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Table of contents Prospectus supplement
Index to financial statements and schedules
Filed Pursuant to Rule 424(b)(5)
Registration No. 333-184162
Subject to completion, dated July 11, 2013
The information in this preliminary prospectus supplement is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell these securities and are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
Preliminary prospectus supplement
(To prospectus dated September 28, 2012)
American Equity Investment Life Holding Company
$400,000,000
% Notes due 2021
Interest payable and
Issue price: %
We are offering $400,000,000 aggregate principal amount of % Notes due 2021 (the "notes"). We will pay interest on the notes on and of each year, beginning , 2013. The notes will mature on , 2021.
We may redeem all or part of the notes at any time on or after , 2017, at the redemption prices set forth in this prospectus supplement plus accrued and unpaid interest, if any, to the redemption date. In addition, we may redeem up to 35% of the notes before , 2016 with the net cash proceeds from certain equity offerings. We may also redeem all or part of the notes at any time and from time to time prior to , 2017, at a price equal to % of the aggregate principal amount of the notes to be redeemed plus a make-whole premium and accrued interest, if any, to the redemption date. See "Description of the notesOptional redemption." In addition, we may be required to make an offer to purchase the notes upon the sale of certain assets or upon a change of control. See "Description of the notesChange of control" and "Description of the notesCertain covenantsLimitations on sales of assets and subsidiary stock."
The notes will be our senior unsecured obligations and will rank equally in right of payment to all of our existing and future senior unsecured debt and senior in right of payment to all of our existing and future subordinated debt. The notes will be effectively subordinated to any of our existing and future secured debt to the extent of the value of the assets securing such debt. None of our subsidiaries will guarantee the notes as of the issue date, and the notes will be structurally subordinated to the liabilities of our subsidiaries. The notes will be guaranteed by certain of our wholly owned domestic subsidiaries (not including our insurance subsidiaries, other subsidiaries not permitted by law or regulation to guarantee the notes and certain immaterial subsidiaries) only under limited circumstances. See "Description of the notesCertain covenantsFuture subsidiary guarantors." The notes will be issued only in registered form in minimum denominations of $2,000 and integral multiples of $1,000 above that amount.
The notes will not be listed on any securities exchange. Currently, there is no public market for the notes.
Investing in the notes involves risks that are described under "Risk factors" beginning on page S-22 of this prospectus supplement.
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Per note | Total | |||||
Public offering price(1) |
% | $ | |||||
Underwriting discount |
% | $ | |||||
Proceeds, before expenses, to us(1) |
% | $ | |||||
(1) Plus accrued interest, if any, from , 2013.
Neither the Securities and Exchange Commission (the "SEC") nor any state securities commission has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
The notes will be ready for delivery in book-entry form only through the facilities of The Depository Trust Company for the accounts of its participants, including Euroclear Bank S.A./N.V., as operator of the Euroclear System, and Clearstream Banking, société anonyme, on or about , 2013.
Sole book-running manager
J.P. Morgan
Co-managers
SunTrust Robinson Humphrey | Citigroup | Deutsche Bank Securities | ||
FBR |
Raymond James |
, 2013
Table of contents
Prospectus supplement
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About this prospectus supplement
This document is in two parts. The first part is this prospectus supplement, which contains the terms of this offering of notes. The second part is the accompanying prospectus, dated September 28, 2012, which is part of our Registration Statement on Form S-3.
This prospectus supplement may add to, update or change the information in the accompanying prospectus or the documents incorporated by reference herein. If information in this prospectus supplement is inconsistent with information in the accompanying prospectus or the documents incorporated by reference herein, the information in this prospectus supplement will apply and will supersede the information in the accompanying prospectus or the documents incorporated by reference herein, as the case may be.
It is important for you to read and consider all information contained or incorporated by reference in this prospectus supplement and the accompanying prospectus in making your investment decision. You should also read and consider the information in the documents to which we have referred you in "Where you can find more information" in this prospectus supplement and the accompanying prospectus.
No person is authorized to give any information or to make any representations other than those contained or incorporated by reference in this prospectus supplement or the accompanying prospectus, and, if given or made, such information or representations must not be relied upon as having been authorized. Neither the delivery of this prospectus supplement and the accompanying prospectus, nor any sale made hereunder, shall under any circumstances create any implication that there has been no change in our affairs since the date of this prospectus supplement, or that the information contained or incorporated by reference in this prospectus supplement or the accompanying prospectus is correct as of any time subsequent to the date of such information.
The distribution of this prospectus supplement and the accompanying prospectus and the offering of the notes in certain jurisdictions may be restricted by law. This prospectus supplement and the accompanying prospectus do not constitute an offer, or an invitation on our behalf or the underwriters or any of them, to subscribe to or purchase any of the notes and may not be used for or in connection with an offer or solicitation by anyone, in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. See "Underwriting."
Unless otherwise stated or the context otherwise requires, as used in this prospectus supplement, all references to "American Equity," the "Company," "we," "our" and similar references are to American Equity Investment Life Holding Company and its consolidated subsidiaries.
Cautionary note regarding forward-looking statements
This prospectus supplement and the accompanying prospectus contain forward-looking statements within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically are identified by the use of terms such as "anticipate," "believe," "plan," "estimate," "expect," "project," "intend," "may," "will," "would," "contemplate," "possible," "attempt," "seek," "should," "could," "goal,"
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"target," "on track," "comfortable with," "optimistic" and similar words, although some forward-looking statements are expressed differently. You should consider statements that contain these words carefully because they describe our expectations, plans, strategies and goals and our beliefs concerning future business conditions, our results of operations, financial position, and our business outlook or they state other "forward-looking" information based on currently available information. The "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 7, 2013 (and any updates of such section in any subsequent filings subsequently incorporated by reference herein), provides examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements. Assumptions and other important factors that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, among other things:
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Other factors and assumptions not identified above are also relevant to the forward-looking statements, and it is not possible for us to predict all of them; nor can we assess the impact of each such factor or the extent to which any factor, or combinations of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by the foregoing cautionary statement. Our forward-looking statements speak only as of the date made. Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update or to publicly announce the results of any revisions to any of the forward-looking statements to reflect actual results, future events or developments, changes in assumptions or changes in other factors affecting the forward-looking statements. You are advised, however, to consult any further disclosures we make on related subjects in reports we file with the SEC.
Market, ranking, industry data and forecasts
This prospectus supplement and the accompanying prospectus include market share, ranking, industry data and forecasts that we obtained from industry publications and surveys, public filings and internal company sources. Industry publications, surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of included information. While we are not aware of any misstatements regarding the industry data presented in this prospectus supplement and the accompanying prospectus, we have not independently verified any of the data from third-party sources, nor have we ascertained the underlying economic assumptions relied upon by those sources. Neither we nor the underwriters can guarantee the accuracy or completeness of such information contained in this prospectus supplement and the accompanying prospectus.
Where you can find more information
We are subject to the informational reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). You may read and copy any document that we file at the public reference facilities of the SEC at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the public reference facilities may be obtained by calling the
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SEC at 1-800-SEC-0330. You may also inspect our annual, quarterly and current reports, any proxy statements and other information over the Internet at the SEC's home page at http://www.sec.gov.
The SEC allows us to "incorporate by reference" information into this prospectus supplement and the accompanying prospectus. This means that we can disclose important information to you by referring you to another document that we have filed separately with the SEC. The information incorporated by reference is considered to be part of this prospectus supplement and the accompanying prospectus. Information that we file with the SEC after the date of this prospectus supplement will automatically modify and supersede the information included or incorporated by reference in this prospectus supplement and the accompanying prospectus to the extent that the subsequently filed information modifies or supersedes the existing information. Nothing in this prospectus supplement or the accompanying prospectus shall be deemed to incorporate by reference information furnished to, but not filed with, the SEC, unless specifically stated otherwise. We incorporate by reference the following documents (each with SEC file number 001-31911):
We will provide to each person, including any beneficial owner, to whom this prospectus supplement is delivered a copy of any or all of the information that we have incorporated by reference into this prospectus supplement or the accompanying prospectus but not delivered with this prospectus supplement, at no cost to the requestor. To receive a free copy of any of the documents incorporated by reference into this prospectus supplement or the accompanying prospectus, other than exhibits, unless they are specifically incorporated by reference into those documents, call or write:
American
Equity Investment Life Holding Company
6000 Westown Parkway
West Des Moines, IA 50266
Attention: Corporate Secretary
Tel: (515) 221-0002
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This summary highlights selected information about us and this offering. It does not contain all of the information that may be important to you in deciding whether to purchase the notes. We encourage you to read the entire prospectus supplement, the accompanying prospectus and the documents that we have filed with the SEC that are incorporated by reference herein.
