American Equity Investment Life Holding Co (AEL) 2020 Q4 法說會逐字稿

Welcome to American Equity Investment Life Holding Company Fourth Quarter 2020 Conference Call. At this time, for opening remarks and introductions, I turn the call over to Julie LaFollette, Coordinator for Investor Relations.

Good morning, and welcome to American Equity Investment Life Holding Company's Conference Call to discuss fourth quarter 2020 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com. Non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents.

Presenting on today's call are Anant Bhalla, Chief Executive Officer; Jim Hamalainen, Chief Investment Officer of Insurance; and Ted Johnson, Chief Financial Officer. Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be made available on our website shortly after today's call. It is now my pleasure to introduce Anant Bhalla.

Thank you, Julie. Good morning, and thank you all for your interest in American Equity.

We enter 2021, focused on being vigilant about realization of shareholder value. 2021 will be a transition year from the AEL 1.0 strategy to the AEL 2.0 business model. It will be the execution year as we make demonstrable progress with closing of already announced reinsurance transaction plan under our Capital Structure pillar and start our migration to alpha assets with investment management partnerships under our Investment Management pillar. I'll share more on these partnerships in a few minutes.

In my time with you this morning, I'd like to reference the AEL 2.0 business model virtuous flywheel of success that I've spoken of in the past including on December 9, as I shared how we are currently working to build and eventually speed up this flywheel to create superior shareholder value.

First, the virtuous flywheel builds on an industry-leading at scale annuity funding origination platform. Second, adding in differentiated investment management capabilities and expertise in aligning the annuity liability funding with cross sector asset allocation now gives us a competitive advantage over traditional asset managers as we leverage expertise for both sides of our balance sheet.

And third, demonstrable success over time on these first 2 using our own capital will attract third-party capital to our business and grow fee revenues for AEL. These fee revenues will be generated by growing third-party assets under management in our investment management partnerships, and from creation of additional sidecar reinsurance vehicles with new equity investors like the 2 we've announced to date with Brookfield and Varde-Agam. These fees will diversify our earnings streams.

Fourth, leveraging third-party capital will transform AEL into a more capital-light business. The combination of differentiated investment strategies and increased capital efficiency improves annuity product competitiveness, thereby enhancing new business growth potential and further strengthening the operating platform. We believe that in the foreseeable market environment, it is imperative for most asset-intensive insurers, including American Equity, to switch the source of earnings generation from traditional core fixed income investing to a blend of core fixed income and alpha generating private credit and real assets, and over the next few years to migrate to a combination of spread and capital-light fee-based businesses.

Regarding American Equity specific execution, the fourth quarter was the start of the turnaround of the Go-to-Market pillar - our strategy to enhance our ability to raise long-term client assets through annuity product sales. We and our distribution partners consider American Equity's marketing capabilities and franchise to be core competitive strengths. The liabilities we originate result in stable, long-term attractive funding, which is invested to earn a spread and return on the prudent level of risk capital.

In the fourth quarter, we reintroduced ourselves to our markets. We used the fourth quarter to tell distribution that we are back and in a big way. Driven by the introduction of competitive 3- and 5-year single premium deferred annuity products at both American Equity and Eagle Life, we saw a substantial increase in sales with total deposits of $1.8 billion, doubling from the prior year quarter and up 221% from the third quarter of 2020. Fixed rate annuities were the major driver of fourth quarter sales increase, while fixed index annuities also increased, up 23% sequentially.

Total sales at Eagle Life were up over sixfold on a sequential basis and for the first time in its history, Eagle Life surpassed American Equity Life in total sales. The competitive positioning we took in the fixed rate annuity market benefited both the fixed index annuity sales and recruiting of new producers.

Our FIA sales in the bank and broker-dealer channel increased 76% sequentially. New representatives appointed with Eagle Life during the quarter increased by nearly 1,200 to over 9,300 at year-end.

While not as dramatic, we saw growth in sales at American Equity Life as well. Total sales increased 103% from the third quarter, while fixed index annuity sales climbed 16%.

The momentum that began in the fourth quarter has continued into the New Year. Pending applications as of this morning at American Equity were 3,198, up from 2,552 at year-end and fourth quarter average of 1,998. Pending applications when we reported third quarter results, stood at 1,625.

