously, and ratio it up. It seems like we are working off of $2.3 billion or $2.4 billion to get to 349%. I don't want to -- we can call you and give you the number after the fact because we know where the 300% comes out at. But I don't know off the top of my head here how much it would take to go from 300% to 325% three years out.

Okay, that's fine.

In terms of capital options, the things that naturally come to our mind are equity capital, reinsurance, which we haven't done for a while but have experience in doing coinsurance arrangements with. We had two counterparty relationships there.

There has been over the last several years several parties have contacted us about the interest in coinsurance. So we think there's people out there that want to do coinsurance and that we would be able to create a relationship.

In terms of debt capital, at the moment that's not an option because one of the criteria in our S&P process is to take our adjusted debt to capital to below 20%, which we've now achieved. Capital charges from S&P kick in if you exceed the 20%. But as equity capital continues to build and that ratio goes down, that puts debt capital as an option out in the future at some point in time.

Okay, great. Are you in open talks with any co-insurers at the moment?

No.

No, okay. All right, great, that's all I have. Thanks.

(Operator Instructions) Steven Schwartz, Raymond James.

A couple of follow-ups. One DOL question again. Ron, even though you are going to be under the PTE 84-24, do you know, will you be a fiduciary under the new rule?

We don't believe so.

Okay, that's interesting. The NMOs would be, though, undoubtedly?

We don't think the NMOs would be either.

Okay, we may have a different understanding about PTE 84-24 works then. We can discuss that later. And then I guess just a theoretical question. Maybe there's no way to do this, but does it makes sense, I don't know, to maybe be a little less competitive and get more return on product?

I understand you've got keep the agents happy, but does it make any sense to be a little less competitive?

Theoretically, yes, but I think your point was you've got to keep the agents happy. And if all of a sudden we change our competitive posture in the marketplace, the agents are going to recognize that and then you're going to start hearing the stories about American Equity doesn't want business and that.

So yes, I think over time we can alter the profile a little, but I don't see us being able to do something in a fairly quick manner that's not going to create confusion in the marketplace and send the wrong signals.

Okay, all right. Thanks, John. Just a thought.

Thank you. I'm showing to further questions at this time. I would now like to turn the call back to Julie LaFollette for any further 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.

Ladies and gentlemen, this does conclude the program and you may all disconnect. Everyone, have a great day.