Overview
We are a leader in the development and sale of fixed index and fixed rate annuity products. We sell fixed index and fixed rate annuities and life insurance in all 50 states and the District of Columbia. Our business consists primarily of the sale of fixed index and fixed rate annuities, and our annuity sales for each of the year ended December 31, 2012 and the twelve months ended March 31, 2013, before coinsurance, were $3.9 billion. Our strategy is focused on growing our annuity business and earning returns by managing investment spreads and investment risk. We had an investment portfolio of $29.2 billion as of March 31, 2013. For the twelve months ended March 31, 2013, we generated total revenues of $1,724.0 million, Operating Income of $113.9 million and net income of $73.4 million. For the year ended December 31, 2012, we generated total revenues of $1,588.6 million, Operating Income of $110.2 million and net income of $57.8 million. See "Summary consolidated financial information" for a reconciliation of Operating Income, which is a non-GAAP financial measure, to net income.
We underwrite our fixed annuity and life insurance products through our wholly-owned life insurance subsidiaries, American Equity Investment Life Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York and Eagle Life Insurance Company ("Eagle Life"). We market those products through a distribution network of approximately 60 national marketing organizations and, through them, approximately 24,000 independent agents.
Annuity market overview
Our target market includes the group of individuals ages 45-75 who are seeking to accumulate tax-deferred savings. We believe that significant growth opportunities exist for annuity products because of favorable demographic and economic trends. According to the U.S. Census Bureau, there were approximately 39 million Americans age 65 and older in 2010, representing 13% of the U.S. population. By 2030, this sector of the population is expected to increase to 20% of the total population. Our fixed index and fixed rate annuity products are particularly attractive to this group as a result of the guarantee of principal with respect to those products, competitive rates of credited interest, tax-deferred growth and alternative payout options.
According to AnnuitySpec's Index Sales & Market Report, total industry sales of fixed index annuities increased 27% to $34.0 billion in 2012 from $26.8 billion in 2008. Our wide range of fixed index and fixed rate annuity products has enabled us to enjoy favorable growth during volatile equity and bond markets.
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Our company strengths
Credit strengths
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American Equity Life has generated a statutory net gain from operations for each of the last five years, which is one of the bases for its capacity to pay dividends to the issuer. In addition, as the invested assets of our operating subsidiaries has grown from $12.7 billion as of December 31, 2008 to $29.2 billion as of March 31, 2013, the amount of investment advisory fees paid by our subsidiaries to the issuer under an intercompany advisory agreement has increased from $19.3 million in 2008 to $36.2 million in 2012.
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management, using appropriate options and other strategies to manage the liabilities we write while mitigating counterparty risk.
Our strategy
Our business strategy is to grow our annuity business and earn predictable returns by managing investment spreads and investment risk. Key elements of this strategy include the following:
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initiatives and other factors, our investment spread increased to 268 basis points in the first quarter of 2013.
Products
Annuities offer our policyholders a tax-deferred means of accumulating retirement savings, as well as a reliable source of income during the payout period. When our policyholders contribute cash to annuities, we account for these receipts as policy benefit reserves in the liability section of our consolidated balance sheet. The annuity deposits collected, by product type, during the three most recent years and the most recent quarter are as follows:
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Year ended December 31, | |||||||||||||||||
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Three months ended March 31, 2013 |
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2012 | 2011 | 2010 | |||||||||||||||||
(Dollars in thousands) |
Deposits collected |
Deposits as a % of total |
Deposits collected |
Deposits as a % of total |
Deposits collected |
Deposits as a % of total |
Deposits collected |
Deposits as a % of total |
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Fixed index annuities: |
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Index strategies |
$ | 604,641 | 65% | $ | 2,225,902 | 56% | $ | 2,839,295 | 56% | $ | 2,401,891 | 51% | ||||||||
Fixed strategy |
243,129 | 26% | 1,208,324 | 31% | 1,377,987 | 27% | 1,551,007 | 33% | ||||||||||||
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847,770 | 91% | 3,434,226 | 87% | 4,217,282 | 83% | 3,952,898 | 84% | ||||||||||||
Fixed rate annuities |
67,166 | 7% | 348,049 | 9% | 567,229 | 11% | 544,193 | 12% | ||||||||||||
Single premium immediate annuities |
14,980 | 2% | 164,657 | 4% | 305,603 | 6% | 171,628 | 4% | ||||||||||||
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$ | 929,916 | 100% | $ | 3,946,932 | 100% | $ | 5,090,114 | 100% | $ | 4,668,719 | 100% | ||||||||
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Fixed index annuities
Fixed index annuities allow policyholders to earn index credits based on the performance of a particular index without the risk of loss of their principal. Most of these products allow policyholders to transfer funds once a year among several different crediting strategies, including one or more index based strategies and a traditional fixed rate strategy. Approximately 97%, 97%, 95% and 95% of our fixed index annuity sales for the three months ended March 31, 2013, and the years ended December 31, 2012, 2011 and 2010, respectively, were "premium bonus" products. The initial annuity deposit on these policies is increased at issuance by a specified premium bonus ranging from 3% to 10%. Generally, there is a compensating adjustment in the surrender charges on the policy or the commission paid to the agent to offset the premium bonus.
The annuity contract value is equal to the sum of premiums paid, premium bonuses and interest credited ("index credits"), which is based upon an overall limit (or "cap") or a percentage (the "participation rate") of the annual appreciation (based in certain situations on monthly averages or monthly point-to-point calculations) in a recognized index or benchmark. Caps and participation rates limit the amount of annual interest the policyholder may earn in any one contract year and may be adjusted by us annually subject to stated minimums.
Fixed rate annuities
Fixed rate deferred annuities include annual reset and multi-year rate guaranteed products. Our annual reset fixed rate annuities have an annual interest rate (the "crediting rate") that is guaranteed for the first policy year. After the first policy year, we have the discretionary ability to change the crediting rate once annually to any rate at or above a guaranteed minimum rate. Our multi-year rate guaranteed annuities are similar to our annual reset products except that the initial crediting rate is guaranteed for up to a seven-year period before it may be changed at our discretion.
The initial crediting rate is largely a function of the interest rate we can earn on invested assets acquired with new annuity deposits and the rates offered on similar products by our competitors. For subsequent adjustments to crediting rates, we take into account the yield on our investment portfolio, annuity surrender assumptions, competitive industry pricing and crediting rate history for particular groups of annuity policies with similar characteristics.
Single premium immediate annuities
We also sell single premium immediate annuities ("SPIAs"). Our SPIAs are designed to provide a series of periodic payments for a fixed period of time or for life, according to the policyholder's choice at the time of issue. The amounts, frequency and length of time of the payments are fixed at the outset of the annuity contract. SPIAs are often purchased by persons at or near retirement age who desire a steady stream of payments over a future period of years. The implicit interest rate on SPIAs is based on market conditions when the policy is issued.
Withdrawal optionsfixed index and fixed rate annuities
Policyholders are typically permitted penalty-free withdrawals of up to 10% of the contract value in each year after the first year, subject to limitations. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period which ranges from 5 to 17 years for fixed index annuities and 3 to 15 years for fixed rate annuities from the
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date the policy is issued. This surrender charge initially ranges from 4.7% to 20% for fixed index annuities and 8% to 25% for fixed rate annuities of the contract value and generally decreases by approximately one to two percentage points per year during the surrender charge period. Surrender charges are set at levels aimed at protecting us from loss on early terminations and reducing the likelihood of policyholders terminating their policies during periods of increasing interest rates. This practice lengthens the effective duration of the policy liabilities and enhances our ability to maintain profitability on such policies. The policyholder may elect to take the proceeds of the annuity either in a single payment or in a series of payments for life, for a fixed number of years or a combination of these payment options.
Beginning in July 2007, substantially all of our fixed index annuity policies were issued with a lifetime income benefit rider. This rider provides an additional liquidity option to policyholders. With the lifetime income benefit rider, a policyholder can elect to receive guaranteed payments for life from their contract without requiring them to annuitize their contract value. The amount of the living income benefit available is determined by the growth in the policy's income account value as defined in the rider (4.5% to 8.0%) and the policyholder's age at the time the policyholder elects to begin receiving living income benefit payments. Living income benefit payments may be stopped and restarted at the election of the policyholder.
Life insurance
These products include traditional ordinary and term, universal life and other interest-sensitive life insurance products. We have approximately $2.4 billion of life insurance in force as of March 31, 2013. We intend to continue offering life insurance products for individual and group markets. Premiums related to this business accounted for 1% or less of revenues for the three months ended March 31, 2013 and the years ended December 31, 2012, 2011 and 2010.
Investments and spread management
Investment activities are an integral part of our business, and net investment income is a significant component of our total revenues. Profitability of many of our products is significantly affected by spreads between interest yields on investments, the cost of options to fund the annual index credits on our fixed index annuities and the rates credited on our fixed rate annuities. We manage the index-based risk component of our fixed index annuities by purchasing call options on the applicable indices to fund the annual index credits on these annuities and by adjusting the caps, participation rates and asset fees on policy anniversary dates to reflect the change in the cost of such options which varies based on market conditions. All options are purchased to fund the index credits on our fixed index annuities on their respective anniversary dates, and new options are purchased at each of the anniversary dates to fund the next annual index credits. All crediting rates on non-multi-year rate guaranteed fixed rate deferred annuities may be changed annually, subject to minimum guarantees. Changes in caps, participation rates and asset fees on fixed index annuities and crediting rates on fixed rate annuities may not be sufficient to maintain targeted investment spreads in all economic and market environments. In addition, competition and other factors, including the potential for increases in surrenders and withdrawals, may limit our ability to adjust or to maintain caps, participation rates, asset fees and crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions.