For fixed index annuities, we will shortly launch a revamped AssetShield product chassis to appeal to a broader market, adding 2 new proprietary indices, the Crédit Suisse Tech Edge Index and the Societe Generale Sentiment Index, in addition to the existing Bank of America Destinations Index, all of which we expect to illustrate extremely well with participation rates that cost well within our pricing budgets to meet our target pricing IRRs. With the introduction of these multi-asset indices, we will offer clients a compelling single accumulation annuity product that covers traditional equity indices as well as multi asset custom indices focused on U.S. risk parity, global risk control asset allocation and sector-specific allocations. Following last year's refresh of IncomeShield, we are very well situated for income. The level of income offered to retail clients dominates the market in almost all the most important combinations of age and deferral periods. And where we don't, we are top 3, which is key to getting distribution partners' attention.

I want to highlight management changes we've made at Eagle Life to accomplish our goals. In September, we announced the hiring of Graham Day as President of Eagle Life. Graham has added quickly to his team from other leading annuity manufacturers, including Greg Alberti as Head of National Accounts and Bryan Albert as Head of Sales. Eagle Life is a key piece of our expansion into being a scale player in a new channel of distribution.

Pending applications as of this morning at Eagle Life were 1,213, up from 1,067 at year-end and fourth quarter average of 962. Pending applications when we reported third quarter results were at 975.

Moving on to the Investment Management pillar. In 2021, we intend to focus on ramping up our allocation to alpha assets. Our first foray in this area includes our partnership with Pretium announced in the fourth quarter, including an equity investment in the General Partner. With Pretium, we expect to expand our focus as both a lender and a landlord in the residential market.

In each new alpha asset subsector that we enter, we expect to partner with a proven industry manager with aligned economic incentives and risk management culture. This allows AEL to have an "open architecture" asset allocation approach versus other insurers that may have a more "closed architecture" approach to asset allocation. Our focus expansion sectors include middle-market credit, real estate, infrastructure debt and agricultural loans.

Yesterday, we announced plans to enter the middle market credit space with Adams Street Partners. American Equity and Adams Street will form a management company joint venture for co-developing insurer capital-efficient assets with secured first lien middle-market credit. Our company will initially commit up to $2 billion of invested assets to build the joint venture, and we expect to bring this capital-efficient asset product to other insurers as well. As this venture and other similar ventures in the future garner third-party assets, American Equity's mix of fee revenues will grow, supporting the migration to a more sustainable, higher return business profile.

The Capital Structure pillar is focused on greater use of reinsurance structuring to both optimize asset allocation for American Equity's balance sheet and to enable American Equity to free up capital and become a capital-light company over time. We are working diligently to complete in 2021, the announced reinsurance partnerships with Varde Partners and Agam Capital Management as well as Brookfield Asset Management, and the formation of our own offshore reinsurance platform. These transactions will enable American Equity to generate deployable capital in order to pivot towards a greater free cash flow generative and a capital-light or ROA, return on assets business model.

Turning to financial results for the fourth quarter and full year. For the fourth quarter of 2020, we reported non-GAAP operating income of $72 million or $0.77 per diluted common share. Financial result were significantly affected by excess cash in the portfolio as we repositioned our investment portfolio by derisking out of almost $2 billion of structured securities and $2.4 billion of corporates in the fourth quarter and built cash we expect to redeploy by transferring to Varde- Agam and Brookfield reinsurance transactions. Overall, 2021 is a transition year for repositioning a significant portion of our balance sheet, and hence, a reset year for American Equity. Over this year, we will explain any transaction execution driven, short-term or one-time notable impacts on financial results.

For full year 2020, we reported non-GAAP operating income of $69.1 million or $0.75 per share. Excluding notable items, specifically the one-time effect of annual actuarial review in the third quarter, a tax benefit from the enactment of CARES Act, and loss on extinguishment of debt, 2020 non-GAAP operating income was $381.4 million or $4.13 per share.

With that, I'll now turn the call over to Jim Hamalainen, Chief Investment Officer of Insurance; Jim, Tolga and Jeff are on this call for any questions.

Thank you, Anant. As part of our AEL 2.0 strategy work, we executed a series of trades designed to raise liquidity to fund the Varde-Agam and Brookfield block reinsurance transactions and de-risk the investment portfolio. As part of this de-risking, we sold nearly $2 billion of structured securities and an additional $2.4 billion of corporates, where we generally focused on securities that we believe were at risk of future downgrades. The sales occurred before the recent ramp-up in interest rates, so our timing was fortuitous.