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For additional information regarding the composition of our investment portfolio and our interest rate risk management, see "Management's discussion and analysis of financial condition and results of operationsFinancial conditionInvestments," "Management's discussion and analysis of financial condition and results of operationsMarket risk" and Note 3 to our audited and unaudited consolidated financial statements included elsewhere in this prospectus supplement.
Marketing
We market our products through a variable cost brokerage distribution network of approximately 60 national marketing organizations and, through them, approximately 24,000 independent agents. We emphasize high quality service to our agents and policyholders along with the prompt payment of commissions to our agents. We believe this has been significant in building excellent relationships with our existing agency force.
We actively recruit new agents and terminate those agents who have not produced business for us in recent periods and are unlikely to sell our products in the future. In our recruitment efforts, we emphasize that agents have direct access to our executive officers, giving us an edge in recruiting over larger and foreign-owned competitors. We also emphasize our products, service and our Gold Eagle program which provides unique cash and equity-based incentives to those agents selling $1 million or more of annuity premium annually. Our Gold Eagle agents accounted for 59% of total production in 2012 and 57% of total production in 2011 and 2010. We also have favorable relationships with our national marketing organizations.
The insurance distribution system is comprised of insurance brokers and marketing organizations. We are pursuing a strategy to increase the efficiency of our distribution network by strengthening our relationships with key national and regional marketing organizations, and we seek opportunities to establish relationships with organizations not presently associated with us. These organizations typically recruit agents for us by advertising our products and our commission structure through direct mail advertising or seminars for insurance agents and brokers. These organizations bear most of the cost incurred in marketing our products. We compensate marketing organizations by paying them a percentage of the commissions earned on new annuity policy sales generated by the agents recruited by such organizations. We also conduct incentive programs for marketing organizations and agents from time to time, including equity-based programs for our leading national marketers and those agents qualifying for our Gold Eagle program. We generally do not enter into exclusive arrangements with these marketing organizations.
In addition, we formed our Eagle Life subsidiary with the goal of developing a network of broker-dealer firms and registered investment advisors to distribute our fixed index annuity products. We believe this to be the most effective means of building a core distribution channel of selling firms with representatives capable of selling $1 million or more of annuity premium annually.
Three of our national marketing organizations accounted for more than 10% of the annuity deposits and insurance premiums collected during 2012, and we expect these organizations to continue as marketers for American Equity Life with a focus on selling our products. The states
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with the largest share of direct premiums collected during 2012 were: Florida (9.3%), California (8.7%), Illinois (6.4%), Texas (6.4%) and Pennsylvania (5.4%).
Recent developments
Redemption of December 2024 notes
On March 25, 2013, we issued a notice of mandatory redemption (the "redemption") for our existing convertible notes due December 2024 (the "December 2024 Notes"). Holders of $25.8 million principal amount of the December 2024 Notes exercised their conversion rights prior to the April 30, 2013 mandatory redemption date. The holders of these December 2024 Notes received the principal amount of their December 2024 Notes in cash and the conversion premium in shares of our common stock. The final number of shares issued in connection with the exercise of conversion rights of the December 2024 Notes was 216,729. The balance of the convertible notes ($2.5 million principal amount) was redeemed for cash. In connection with the redemption, on May 14, 2013, we drew $15.0 million on our existing revolving credit facility (our "existing revolving credit facility").
Pretax charge for the second quarter of 2013
On July 3, 2013, we announced that our financial results for the second quarter of 2013 are expected to include a pretax charge of up to $8.5 million ($5.5 million after applicable income taxes) to cover assessments from state guaranty fund associations related to the insolvency of Executive Life Insurance Company of New York ("ELNY"). ELNY was placed into rehabilitation by the New York Insurance Department in 1991. ELNY was never affiliated with our company, but our insurance subsidiaries are required under the solvency or guaranty laws of most states in which they do business to pay assessments up to certain prescribed limits to fund policyholder losses or liabilities of insolvent insurance companies such as ELNY. The amount of our expected pretax charge represents assessments already received and estimates of assessments expected to be received in the coming months. The estimates of assessments expected to be received are based upon information currently available and are subject to ongoing evaluation.
Related transactions
Exchange offers for September 2015 notes and December 2029 notes
Following completion of this offering, we intend to commence an offer to exchange (the "2015 Exchange Offer") any and all of our outstanding 3.5% Convertible Senior Notes due 2015 (the "September 2015 Notes") for cash and newly issued shares of our common stock. We further intend to commence an offer to exchange (the "2029 Exchange Offer" and, together with the 2015 Exchange Offer, the "Exchange Offers") any and all of our outstanding 5.25% Contingent Convertible Senior Notes due 2029 (the "December 2029 Notes") for cash and newly issued shares of our common stock. As an alternative to one or both of the Exchange Offers, we may tender for, repurchase in the open market, or otherwise acquire for cash, a combination of cash and securities, or other consideration any or all of the September 2019 Notes or the December 2029 Notes. This offering is not conditioned upon the commencement or completion of the Exchange Offers. Our decision to commence an offer for the September 2015 Notes and/or the December 2029 Notes will depend on market conditions and other factors. In the alternative or in addition, we may use the net proceeds of the offering of the notes for one or
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more of the other purposes described in "Use of proceeds." This prospectus supplement is not an offer to exchange the September 2015 Notes or the December 2029 Notes, and any exchange offer will be made only by and pursuant to the terms of an Exchange Offer prospectus.
In connection with any Exchange Offer for our September 2015 Notes, we expect to receive cash in the settlement of the hedge transactions we entered into at the time we issued the September 2015 Notes. As of March 31, 2013, the hedges had an estimated fair value of $71.2 million. For more information about the hedge transactions, see "Description of certain indebtednessSeptember 2015 notes." References in this prospectus supplement to the Exchange Offers are intended to include the cash settlement of these hedge transactions.
We may file one or more registration statements (including a prospectus) with the SEC for either or both of the Exchange Offers. Before you invest, you should read any prospectus in such registration statements and other documents we have filed with the SEC for more complete information about us and any such exchange offer. You may get these documents for free by visiting EDGAR on the SEC website at http://www.sec.gov. Alternatively, we will arrange to send you any prospectus after filing if you request it by calling 1-800-245-8812.
Additional information
Our company is incorporated under the laws of the State of Iowa. Our principal executive offices are located at 6000 Westown Parkway, West Des Moines, IA 50266, and our telephone number is (515) 221-0002. Our principal website is located at http://www.american-equity.com. The contents of our website are not a part of this prospectus supplement.
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Issuer | American Equity Investment Life Holding Company. | |
Securities offered |
$400,000,000 aggregate principal amount of % Notes due 2021, which we refer to herein as the "notes." |
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Maturity |
The notes will mature on , 2021. |
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Interest |
Interest on the notes will accrue from , 2013 at a rate of % and will be payable semi-annually in arrears on and of each year, commencing , 2013. |
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Optional redemption |
We may redeem all or part of the notes beginning on , 2017, at the redemption prices described under "Description of the notesOptional redemption," plus accrued and unpaid interest, if any, to the date of redemption. |
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In addition, we may redeem up to 35% of the notes before , 2016 with the net cash proceeds from certain equity offerings at a redemption price equal to % of the principal amount of each note to be redeemed, plus accrued and unpaid interest, if any, to the date of redemption. |
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We may also redeem all or part of the notes at any time and from time to time prior to , 2017, at a price equal to 100% of the aggregate principal amount of the notes to be redeemed plus a make-whole premium described under "Description of the notesOptional redemption," and accrued and unpaid interest, if any, to the date of redemption. |
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Change of control |
If we experience certain kinds of changes of control, we must offer to purchase the notes at 101% of their principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase. See "Description of the notesChange of control." |
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Asset disposition offer |
If we or our restricted subsidiaries sell assets, under certain circumstances, we will be required to use the net proceeds to make an offer to purchase notes at an offer price in cash in an amount equal to 100% of the principal amount of the notes plus accrued and unpaid interest, if any, to the repurchase date. See "Description of the notesCertain covenantsLimitation on sales of assets and subsidiary stock." |
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No guarantees on the issue date; future subsidiary guarantees | None of our subsidiaries will guarantee the notes as of the issue date, and the notes will be structurally subordinated to the liabilities of our subsidiaries. See "Ranking" below. | |
The notes will be guaranteed only by: |
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any wholly owned domestic subsidiary that we form or acquire after the issue date (other than any insurance subsidiary, any other subsidiary not permitted by law or regulation to guarantee the notes or certain immaterial subsidiaries that hold less than 5% of our consolidated total assets or account for less than 5% of our consolidated revenues); |
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any restricted subsidiary that guarantees any other indebtedness of our company or any subsidiary guarantor; and |
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if our risk-based capital ratio is less than 225% as of the last day of any fiscal year or fiscal quarter of the Company, any other wholly owned domestic subsidiary (other than any insurance subsidiary, any other subsidiary not permitted by law or regulation to guarantee the notes or certain immaterial subsidiaries that have assets with a fair market value less than $2.5 million or have revenues less than $2.5 million for the most recently ended period of four consecutive quarters). |
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To the extent any of our subsidiaries guarantee the notes in the future, those subsidiary guarantors may be released from their subsidiary guarantees under certain circumstances without the consent of the holders of notes. See "Description of the notesCertain covenantsFuture subsidiary guarantors." |
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Ranking |
The notes will be our senior unsecured obligations and will: |
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rank senior in right of payment to all of our existing and future subordinated indebtedness; |
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rank equally in right of payment with all of our existing and future senior indebtedness; |
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be effectively subordinated to any of our existing and future secured debt, to the extent of the value of the assets securing such debt; and |
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be structurally subordinated to all of the existing and future liabilities (including trade payables) of each of our subsidiaries, except to the extent any such subsidiary guarantees the notes in the future, as described in "No guarantees on the issue date; future subsidiary guarantees" above. |
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For the twelve months ended March 31, 2013, our subsidiaries: |
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represented approximately 99.8% of our total revenues; |
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represented approximately 124.8% of Operating Income (which is a non-GAAP financial measure); and |
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represented approximately 142.2% of our net income. |
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As of March 31, 2013, our subsidiaries: |
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represented 99.7% of our total assets; and |
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had $34.5 billion of total liabilities, including trade payables but excluding intercompany liabilities. |
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As of March 31, 2013, after giving effect to this offering and our use of the net proceeds therefrom (including the Exchange Offers): |
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we would have had approximately $669.6 million of total indebtedness (including the notes), none of which would have ranked equally with the notes and $269.6 million of which would have been subordinated to the notes; |
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we would have had commitments available to be borrowed under our existing revolving credit facility of $160.0 million; and |
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our subsidiaries would have had approximately $34.5 billion of total liabilities (including trade payables but excluding intercompany liabilities), all of which would have been structurally senior to the notes. |
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Certain covenants |
The Indenture governing the notes will contain certain covenants that limit, among other things, our ability and the ability of our restricted subsidiaries to: |
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incur additional indebtedness or, in the case of our restricted subsidiaries, issue preferred stock; |
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pay dividends, make certain investments or make other restricted payments; |
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create liens; |
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sell assets; |
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enter into transactions with affiliates; |
S-13
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enter into mergers, consolidations, or sales of all or substantially all of our assets; and |
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allow limitations on any restricted subsidiary's ability to pay dividends, make loans or sell assets to American Equity Investment Life Holding Company or other restricted subsidiaries. |
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These covenants are subject to important exceptions and qualifications, which are described in "Description of the notesCertain covenants." |
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Use of proceeds |
We estimate that the net proceeds from this offering will be approximately $391.0 million after deducting the underwriting discounts and our expenses related to the offering. We intend to use the net proceeds of this offering (1) to pay the consideration required to exchange the September 2015 Notes and the December 2029 Notes tendered in connection with the Exchange Offer for any and all of our outstanding September 2015 Notes and December 2029 Notes if we commence the Exchange Offers, including the payment of any applicable accrued and unpaid interest on such September 2015 Notes and December 2029 Notes, (2) to repay all amounts outstanding under our existing revolving credit facility, (3) to pay related fees and expenses and (4) for general corporate purposes. Our decision to commence an offer for the September 2015 Notes and the December 2029 Notes will depend on market conditions and other factors. In the alternative or in addition, we may use the net proceeds of the offering of the notes for one or more of the other purposes described in footnote (1) of the table set forth in "Use of proceeds." |
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Further issuances |
We may from time to time, without notice to or the consent of the holders of the notes, create and issue further notes having the same ranking and terms and conditions as the notes offered hereby, except for the issue date, the public offering price and, in some cases, the first interest payment date, as described under "Description of the notesGeneral." Any additional notes having such similar terms, together with the notes, will constitute a single series of securities under the indenture. |
S-14
Absence of public market for the notes | The notes are a new issue of securities and there is currently no established trading market for the notes. We do not intend to apply for a listing of the notes on any securities exchange or an automated dealer quotation system. Accordingly, a liquid market for the notes may not develop. The underwriters have advised us that they currently intend to make a market in the notes. However, they are not obligated to do so, and any market making with respect to the notes may be discontinued without notice. | |
Denomination and form |
We will issue the notes in the form of one or more fully registered global notes registered in the name of the nominee of The Depository Trust Company, or "DTC." Beneficial interests in the notes will be represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC. Clearstream Banking, société anonyme and Euroclear Bank, S.A./N.V., as operator of the Euroclear System, will hold interests on behalf of their participants through their respective U.S. depositaries, which in turn will hold such interests in accounts as participants of DTC. Except in the limited circumstances described in this prospectus supplement, owners of beneficial interests in the notes will not be entitled to have notes registered in their names, will not receive or be entitled to receive notes in definitive form and will not be considered holders of notes under the Indenture. The notes will be issued only in minimum denominations of $2,000 and integral multiples of $1,000 above that amount. |
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Trustee |
Wells Fargo Bank, National Association |
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Governing law |
New York |
In evaluating an investment in the notes, prospective investors should carefully consider, along with the other information in this prospectus supplement and the accompanying prospectus, the specific factors set forth under "Risk factors" for risks involved with an investment in the notes.
S-15
Summary consolidated financial information
The following table sets forth our summary consolidated financial information as of and for the years ended December 31, 2012, 2011 and 2010 and as of and for the three months ended March 31, 2013 and 2012. The information as of and for the years ended December 31, 2012, 2011 and 2010 was derived from our audited annual consolidated financial statements. The information as of and for the three months ended March 31, 2013 and 2012 was derived from our unaudited interim consolidated financial statements and includes, in the opinion of management, all normal and recurring adjustments necessary to present fairly the information for such periods. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013.
The summary unaudited historical statements of operations and other financial data for the twelve months ended March 31, 2013 have been calculated by subtracting the applicable unaudited consolidated statements of operations and other financial data for the three months ended March 31, 2012 from the sum of (1) the applicable audited consolidated statements of operations data for the year ended December 31, 2012 and (2) the applicable unaudited consolidated statements of operations data for the three months ended March 31, 2013.
You should read the following summary consolidated financial information together with "Management's discussion and analysis of financial condition and results of operations" and our audited consolidated financial statements and unaudited consolidated financial statements, including the related notes, included elsewhere in this prospectus supplement.