As of the fourth quarter, the fixed maturity securities portfolio had an average rating of A minus with almost 97% rated NAIC 1 or 2. In addition, almost 80% of our commercial mortgage loan portfolio was rated CM1 at year-end, with 99.7% rated either CM1 or CM2. All commercial mortgage loans in the portfolio were paid current as of year-end. And in the fourth quarter of 2020, there were no additional forbearances granted.

Back on our first quarter 2020 call, we laid out an estimate of our capital sensitivity to a 12- to 18-month adverse recessionary scenario modeled on the Fed's CCAR stress test. Through year-end, the portfolio performed better than expectations. The impact of ratings migrations totaled 23 RBC points compared to the projection of 50 RBC points in that 12- to 18-month economic stress scenario. The impact of credit losses and impairments was 10 points, which compared to a projection of 25 RBC points in the stress scenario. Following the de-risking activities in the fourth quarter, we would expect our capital sensitivity in an adverse economic environment to be truncated relative to our March 2020 estimates.

Looking forward, we expect to reposition the portfolio starting this year. With the completion of the reinsurance transactions with Varde- Agam and Brookfield, AEL will free up capital and then redeploy part of that capital to support a move into alpha generating assets. Going forward, we expect to operate at lower invested asset leverage than in the past. With that, I'll turn it over to Ted.

Thank you, Jim. As we reported yesterday afternoon, operating income for the fourth quarter of 2020 was $72 million or [$0.77] (corrected by company after the call) per share compared to $126 million or $1.37 per share for the fourth quarter of 2019. Fourth quarter 2019 results included a $2 million or $0.02 per share loss from the write-off of unamortized debt issue costs for subordinated debentures that were redeemed during the period.

Average yield on invested assets was 3.88% in the fourth quarter of 2020 compared to 4.10% in the third quarter of this year. The decrease was attributable to a 22 basis point reduction from interest foregone due to an increase in the amount of cash held in the quarter. Cash and short-term investments in the investment portfolio averaged $4.4 billion over the fourth quarter, up from $1.7 billion in the third quarter.

At year-end, we held $7.3 billion in cash and short-term investments in the life insurance company portfolios, yielding roughly 7 basis points. The current point in time yield on the portfolio, including excess cash is approximately 3.4%; so the pressure on investment spread will continue in the first quarter. Excluding excess cash and invested assets to be transferred as part of the reinsurance transactions, we estimate the current point in time yield on the investment portfolio to be roughly 4%.

As we expect to close the reinsurance transactions in or after the second quarter, starting in March, we may partially preinvest the assets for the reinsurance transactions thereby offsetting some cash drag. We do not expect significant benefit in the first quarter from such pre-investing. On our future quarterly earnings calls, we will call out the effect of excess cash, if any, related to the reinsurance transactions.

The aggregate cost of money for annuity liabilities was 163 basis points down 3 basis points from the third quarter of 2020. The cost of money in the fourth quarter benefited from 1 basis point of hedging gains compared to a 3 basis point gain in the third quarter. Excluding hedging gains, the decline in the adjusted cost of money reflects a year-over-year decrease in option costs due to past renewal rate actions.

Reflecting the decline in the portfolio yield, investment spread fell to 225 basis points from 244 basis points in the third quarter. Excluding non-trendable items, adjusted spread in the fourth quarter was 213 basis points compared to 231 basis points in the third quarter of 2020.

The average yield on long-term investments acquired in the quarter was 4.46%, gross of fees compared to 3.59% gross of fees in the third quarter of the year. We purchased $152 million of fixed income securities at a rate of 3.32%, originated $142 million of commercial mortgage loans at a rate of 3.67% and purchased $224 million of residential mortgage loans at 5.63% gross of fees.

The cost of options declined slightly to 139 basis points from 142 basis points in the third quarter. All else equal, we would expect to continue to see the cost of money continue to decline throughout most of 2021, reflecting lower volatility and the actions taken in June of last year to reduce participation rates on $4.3 billion of policyholder funds and S&P annual point-to-point and monthly average strategies. The cost of options for the hedge week ended February 9 was 143 basis points.