S-16
|
|
Three months ended March 31, |
Year ended December 31, |
||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Twelve months ended March 31, 2013(a) |
||||||||||||||||||
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
||||||||||||||
|
(unaudited) |
(unaudited) |
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|
||||||||||||||
Consolidated statements of operations data: |
|||||||||||||||||||
Revenues: |
|||||||||||||||||||
Traditional life insurance premiums |
$ | 12,353 | $ | 2,698 | $ | 3,222 | $ | 12,877 | $ | 12,151 | $ | 11,982 | |||||||
Annuity product charges |
91,094 | 21,481 | 19,393 | 89,006 | 76,189 | 69,075 | |||||||||||||
Net investment income |
1,289,703 | 329,690 | 326,910 | 1,286,923 | 1,218,780 | 1,036,106 | |||||||||||||
Change in fair value of derivatives |
335,939 | 373,962 | 259,161 | 221,138 | (114,728 | ) | 168,862 | ||||||||||||
Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses |
10,207 | 10,585 | (6,076 | ) | (6,454 | ) | (18,641 | ) | 23,726 | ||||||||||
Net OTTI losses recognized in operations |
(15,288 | ) | (3,237 | ) | (2,881 | ) | (14,932 | ) | (33,976 | ) | (23,867 | ) | |||||||
Loss on extinguishment of debt |
| | | | | (292 | ) | ||||||||||||
Total revenues |
1,724,008 | 735,179 | 599,729 | 1,588,558 | 1,139,775 | 1,285,592 | |||||||||||||
Benefits and expenses: |
|||||||||||||||||||
Insurance policy benefits and change in future policy benefits |
7,693 | 1,735 | 2,117 | 8,075 | 7,870 | 8,251 | |||||||||||||
Interest sensitive and index product benefits |
904,773 | 225,809 | 139,123 | 818,087 | 775,757 | 733,218 | |||||||||||||
Change in fair value of embedded derivatives |
291,105 | 363,272 | 359,066 | 286,899 | (105,194 | ) | 130,950 | ||||||||||||
Amortization of deferred sales inducements and policy acquisition costs |
276,143 | 75,061 | 50,994 | 252,076 | 215,259 | 196,261 | |||||||||||||
Interest expense on notes payable and subordinated debentures |
41,613 | 10,257 | 10,581 | 41,937 | 45,610 | 37,031 | |||||||||||||
Interest expense on amounts due under repurchase agreements |
| | | | 30 | | |||||||||||||
Other operating costs and expenses |
93,302 | 19,520 | 21,713 | 95,495 | 67,529 | 114,615 | |||||||||||||
Total benefits and expenses |
1,614,629 | 695,654 | 583,594 | 1,502,569 | 1,006,861 | 1,220,326 | |||||||||||||
Income before income taxes |
109,379 | 39,525 | 16,135 | 85,989 | 132,914 | 65,266 | |||||||||||||
Income tax expense |
36,021 | 13,494 | 5,664 | 28,191 | 46,666 | 22,333 | |||||||||||||
Net income |
$ | 73,358 | $ | 26,031 | $ | 10,471 | $ | 57,798 | $ | 86,248 | $ | 42,933 | |||||||
Non-GAAP financial measures (unaudited)(b): |
|||||||||||||||||||
Reconciliation of net income to Operating Income: |
|||||||||||||||||||
Net income |
$ | 73,358 | $ | 26,031 | $ | 10,471 | $ | 57,798 | $ | 86,248 | $ | 42,933 | |||||||
Net realized (gains) losses and net OTTI losses on investments, net of offsets(c) |
2,297 | (2,804 | ) | 3,547 | 8,648 | 18,354 | 379 | ||||||||||||
Net effect of derivatives and embedded derivatives, net of offsets(c) |
28,656 | 10,237 | 15,742 | 34,161 | 29,051 | 38,167 | |||||||||||||
Convertible debt extinguishment, net of income taxes |
| | | | | 171 | |||||||||||||
Litigation reserve, net of offsets(c) |
9,580 | | | 9,580 | | 27,297 | |||||||||||||
Operating Income(d) |
$ | 113,891 | $ | 33,464 | $ | 29,760 | $ | 110,187 | $ | 133,653 | $ | 108,947 | |||||||
S-17
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As of and for the three months ended March 31, |
As of and for the year ended December 31, |
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---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
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(unaudited) |
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|
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Consolidated balance sheet data: |
||||||||||||||||
Total investments |
$ | 29,245,856 | $ | 24,034,739 | $ | 27,537,210 | $ | 24,383,451 | $ | 19,816,931 | ||||||
Total assets |
36,852,969 | 33,038,533 | 35,133,478 | 30,874,719 | 26,426,763 | |||||||||||
Policy benefit reserves |
32,937,308 | 29,255,621 | 31,773,988 | 28,118,716 | 23,655,807 | |||||||||||
Notes payable |
313,043 | 300,567 | 309,869 | 297,608 | 330,835 | |||||||||||
Subordinated debentures |
245,913 | 268,574 | 245,869 | 268,593 | 268,435 | |||||||||||
Accumulated other comprehensive income ("AOCI") |
661,663 | 408,747 | 686,807 | 457,229 | 81,820 | |||||||||||
Total stockholders' equity |
1,730,229 | 1,373,584 | 1,720,237 | 1,408,679 | 938,047 | |||||||||||
Statutory financial data: |
||||||||||||||||
Life subsidiaries' statutory capital and surplus and asset valuation reserve |
1,769,118 | 1,676,839 | 1,741,637 | 1,655,205 | 1,456,679 | |||||||||||
Life subsidiaries' statutory net gain from operations before income taxes and realized capital gains (losses) |
44,403 | 35,632 | 182,057 | 344,538 | 322,133 | |||||||||||
Life subsidiaries' statutory net income |
25,441 | 12,034 | 79,644 | 167,925 | 172,865 | |||||||||||
Other data (unaudited): |
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Adjusted Debt to total capitalization ratio(e) |
19.3% | 22.1% | 20.0% | 22.3% | 26.2% | |||||||||||
Debt to total capitalization ratio(e) |
34.3% | 37.1% | 35.0% | 37.3% | 41.2% | |||||||||||
Risk-based capital ("RBC") ratio(f) |
330% | 343% | 332% | 346% | 339% | |||||||||||
Ratio of consolidated earnings to fixed charges(g) |
1.1x | 1.1x | 1.1x | 1.1x | 1.1x | |||||||||||
Ratio of consolidated earnings to fixed charges, both excluding interest-sensitive and index product benefits and amortization of deferred sales inducements(g) |
4.8x | 2.5x | 3.0x | 3.9x | 2.7x | |||||||||||
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For the twelve months ended March 31, |
For the year ended December 31, |
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|
2013 |
2012 |
2012 |
2011 |
2010 |
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Other data (unaudited) (continued): |
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Operating Income Return on Average Equity Excluding Average AOCI(h) |
11.2% | 14.3% | 11.1% | 14.8% | 13.3% | |||||||||||
Net Income Return on Average Equity Excluding Average AOCI(h) |
7.2% | 7.0% | 5.8% | 9.5% | 5.2% | |||||||||||
(a) The statement of operations and other financial data for the twelve months ended March 31, 2013 have been calculated in the manner described in the introduction to the table. This presentation is not in accordance with U.S. generally accepted accounting principles, or GAAP. We believe that this presentation provides useful information to investors regarding our recent financial performance, and we view this presentation of the four most recently completed quarters as a key measurement period for investors to assess our historical results. In addition, our management uses trailing four-quarter financial information to evaluate the financial performance of the company for ongoing planning purposes. This presentation has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.
(b) In addition to net income, we have consistently utilized Operating Income, a non-GAAP financial measure commonly used in the life insurance industry, as an economic measure to evaluate our financial performance. Operating Income equals net income adjusted to eliminate the impact of net realized gains (losses) on investments, including net OTTI losses recognized in operations, fair value changes in derivatives and embedded derivatives, (gain) loss on extinguishment of convertible debt and litigation reserves. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of Operating Income together with net income provides information that may enhance an investor's understanding of our underlying results and profitability.
Operating Income is not a substitute for net income determined in accordance with GAAP. The adjustments made to derive Operating Income are important to understanding our overall results from operations, and, if evaluated without proper context, Operating Income possesses material limitations:
S-18
Therefore, our management and board of directors also separately review net realized investment gains (losses) and analyses of our net investment income, including impacts related to OTTI write-downs, in connection with their review of our investment portfolio. In addition, our management and board of directors examine net income as part of their review of our overall financial results. The adjustments made to net income to arrive at Operating Income for the three months ended March 31, 2013 and 2012, for the years ended December 31, 2012, 2011 and 2010 and for the twelve months ended March 31, 2013 are set forth in the table above.
(c) The adjustments to net income to arrive at Operating Income are presented net of related adjustments to amortization of deferred sales inducements ("DSI") and deferred policy acquisition costs ("DAC") and net of income taxes, as set forth in the table below (unaudited):
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Three months ended March 31, |
Year ended December 31, |
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|
Twelve months ended March 31, 2013 |
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(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
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Net realized (gains) losses and net OTTI losses on investments, net of offsets: |
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Net realized (gains) losses on investments, including OTTI |
$ | 5,081 | $ | (7,348 | ) | $ | 8,957 | $ | 21,386 | $ | 52,617 | $ | 141 | ||||||
Amortization of DAC and DSI |
(1,446 | ) | 3,093 | (3,450 | ) | (7,989 | ) | (24,117 | ) | 446 | |||||||||
Income taxes |
(1,338 | ) | 1,451 | (1,960 | ) | (4,749 | ) | (10,146 | ) | (208 | ) | ||||||||
|
$ | 2,297 | $ | (2,804 | ) | $ | 3,547 | $ | 8,648 | $ | 18,354 | $ | 379 | ||||||
Net effect of derivatives and embedded derivatives, net of offsets: |
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Change in fair value of derivatives and embedded derivatives |
$ | 128,325 | $ | 35,680 | $ | 59,050 | $ | 151,695 | $ | 125,721 | $ | 146,682 | |||||||
Amortization of DAC and DSI |
(83,883 | ) | (20,240 | ) | (34,663 | ) | (98,306 | ) | (80,858 | ) | (87,545 | ) | |||||||
Income taxes |
(15,786 | ) | (5,203 | ) | (8,645 | ) | (19,228 | ) | (15,812 | ) | (20,970 | ) | |||||||
|
$ | 28,656 | $ | 10,237 | $ | 15,742 | $ | 34,161 | $ | 29,051 | $ | 38,167 | |||||||
Litigation reserve, net of offsets: |
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Litigation reserve recorded in other operating costs |
$ | 17,532 | $ | | $ | | $ | 17,532 | $ | | $ | 48,000 | |||||||
Amortization of DAC and DSI |
(2,656 | ) | | | (2,656 | ) | | (5,712 | ) | ||||||||||
Income taxes |
(5,296 | ) | | | (5,296 | ) | | (14,991 | ) | ||||||||||
|
$ | 9,580 | $ | | $ | | $ | 9,580 | $ | | $ | 27,297 | |||||||
(d) Operating Income reflects the following expenses and adjustments for the periods indicated:
(e) The Adjusted Debt to total capitalization ratio is calculated by dividing Adjusted Debt by total capitalization excluding AOCI. Adjusted Debt is the sum of notes payable and the portion of the total subordinated debentures payable to statutory trusts outstanding (qualifying trust preferred securities) that exceeds 15% of total capitalization excluding AOCI. The debt to total capitalization ratio is calculated by dividing the sum of notes payable and subordinated debentures by total capitalization excluding AOCI.
In addition to total debt in accordance with GAAP, we use Adjusted Debt, a non-GAAP financial measure, as an alternate measure of our leverage. Adjusted Debt is the sum of notes payable and the portion of total subordinated debentures payable to statutory trusts outstanding that exceeds 15% of total capitalization excluding AOCI. Because rating agencies and certain
S-19
analysts and investors give equity credit to a portion of our subordinated debentures in analyzing our leverage and financial condition, we use Adjusted Debt as a supplemental measure in evaluating our leverage.
Total capitalization excluding AOCI, a non-GAAP financial measure, is the sum of total debt and total stockholders' equity minus AOCI. Since AOCI fluctuates from quarter to quarter due to unrealized changes in the fair value of available for sale investments, we believe that total capitalization excluding AOCI provides useful supplemental information in evaluating our total capitalization.
In addition, our existing revolving credit facility requires us to maintain a ratio of Adjusted Debt to total capitalization excluding AOCI below a specified level. We also use these measures, therefore, in evaluating our leverage and ongoing compliance with our existing revolving credit facility.
The table below demonstrates how we calculate Adjusted Debt and sets forth a reconciliation of our Adjusted Debt to our total debt for the periods indicated, as well as the components for the calculation of the debt to total capitalization ratio and the Adjusted Debt to total capitalization ratio (unaudited):
|
As of March 31, | As of December 31, | ||||||||||||||
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(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
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Notes payable |
$ | 313,043 | $ | 300,567 | $ | 309,869 | $ | 297,608 | $ | 330,835 | ||||||
Portion of total subordinated debentures payable to statutory trusts outstanding that exceeds 15% of total capitalization excluding AOCI (A) |
1,785 | 38,477 | 7,494 | 40,945 | 50,110 | |||||||||||
Adjusted Debt |
314,828 | 339,044 | 317,363 | 338,553 | 380,945 | |||||||||||
Remaining portion of total subordinated debentures (B) |
244,128 | 230,097 | 238,375 | 227,648 | 218,325 | |||||||||||
Total subordinated debentures (A+B) |
245,913 | 268,574 | 245,869 | 268,593 | 268,435 | |||||||||||
Total debt |
558,956 | 569,141 | 555,738 | 566,201 | 599,270 | |||||||||||
Total stockholders' equity |
1,730,229 | 1,373,584 | 1,720,237 | 1,408,679 | 938,047 | |||||||||||
Total capitalization |
2,289,185 | 1,942,725 | 2,275,975 | 1,974,880 | 1,537,317 | |||||||||||
AOCI |
661,663 | 408,747 | 686,807 | 457,229 | 81,820 | |||||||||||
Total capitalization excluding AOCI |
$ | 1,627,522 | $ | 1,533,978 | $ | 1,589,168 | $ | 1,517,651 | $ | 1,455,497 | ||||||
(f) The risk-based capital (RBC) ratio is calculated by dividing total adjusted statutory capital by regulatory required capital. Total adjusted statutory capital is calculated based on a formula specified by the National Association of Insurance Commissioners ("NAIC") that includes American Equity Life's statutory capital and surplus and asset valuation reserve and certain other adjustments. For more information about American Equity Life's statutory capital and surplus, see Note 12 to our audited consolidated financial statements included in this prospectus supplement.
The table below sets forth the components for our calculation of the RBC ratio (unaudited):
|
As of March 31, | As of December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
|||||||||||
American Equity Life's statutory capital and surplus and asset valuation reserve |
$ | 1,769,201 | $ | 1,676,839 | $ | 1,741,638 | $ | 1,655,205 | $ | 1,456,679 | ||||||
Regulatory required capital |
536,501 | 488,808 | 524,928 | 479,023 | 430,064 | |||||||||||
(g) For information on how we calculate these ratios, see "Ratio of earnings to fixed charges" later in this prospectus supplement.
(h) Return on Average Equity Excluding Average AOCI is calculated by dividing net income and Operating Income for the trailing twelve months by average equity excluding average AOCI. We use Return on Average Equity Excluding Average AOCI as a supplemental measure of evaluating the net income and Operating Income we generate as a percentage of our equity. In that calculation, we use average equity over the applicable twelve-month period to mitigate the effects of fluctuations in our equity during that period. In addition, we exclude AOCI because AOCI fluctuates from quarter to quarter due to unrealized changes in the fair value of available for sale investments. We believe that Return on Average Equity Excluding Average AOCI
S-20
provides useful supplemental information regarding our financial performance to analysts and investors. The table demonstrates how we calculate Average Equity Excluding Average AOCI for the periods indicated (unaudited):
|
Twelve months ended March 31, |
Year ended December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
|||||||||||
Average Stockholders' Equity: |
||||||||||||||||
Average equity including average AOCI |
$ | 1,551,907 | $ | 1,167,380 | $ | 1,564,458 | $ | 1,173,363 | $ | 846,335 | ||||||
Average AOCI |
535,205 | 238,163 | 572,018 | 269,525 | 25,682 | |||||||||||
Average equity excluding average AOCI |
1,016,702 | 929,217 | 992,440 | 903,838 | 820,653 | |||||||||||
Net income |
73,358 | 65,376 | 57,798 | 86,248 | 42,933 | |||||||||||
Operating Income |
113,891 | 132,839 | 110,187 | 133,653 | 108,947 | |||||||||||
Return on Average Equity Excluding Average AOCI: |
||||||||||||||||
Net income |
7.2% | 7.0% | 5.8% | 9.5% | 5.2% | |||||||||||
Operating Income |
11.2% | 14.3% | 11.1% | 14.8% | 13.3% | |||||||||||
S-21
Investing in the notes involves a high degree of risk. Before making an investment decision, and in consultation with your own financial and legal advisors, you should carefully consider the following risk factors and all other information contained or incorporated by reference in this prospectus supplement (including the risk factors contained under the heading "Risk factors" in our annual report on Form 10-K for the year ended December 31, 2012). The risks and uncertainties described below and incorporated by reference herein are not the only ones facing us. Additional risks and uncertainties of which we are unaware, or that we currently deem immaterial, also may become material factors that affect us. If any of the following risks or those incorporated by reference herein occur or intensify, our business, financial condition or results of operations could be materially and adversely affected. If this were to happen, the value of the notes could decline significantly, and you may lose some or all of your investment. In connection with the forward-looking statements that appear in this prospectus supplement, you should also carefully review the cautionary statements under "Cautionary note regarding forward-looking statements."
Risks related to the notes
Despite our current debt levels, we may still incur substantially more debt or take other actions which would intensify the risks discussed below.
Our level of indebtedness will increase as a result of this offering, even after the use of the net proceeds of the offering to purchase debt securities in the Exchange Offers. As of March 31, 2013, after giving effect to this offering and the use of proceeds therefrom (including the Exchange Offers), our total debt would have been approximately $669.6 million.
Despite our current consolidated debt levels, we and our subsidiaries may be able to incur substantial additional debt in the future, subject to the restrictions contained in our debt instruments. We will not be restricted under the terms of the indenture governing the notes from incurring additional debt, recapitalizing our debt or taking a number of other actions that are not limited by the terms of the indenture governing the notes that could have the effect of diminishing our ability to make payments on the notes when due. If we incur any additional indebtedness that ranks equally with the notes, the holders of that debt will be entitled to share ratably with you in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of our company. This may have the effect of reducing the amount of proceeds paid to you. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness.
In addition, we expect to repay all amounts outstanding under our existing revolving credit facility in connection with the issuance of the notes. Our existing revolving credit agreement expires in 2014, and we anticipate (though we can give no assurances) that we will enter into a new senior term loan and/or revolving credit facility to meet our working capital needs. Any new facility may (1) contain covenants that limit the discretion of our management with respect to certain business matters, and (2) require us to meet certain financial ratios and financial condition tests.
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Such new credit facility, and, generally, our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by the terms of the indenture and the notes could have important consequences for you. For example, it could:
In addition, it is possible that we may need to incur additional indebtedness in the future in the ordinary course of business or otherwise. Furthermore, if future debt financing is not available to us when required or is not available on acceptable terms, we may be unable to grow our business, take advantage of business opportunities, respond to competitive pressures or refinance maturing debt, any of which could have a material and adverse effect on our operating results and financial condition.
Servicing our debt requires a significant amount of cash, and we may not have sufficient cash flow from our business to pay our debt.
Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the notes, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
The notes will be effectively subordinated to any secured indebtedness of our company to the extent of the value of the property securing that indebtedness.