Should the yields available to us decrease or the cost of money rise, we continue to have flexibility to reduce our rates if necessary and could decrease our cost of money by roughly 62 basis points if we reduce current rates to guaranteed minimums. This is down slightly from the 63 basis points we cited on our third quarter call.

The liability for lifetime income benefit riders increased $79 million this quarter, which included negative experience of $16 million relative to our modeled expectations. Coming out of the third quarter actuarial assumption review, we said we had expected for that quarter, a $63 million increase in the gap LIBOR reserve based on our actuarial models while actuarial and policyholder experience true-ups had added an additional $5 million of reserve increase. We said that we thought expected plus or minus $10 million would seem reasonable, so the fourth quarter of 2020 was a little bit above that range. There were pluses and minuses in the fourth quarter with the biggest differences due to a $6 million increase from lower-than-expected decrements on policies with lifetime income benefit riders and a $10 million increase as a result of lower caps and par rates due to renewal rate changes and policies having anniversary dates during the quarter. We will continue to experience the impact from renewal rate changes made in the second quarter of 2020 in the first and second quarters of this year.

Deferred acquisition cost and deferred sales inducement amortization totaled $113 million, $16 million less than modeled expectations. The biggest items driving the positive experience were lower than modeled interest and surrender margins, lower-than-expected utilization of lifetime income benefit riders and the second quarter of 2020 renewal rate changes I spoke about previously. The benefit on the combined deferred acquisition costs and deferred sales inducement amortization from the second quarter 2020 renewal rate changes was $10 million, effectively offsetting the negative effect on the lifetime income benefit rider reserve.

Other operating cost and expenses increased to $55 million from $43 million in the third quarter. Notable items not likely to reoccur in the first quarter of 2021, primarily advisory fees related to the unsolicited offer for the company in September, totaled approximately $3 million with much of the remaining increase associated with the implementation of AEL 2.0. Post-closing of the announced reinsurance transactions with Varde-Agam and Brookfield and the creation of the affiliated reinsurance platform, we would expect the level of other operating costs and expenses to fall in the mid- to high $40 million range.

We expect to complete the execution of the already announced accelerated share repurchase program in the first quarter. Based on current estimates, we expect an additional 520,000 shares to be delivered to us in addition to the initial 3.5 million shares delivered at the initiation. Combined with the 1.9 million shares we repurchased in the open market prior to the initiation of the ASR program, we will have effectively reduced the share dilution resulting from the November 30 initial equity investment of 9.1 million shares from Brookfield asset management by approximately 2/3.

The risk-based capital ratio for American Equity Life was 372%, flat with year-end 2019.

Total debt to total capitalization, excluding accumulated other comprehensive income, was 12.2% compared to 17.7% at year-end 2019. At year-end, cash and short-term investments at the holding company totaled $484 million. We expect to have over $300 million of cash at the Holding company even after buying back additional shares after completion of the existing ASR to fully offset Brookfield issuance related dilution.

We are strongly capitalized as we look to execute AEL 2.0 with ample liquidity at the Holding company, low leverage ratio relative to our industry peers and robust capitalization at the life company.

Now I'll turn the call over to the operator to begin Q&A.

(Operator Instructions) Our first question will come from the line of Ryan Krueger from KBW.

I had a question on the ROE outlook. I think last quarter, you talked about 11% to 14% intermediate term and the lower end of that being likely in 2021. Given the excess liquidity and some of the elevated expenses in 2021. I guess, is it reasonable to think that you'd probably come in below the 11% to 14% this year, but then migrate back into it in 2022 once some of the reinsurance transactions are complete?

Ryan, this is Ted. Yes, based upon the liquidity that we're holding right now, I would expect us probably to come in a little lower than the low end of that. Obviously, the determining fact off of where that ends up is going to be dependent on whether or not -- one, on the timing of when the reinsurance transactions are executed and whether or not we invest any of that liquidity into securities prior to the execution.

Ryan, I'll just add one thing to what Ted already said, which is spot on, is that we're leaving 2021 or at least the first few quarters of it as a reset year. So focusing on '22 is probably the right way if you think of metrics for us.

And then separately, do you -- I guess, MYGAs have not been a focus product in the past for AEL. It seems like they are more of one now. I guess, just generally, going forward, would you expect somewhat of a more balanced mix between MYGA and the FIA sales going forward?