The notes will not be secured by any of our assets. As a result, the notes will be effectively subordinated to any secured indebtedness with respect to the assets that secure that indebtedness. As of May 31, 2013, we have no secured indebtedness, but we may incur secured debt in the future. The effect of this subordination is that upon a default in payment on, or the acceleration of, any of our secured indebtedness, or in the event of bankruptcy, insolvency, liquidation, dissolution or reorganization of our company, the proceeds from the sale of assets securing our secured indebtedness will be available to pay obligations on the notes only after
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all secured indebtedness has been paid in full. As a result, the holders of the notes may receive less, ratably, than the holders of secured debt in the event of our bankruptcy, insolvency, liquidation, dissolution or reorganization.
The notes will be structurally subordinated to all obligations of our subsidiaries, except to the extent any of those subsidiaries become guarantors of the notes in the future.
None of our subsidiaries will guarantee the notes as of the issue date. The notes will be guaranteed by certain of our wholly owned domestic subsidiaries only under the limited circumstances described in "Description of the notesCertain covenantsFuture subsidiary guarantors." Even if certain of our wholly owned domestic subsidiaries guarantee the notes in the future, those subsidiaries will not include our insurance subsidiaries, other subsidiaries not permitted by law or regulation to guarantee the notes and certain immaterial subsidiaries. Except to the extent that certain of our wholly owned domestic subsidiaries guarantee the notes in the future, our subsidiaries will have no obligation, contingent or otherwise, to pay amounts due under the notes or to make any funds available to pay those amounts, whether by dividend, distribution, loan or other payment. The notes and any future subsidiary guarantees will be structurally subordinated to all indebtedness and other obligations of any non-guarantor subsidiary such that in the event of insolvency, liquidation, reorganization, dissolution or other winding up of any subsidiary that is not a guarantor, all of that subsidiary's creditors (including trade creditors) would be entitled to payment in full out of that subsidiary's assets before we would be entitled to any payment.
In addition, the indenture that will govern the notes will, subject to some limitations, permit these subsidiaries to incur additional indebtedness and will not contain any limitation on the amount of other liabilities, such as trade payables, that may be incurred by these subsidiaries.
For the twelve months ended March 31, 2013, our subsidiaries represented 99.8% of our total revenues, 124.8% of our Operating Income (which is a non-GAAP financial measure) and 142.2% of our net income. As of March 31, 2013, our subsidiaries represented 99.7% of our total assets and had $34.5 billion of total liabilities, including trade payables but excluding intercompany liabilities.
In addition, to the extent any of our subsidiaries guarantee the notes in the future, those subsidiary guarantees will be automatically released from those note guarantees upon the occurrence of certain events, including the following:
If any subsidiary guarantee is released, no holder of the notes will have a claim as a creditor against that subsidiary, and the indebtedness and other liabilities, including trade payables and preferred stock, if any, whether secured or unsecured, of that subsidiary will be effectively senior to the claim of any holders of the notes. See "Description of the notesCertain covenantsFuture subsidiary guarantors."
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The terms of our existing revolving credit facility restrict, and the terms of the indenture that will govern the notes will restrict, our current and future operations, particularly our ability to respond to changes or to take certain actions.
Our existing revolving credit facility contains, and the indenture that will govern the notes offered hereby will contain, a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interest. In addition, any new senior term loan or revolving credit facility that we enter into to replace our existing revolving credit facility would have similar restrictive covenants. These covenants include restrictions on our ability to:
A breach of the covenants or restrictions under the existing revolving credit facility, any new senior term loan or revolving credit facility and the indenture that will govern the notes could result in an event of default under the applicable indebtedness. Such a default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies.
We conduct substantially all of our operations through our subsidiaries, which are not expected to guarantee the notes.
American Equity Investment Life Holding Company is a holding company with no business operations of its own. We conduct our operations through our subsidiaries, which are not expected to guarantee the notes, except under the limited circumstances described in "Description of the notesCertain covenantsFuture subsidiary guarantors." Accordingly, repayment of our indebtedness, including the notes, is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Our subsidiaries do not have any obligation to pay amounts due on the notes or our other indebtedness or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness, including the notes. Each subsidiary is a distinct legal entity, and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While the indenture that will govern the notes will limit the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make other intercompany payments to us, these limitations are subject to qualifications and exceptions. In the event that we do not receive distributions from our
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subsidiaries, we may be unable to make required principal and interest payments on our indebtedness, including the notes.
Our liquidity and ability to meet our obligations under the notes may be constrained by the ability of our insurance subsidiaries to distribute cash to us.
We depend on our insurance subsidiaries for cash to make principal and interest payments on debt and to pay administrative expenses and income taxes. We receive cash from our insurance subsidiaries, consisting of dividends and distributions, fees earned under investment advisory agreements, principal and interest payments on surplus debentures and tax-sharing payments, as well as cash from our non-insurance subsidiaries consisting of dividends, distributions, loans and advances. Deterioration in the financial condition, earnings or cash flow of these significant subsidiaries for any reason could hinder the ability of such subsidiaries to pay cash dividends or other disbursements to American Equity, which would limit our ability to meet our debt service requirements, including our obligations under the notes, and satisfy other financial obligations. In addition, we may elect to contribute additional capital to certain insurance subsidiaries to strengthen their surplus for covenant compliance or regulatory purposes (including, for example, maintaining adequate RBC levels) or to provide the capital necessary for growth, in which case it is less likely that our insurance subsidiaries would pay us dividends. Accordingly, this could limit our ability to meet debt service requirements and satisfy other holding company financial obligations.
The payment of dividends or surplus debenture interest by our insurance subsidiaries to American Equity is subject to state insurance department regulations and may be prohibited by insurance regulators if they determine that such dividends or other payments could be adverse to our policyholders or contract holders. Insurance regulations generally permit dividends to be paid from statutory earned surplus of the insurance company without regulatory approval for any twelve-month period in amounts equal to the greater of (or in a few states, the lesser of):
This type of dividend is referred to as an "ordinary dividend." In the year ended December 31, 2012, our insurance subsidiaries paid no ordinary dividends, and for 2013, up to $165.6 million can be distributed as ordinary dividends. Any dividend in excess of these levels requires the approval of the director or commissioner of the applicable state insurance department and is referred to as an "extraordinary dividend." In the year ended December 31, 2012, our insurance subsidiaries paid no extraordinary dividends to American Equity.
In addition, although we are under no obligation to do so, we may elect to contribute additional capital to strengthen the surplus of certain insurance subsidiaries for covenant compliance or regulatory purposes or to provide the capital necessary for growth. Any election regarding the contribution of additional capital to our insurance subsidiaries could affect the ability of our insurance subsidiaries to pay dividends. The ability of our insurance subsidiaries to pay dividends is also impacted by various criteria established by rating agencies to maintain or receive higher financial strength ratings and by the capital levels that we target for our insurance subsidiaries, as well as RBC and statutory capital and surplus compliance requirements under our existing revolving credit facility.
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There is currently no public market for the notes, and we do not know if a market will ever develop or, if a market does develop, whether it will be sustained.
The notes are a new issue of securities, and there is no existing trading market for the notes. Although the underwriters have informed us that they intend to make a market in the notes, they have no obligation to do so and may discontinue making a market at any time without notice. As a result, a liquid market may not develop for the notes, and you may not be able to sell your notes when you wish to sell them, or the prices that you receive when you sell the notes may not be favorable. We do not intend to apply for listing of the notes on any securities exchange. If a market for the notes does not develop, you may not be able to resell your notes for an extended period of time, if at all. Moreover, if markets for the notes do develop in the future, these markets may not continue indefinitely, and the notes may not be sold at a price equal to or greater than their initial offering price. In addition, in response to prevailing interest rates and market conditions generally, as well as our performance, the notes could trade at a price lower than their initial offering price.
We may not be able to repurchase the notes upon a change of control.
Upon the occurrence of a Change of Control, each holder of notes will have the right to require us to repurchase all or any part of such holder's notes for cash at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to the date of such repurchase. If a Change of Control occurs, we may not have sufficient financial resources available to satisfy our obligations to repurchase the notes, or the terms of other indebtedness may preclude us from doing so. Our failure to repurchase the notes as required under the indenture governing the notes would result in a default under the indenture that could have material adverse consequences for us and the holders of the notes. In order to avoid the obligations to repurchase the notes and events of default and potential breaches of our existing revolving credit facility and other indebtedness, we may have to avoid certain change of control transactions that would otherwise be beneficial to us.
In addition, certain important corporate events, such as leveraged recapitalizations, may not, under the indenture that will govern the notes, constitute a "change of control" that would require us to repurchase the notes, even though those corporate events could increase the level of our indebtedness or otherwise adversely affect our capital structure, credit ratings or the value of the notes. See "Description of the notesChange of control."
Holders of the notes may not be able to determine when a change of control giving rise to their right to have the notes repurchased has occurred following a sale of "substantially all" of our assets.
One of the circumstances under which a change of control may occur is upon the sale or disposition of "all or substantially all" of our assets. There is no precise established definition of the phrase "substantially all" under applicable law, and the interpretation of that phrase will likely depend upon particular facts and circumstances. Accordingly, the ability of a holder of notes to require us to repurchase its notes as a result of a sale of less than all our assets to another person may be uncertain.