I can take that, and then Jim can add in. MYGAs were -- or single premium deferred annuities were a good way for us to reintroduce into the market. We think that's compelling. It's priced to our [internal] (corrected by company after the call) returns. We are focused on fixed index annuities. And you would see the rest of the year -- us really focusing on the fixed indexed annuity side.

Now given the pending numbers I gave earlier, you can see we're pretty robust in the first quarter as well. But second quarter onwards, you'll probably see us pivoting much more towards fixed index annuities as new product introductions come to market like AssetShield.

(Operator Instructions)

Our next question will come from the line of Pablo Singzon from JPMorgan.

My first question is, in thinking about the next several years, how much of your portfolio do you intend to allocate to alpha generating assets? I think most insurers seem to allocate somewhere between 3% to 5% in the alt sleeve, is your thinking that you'll end up with a similar allocation longer term?

It's Anant. I think the definition of alpha generating is very important in this case. We believe where we are in the markets right now, and this is informed by leading partners as well, actually allocating to traditional private equity, hedge funds and publicly traded equities is more risky. And so our allocation there is basically 0 or near 0. So, the definition of alpha generating from our point of view is stable cash flow, like traditional fixed income investing, but in private markets. Hence, middle market credit, for example, is an alpha generating, it's not equity.

This broader definition of alpha generating there is basically anything that is not CUSIPed in public markets because anything that is CUSIPed in public markets is grinding downwards in a world of excess supply -- excess demand for bonds is grinding towards very low yields.

So, if you look at private credit real estate with contractual cash flows or infrastructure debt, all those are always going to have the flavor of a more traditional fixed asset which may have a residual equity sleeve as you structure it for capital efficiency. That's one important point.

As we think of that, we'll probably put around 5% to 10% of the portfolio in it progressively each year. And ultimately, as a target asset allocation, these private assets would be between 20% to 30% of the portfolio.

Understood. And then the follow-up question I had, just regarding your ROE aspirations to grow to the mid-teens longer term. I know it's early days, but I was wondering if it's possible to give us a rough indication of how much of that expansion will be driven by higher earnings versus a lower capital base to -- whether through buybacks or leaning into third party capital?

I'll start. The others can chime in. I think, Pablo, you bring up a very important point. There are a few drivers of a high ROE over time. First of all, one thing that we're very proud of this year, which may go unnoticed is that the asset leverage of our business has gone down meaningfully.

And if you do the math on Page 9 and Page 1 of the supplement, you'll see that asset leverage has gone down on a GAAP basis from like 18x to 12.5x. So, it's actually applying to alpha assets, which create greater earnings. So primary driver will be earnings, and I would say there are 3 drivers of that ROE expansion: first, alpha asset investment income, growing; second, fee income that's no-equity related because it's fee income from like the asset management ventures or reinsurance, growing. So those are 2 in the numerator of ROE.

And then finally, equity will go down as we redeploy more of that cash earnings back in our ongoing share repurchase programs or capital return programs like we outlined. Two of the items grow the numerator, one item reduces the denominator as we return cash to shareholders.

Our next question comes from the line of Randy Binner from B. Riley.

It's Randy Binner. So, I had the question just, Anant, the pending accounts you mentioned currently on the call, I think it was kind of running something like 3,500 at AEL and then like 1,200 Eagle Life, are those the right numbers generally for pendings?

They are as of this morning, Randy. Hi, happy new year, nice to hear your voice again. Yes, as of this morning, I would expect that as we pivot from SPDA to more FIA. Sorry everyone else for throwing jargon at you. But as we sell more fixed index annuities, that pending will probably trend down a little bit. It's at a high point is probably the way I'd put it.

Yes. So that's -- I just wanted to confirm those numbers, so that would be the highest in history. I guess I'm curious just kind of can you characterize a little bit more where you're sitting kind of from a market competition perspective to get those numbers? And just confirm that from an operational perspective, you're absorbing all that volume well. Just kind of curious how the sales and operations organization is dealing with that kind of flow.

It's a great question. It's nuanced and on the point. It's allowed us to actually understand our operational capabilities, the strength, if you recall, the fourth pillar of our foundational capabilities -- of our strategy was foundational capabilities, and it's been a great test case for us to realize how our base operation is doing. It's doing great. Did it get pushed? It did. Does it make us realize where we need to make investments in our business a year, 2 years from now? Yes.

So, we will be bolstering what we do in operations, but it's done well. It held up well to answer your question. And it's been a great test case for us to see both how we reengage with the market, bring in new producers, Eagle hits new highs and is off to the races. So that we can actually do, which very few companies do, dominate 2 channels, and then figure out other avenues for growth.

Yes. And then just can you characterize kind of where you're fitting in versus other competitors in the market. You obviously were very competitive at the end of last year. Can you give us any color of kind of where you're fitting in against key competitors so far in 2021?

We probably fit into in the first quartile is the way to think about it. It will be probably within the first half by the end of this year -- by the end of this quarter. We're going to take some rate actions on the SPDA side. We have this accumulation product coming out later this -- early next week actually launches Monday. So we're -- we've gone from first quartile to middle of the pack by the end of the quarter.

We're still pricing to meet our -- returns, and we've got the assets on the balance sheet and the returns on the balance sheet to make that work. As long as your asset returns are mid-3s, we're meeting our product pricing return hurdles, which are like in the 10% area unlevered, not to steal Jim's thunder, but if you have any more questions, I'm sure Jim can add in.

I'll leave it there on the product stuff.

And our next question is from Erik Bass from Autonomous Research.

Anant, your comments on focusing on 2022, I think, make a lot of sense given all the moving pieces near term. Is your expectation that you'll be at, call it, a normalized level of cash and expenses by the end of 2021? And then probably also executed some meaningful capital management by that time so that you'll enter '22 at more of a normal run rate for earnings?

Erik, yes. You got it spot on right.

Great. And then you also commented, obviously, part of the longer-term strategy is to increase the level of fee income for AEL. And we've got good line of sight into the ceding commissions you'll be getting from Brookfield. But can you help us think about maybe the initial level of fee income you expect from Värde, Agam in the asset management partnerships you've announced? And how you see that building over time?

It's a fair question, and I'd probably sequence it this way, it's early to give you any exact views on that. Other than the fact that as we -- other than the fact like the answer I was giving Pablo earlier about ROE improvement over time, right, and how earnings change. The first driver of earnings growth will be actual spread income on alpha assets because of higher yields. So, sustaining 4% and growing from 4% yields. That's one.

The second part will be actually constantly returning capital to shareholders from the earnings that are cash generative. And some of the capital that's freed up, which will then impact the denominator of all these calculations.

And then the third part of it will be the ramping up of fee income, as you mentioned. Reinsurance fee income will be greater than asset management fee income. As you know, it takes time to ramp it up. So like in the case of our Brookfield transaction, you can see we have 90 basis points between ALM fees and insurance fees.

Those kind of transactions, like we did with Brookfield, obviously, are more substantial. You get 90 basis points of assets transferred. And then when we do asset management deals, I think it is fair to say you should expect us to earn from that asset management stream, which is the third driver here around double-digit basis points on other people's money as we make insurance capital-efficient products available for them and grow that. So that's a slower ramp. I think that's a multiyear ramp, but it's a demonstrable ramp with these differentiated asset classes.

Let me pause there because that was a mouthful. Do those 3 drivers make sense and then sort of my sequencing it out? And if not, I'm happy to add on to it because I did do about -- throw a mouthful there.

No, I think that makes sense. Just one to clarify, on the asset management deals, you talked about earning a double-digit basis points on other people's money. So to clarify, does that mean you're not earning any investment fee on the capital you're putting in. But it's if -- you -- if the platform grows and takes on other kind of third-party money, then that's where you'll [get the fee] income?

No. No, it's a great question. I'm glad you asked to clarify. We make it on our own too, but that's how -- you can look at returns on a gross or net basis. So yes, we earn rev share or we earn economics in the ventures on our own money too, but it really is additive to us. If I go through the construct, right, because it comes through a high-yield net of fees in the first driver; you return capital, the second driver. But when you have other people's assets, which is not in AEL 1.0. Now you have third-party assets and we're making fees on that. I think that's additive.

Got it. That's helpful. And I can just sneak in one other. I think the Pretium acquisition is done in the general account. Is that where you expect most of the asset management partners to sit? Or would you hold any of them at the holding company, so you don't have to kind of go through a dividend process to get the fee income out?

We'll probably do more of the latter. And we don't have to own equity in all the partnerships. The Pretium partnership and the Adam Street partnership, which we haven't talked too much in great deal about, are very different constructs. One is an equity investment, the Pretium one; the Adam Street one is building something together, maybe equity in the future. But right now, it's more P&L oriented. So that does not need equity. We expect the blueprint to be that we're not really making that many equity investments only. A lot of them are going to be forms of revenue shares or P&L sharing arrangements.

And our next question comes from the line of Wilma Burdis from Crédit Suisse.

Do you still feel comfortable with targeted capital return of $250 million to $300 million in 2021? And I think that was above the buybacks required to offset the Brookfield deal?

Yes, Wilma.

Wilma, with the reinsurance transactions that we're executing along with where we want to hold capital. And remember, in normal times, we would want to hold capital around a 400% RBC or in excess of that. So, when we look at that in the reinsurance transaction, certainly, we believe that this year, potentially, we should be able to return that $250 million to $300 million above the buybacks.

And then as we go forward and as Anant talked about the creation of the AEL 2.0 model and the fee revenue generation, et cetera, we believe that's going to increase our cash generation profile to be able to hit those targets as we go forward.

Yes. Wilma, Ted covered it. If you think of it, the cash we have at the holding company is plentiful for us to offset the Brookfield dilution as well as meet the target we had for the year. So, we already have the cash we need to put to work.

Got it. That makes sense. And then could you guys talk about the expected AEL 2.0 implementation costs, especially in 2021. I mean I know the costs were a little bit higher in 4Q. Just if you could give us maybe some idea of what it looks like this year?

On the nature of the cost? I mean, the nature of the cost is (inaudible)

No, the level. The outlook for 2021.

Certainly, as we go through 2021 here, we're going to see potentially elevated expenses. We were at $55 million of operating expenses. What we indicated is, on a go-forward basis, post the transactions, we probably would be somewhere in that mid-40s range to high-40s range. But I would say we're going to see expenses -- we called out $3 million in this quarter. So, you're still in the low 50s for operating expenses as we go forward through 2021, which really represents additional expenses that we're incurring for advisory fees related to the transactions and the other work that's been doing.

Now the other part, when we talk about run rate, the reason why the run rate we're quoting that $45 million or higher 40s is certainly staffing and creating the infrastructure for AEL 2.0. It's different than what was there for AEL 1.0, but we have factored that into our modeling and our expense structure when we're quoting what ROEs we think we're going to be able to hit in the future.

Got it. And then I've got just one more. Could you just provide any outlook for kind of 2021, 2022 sales? I know the sales were very strong in the fourth quarter, just -- and you talked about some of the trends for this -- early this year, but just any thoughts on the outlook?

Wilma, historically, we don't give any outlook on sales but beyond quoting the pending numbers that we currently have. And I think Anant touched on those pending numbers. And also talked about potentially how we would, over the year, move away from maybe the higher levels of sales to SPDA multiyear products to more of the fixed indexed annuity products.

And our next question will come from the line of Mark Hughes from Truist.

Independent agent channel -- yes, can you hear me?

Yes, Mark, we can hear you.

On the independent agent channel, can you talk about how they're operating with still presumably some COVID-related restrictions? What's the -- you might say capacity utilization on the -- on that channel. Just in general, are they back up and going? Or still at reduced capacity?

Mark, it's Anant. The channel is fairly active. I mean we've all adapted to this new way of working, which is largely remote. We're not actively in the market face-to-face. We're putting health first in that point of view and in that channel. But it's functional. It's doing well. It's easier to sell SPDA also as a product when you don't have face-to-face interaction with the client. When you're not doing -- the way they go to market, a lot of them have seminars, dinners. But I would say the channel activity is good. The IMO partners are helping the producers of the agents to figure out how to sell.

And more importantly, I think the kind of products we have with the product refresh, we are launching. IncomeShield, for example, got refreshed. That's doing well. And actually, IncomeShield is one of the products that's reinsured to Brookfield. So it's good. We've got that working well. AssetShield with the revamp will make it a very simple compelling proposition where a client for accumulation can grow that.

And then we have some additional product ideas in mind, working with distribution that we think are going to pivot things forward. But no one knows what the new normal is of working, but it's working fine.

On future deals where you've got other asset managers or potential reinsurance deals. Is there anything unique about these transactions that contributes to the cash drag? Could future deals also have kind of periods where you've got this buildup of capital?

Related to the cash drag, the asset managers, those are not -- those transactions aren't going to create cash drag for us. The cash drag is much more related to reinsurance transactions. And if we would do another reinsurance transaction outside of the ones we said, and it wasn't transfer of securities or it was a transfer of cash. Yes, we could see cash built up. But really, our current cash that we have on the balance sheet is specifically related to the couple reinsurance transactions that we're currently working on.

Yes. And I'll just add in, Mark, is that we feel very good about actually the strengthening of the balance sheet as we did in the -- which we did last year. And the fact that the asset leverage is down -- financial leverage is down from 17.7% to 12.2%, asset leverage is down from 18x to around 12x, 12x to 13x. And so cash drag is actually a part of implementing a new business model that's actually less risky.

And with the balance sheet being strong and capitalizations being at the highest levels in our history and staying in those levels on a go-forward basis, allows us to execute. So, we really view the cash impact of holding liquidity to be a transitionary nature related to the 2 reinsurance transactions because we are transforming 20% of the balance sheet with these reinsurance transactions and the rest of the balance sheet moving the way they're going.

Having derisked out of -- it's good to be smart. If you can be smart and lucky, we'll take it. And I think our timing was really good. The team did a good job, Jeff, Jim, Tolga, on derisking some of the structured securities. And frankly, it's better because it worked out with -- it's the part of being lucky, rates are up 40 basis points in the last one month. So, it's actually being good to be in cash.

But it will be a short-term impact on results, and we expect first quarter to be impacted by that because we have more cash in first quarter than we had on average in the fourth quarter. Rather long answer to your very simple question. I apologize for that, but happy to take any further on -- follow-up on it.

Next question is from the line of John Barnidge from Piper Sandler.

Apologies if I missed it in your prepared remarks, but what was the yield on securities purchased during the quarter?

Mark [sic) [John], it's Ted. I said those in my remarks. The average yield on investments acquired this quarter was 4.46% gross of fees that was compared to 3.59% last quarter.

And then maybe as part of AEL 2.0, have you looked into building maybe like a third-party claims and policy administration tax platform that could generate additional servicing revenue?

Do you hang out in our strategy session?

No, I guess I'm asking the right question, though.

You're asking exactly the right question. I think it's an element of that foundational capability, pillar, the fourth pillar. This year, we are really focused on investment management and capital structure. And you're spot on right, but it's too early to talk about that fourth pillar and what that could be. But as I said, I think you hang out in our strategy sessions. So, jokes apart, that is -- that's the stretch. It's doable, but it will require some more investment. That's not reflected in anything we've shared with you it's sort of upside over the long term.

We certainly recognize that there's an opportunity in the marketplace out there to do that. But as Anant said, that's not in our near-term plan, but certainly, it is something we are looking at long term.

And our last question will be from Pablo Singzon from JPMorgan.

So Anant and Ted, I just wanted to follow up on your capital deployment comment. But to your point, if you consider the next maybe 2 to 3 years, your capital deployment is already covered by the reinsurance transactions and available capital in the balance sheet. At what point, though, would you need to start relying more on earnings to support capital deployment?

And I guess related to that, how should we think about the quantum of earnings uses for deals and buybacks? And the context of that question is that I think in the past, most of the excess capital was used to fund sales.

Pablo, happy to take the follow-on. Yes, so you're spot on right. We expect to free up capital. I go back to my -- the 3 building blocks that I tried to articulate to your earlier question, earnings will go up as investment income goes up with alpha assets being a greater portion of their investment portfolio.

If it goes up from 10% this year to 20% -- 15% to 20% next year, 25% to 30% the following year. That's how earnings will grow. Those earnings, including our reinsurance platform that's created, so that in our -- a lot of those earnings are coming out of the reinsurance platform will be able to be returned to shareholders as will capital freed up, as will then fee income from investment management partnerships or transaction that we talk about.

But it will be -- we will not need capital to fund growth. We will be more than self-sufficient to fund growth. The devil will be in the details as we work through all the execution. But I think the priority order that I just gave you with the existing capital we free up, that goes back to shareholders.

And then with the growth of the earnings, that sustainable earnings, including out of the reinsurance platform and the investment management partnerships will be free cash flow up to shareholders.

I'm not showing any further questions. I'd like to turn the call back over to speakers for any closing 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 concludes today's conference call. Thank you for participating.