Our credit ratings may not reflect all risks of your investment in the notes.
Our credit ratings are an assessment by rating agencies of our ability to pay our debts when due. Consequently, real or anticipated changes in our credit ratings will generally affect the
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market value of the notes. These credit ratings may not reflect the potential impact of risks relating to the structure or marketing of the notes. In addition, if any of our outstanding debt that is rated is downgraded, raising capital will become more difficult for us, and borrowing costs under our credit agreement and other future borrowings may increase. Agency ratings are not a recommendation to buy, sell or hold any security and may be revised or withdrawn at any time by the issuing organization. Each agency's rating should be evaluated independently of any other agency's rating.
Federal and state fraudulent transfer laws may permit a court to void the notes and/or any future subsidiary guarantees, and if that occurs, you may not receive any payments on the notes.
Federal and state fraudulent transfer and conveyance statutes may apply to the issuance of the notes and the incurrence of any future subsidiary guarantees of the notes. Under federal bankruptcy law and comparable provisions of state fraudulent transfer or conveyance laws, which may vary from state to state, the notes or any future subsidiary guarantees thereof could be voided as a fraudulent transfer or conveyance if we or any future subsidiary guarantor, as applicable, (a) issued the notes or incurred any subsidiary guarantee with the intent of hindering, delaying or defrauding creditors or (b) received less than reasonably equivalent value or fair consideration in return for either issuing the notes or incurring any subsidiary guarantee and, in the case of (b) only, one of the following is also true at the time thereof:
As a general matter, value is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred or a valid antecedent debt is secured or satisfied. A court would likely find that a future subsidiary guarantor did not receive reasonably equivalent value or fair consideration for its subsidiary guarantee to the extent the subsidiary guarantor did not obtain a reasonably equivalent benefit directly or indirectly from the issuance of the notes.
We cannot be certain as to the standards a court would use to determine whether or not we or any future subsidiary guarantor was insolvent at the relevant time or, regardless of the standard that a court uses, whether the notes or any future subsidiary guarantee would be
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subordinated to our or any subsidiary guarantors' other debt. In general, however, a court would deem an entity insolvent if:
If a court were to find that the issuance of the notes or the incurrence of any future subsidiary guarantee was a fraudulent transfer or conveyance, the court could void the payment obligations under the notes or that subsidiary guarantee, could subordinate the notes or that subsidiary guarantee to presently existing and future indebtedness of ours or of the related subsidiary guarantor or could require the holders of the notes to repay any amounts received with respect to that subsidiary guarantee. In the event of a finding that a fraudulent transfer or conveyance occurred, you may not receive any repayment on the notes. Further, the avoidance of the notes could result in an event of default with respect to our and our subsidiaries' other debt that could result in acceleration of that debt.
Finally, as a court of equity, the bankruptcy court may subordinate the claims in respect of the notes to other claims against us under the principle of equitable subordination if the court determines that (1) the holder of notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to our other creditors or conferred an unfair advantage upon the holders of notes and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code.
Risks related to the business
We are exposed to significant financial and capital risk, including changing interest rates, credit spreads and equity prices which may have an adverse effect on sales of our products, profitability, investment portfolio and reported book value per share.
Future changes in interest rates, credit spreads and equity and bond indices may result in fluctuations in the income derived from our investments. These and other factors due to the current economic uncertainty could have a material adverse effect on our financial condition, results of operations or cash flows.
Interest rate and credit spread risk. Our interest rate risk is related to market price and changes in cash flow. Substantial and sustained increases and decreases in market interest rates can materially and adversely affect the profitability of our products, our ability to earn predictable returns, the fair value of our investments and the reported value of stockholders' equity. A rise in interest rates, in the absence of other countervailing changes, will decrease the unrealized gain position of our investment portfolio and may result in an unrealized loss position. With respect to our available for sale fixed maturity securities, such declines in value (net of income taxes and certain adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements) reduce our reported stockholders' equity and book value per share.
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If interest rates rise dramatically within a short period of time, our business may be exposed to disintermediation risk. Disintermediation risk is the risk that our policyholders may surrender all or part of their contracts in a rising interest rate environment, which may require us to sell assets in an unrealized loss position. Alternatively, we may increase crediting rates to retain business and reduce the level of assets that may need to be sold at a loss. However, such action would reduce our investment spread and net income.
We hold an amount of fixed maturity securities that are callable by the issuer prior to maturity, and since 2008, we have received significant amounts of redemption proceeds related to calls of securities issued by United States Government sponsored agencies. We have reinvested the proceeds from these redemptions into new securities issued by such agencies, corporate securities and securities issued by United States municipalities, states and territories. The callable United States Government sponsored agencies that we own / purchase typically provide for 12 months of call protection, after which they may be called on the first anniversary of the issue date, or any semi-annual or annual redemption date thereafter. As such, at any financial reporting date, substantially all of the securities we own issued by United States Government sponsored agencies that are not residential mortgage-backed securities are callable by the respective agency within 12 months.
Due to the long-term nature of our annuity liabilities, sustained declines in long-term interest rates may result in increased redemptions of our fixed maturity securities that are subject to call redemption prior to maturity by the issuer and expose us to reinvestment risk. If we are unable to reinvest the proceeds from such redemptions into investments with credit quality and yield characteristics of the redeemed securities, our net income and overall financial performance may be adversely affected. We have a certain ability to mitigate this risk by lowering crediting rates on our products subject to certain restrictions as discussed below.
Our exposure to credit spreads is related to market price and changes in cash flows related to changes in credit spreads. If credit spreads widen significantly it would probably lead to additional other than temporary impairments. If credit spreads tighten significantly it could result in reduced net investment income associated with new purchases of fixed maturity securities.
Credit risk. We are subject to the risk that the issuers of our fixed maturity securities and other debt securities and borrowers on our commercial mortgages will default on principal and interest payments, particularly if a major downturn in economic activity occurs. An increase in defaults on our fixed maturity securities and commercial mortgage loan portfolios could harm our financial strength and reduce our profitability.
Credit and cash flow assumption risk is the risk that issuers of securities, mortgagees on mortgage loans or other parties, including reinsurers and derivatives counterparties, default on their contractual obligations or experience adverse changes to their contractual cash flow streams. We attempt to minimize the adverse impact of this risk by monitoring portfolio diversification by asset class, creditor, industry, and by complying with investment limitations contained in state insurance laws and regulations as applicable. We also consider all relevant objective information available in estimating the cash flows related to residential and commercial mortgage-backed securities. We monitor and manage exposures to determine whether securities are impaired or loans are deemed uncollectible.
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We use derivative instruments to fund the annual credits on our fixed index annuities. We purchase derivative instruments, consisting primarily of one-year call options, from a number of counterparties. Our policy is to acquire such options only from counterparties rated "A-" or better by a nationally recognized rating agency, and the maximum credit exposure to any single counterparty is subject to concentration limits. In addition, we have entered into credit support agreements which allow us to require posting of collateral by our counterparties to secure their obligations to us under the derivative instruments. If our counterparties fail to honor their obligations under the derivative instruments, our revenues may not be sufficient to fund the annual index credits on our fixed index annuities. Any such failure could harm our financial strength and reduce our profitability.
Liquidity risk. We could have difficulty selling our commercial mortgage loans because they are less liquid than our publicly traded securities. If we require significant amounts of cash on short notice, we may have difficulty selling these loans at attractive prices or in a timely manner, or both.
Fluctuations in interest rates and investment spread could adversely affect our financial condition, results of operations and cash flows.
A key component of our net income is the investment spread. A narrowing of investment spreads may adversely affect operating results. Although we have the right to adjust interest crediting rates (cap, participation or asset fee rates for fixed index annuities) on most products, changes to crediting rates may not be sufficient to maintain targeted investment spreads in all economic and market environments. In general, our ability to lower crediting rates is subject to minimum crediting rates filed with and approved by state regulators. In addition, competition and other factors, including the potential for increases in surrenders and withdrawals, may limit our ability to adjust or maintain crediting rates at levels necessary to avoid the narrowing of spreads under certain market conditions. Our policy structure generally provides for resetting of policy crediting rates at least annually and imposes surrender charges for withdrawals during the first 3 to 17 years a policy is in force.
Managing the investment spread on our fixed index annuities is more complex than it is for fixed rate annuity products. We manage the index-based risk component of our fixed index annuities by purchasing call options on the applicable indices to fund the annual index credits on these annuities and by adjusting the caps, participation rates and asset fees on policy anniversary dates to reflect changes in the cost of such options which varies based on market conditions. The price of such options generally increases with increases in the volatility in both the indices and interest rates, which may either narrow the spread or cause us to lower caps or participation rates. Thus, the volatility of the indices adds an additional degree of uncertainty to the profitability of the index products. We attempt to mitigate this risk by resetting caps, participation rates and asset fees annually on the policy anniversaries.
Persistent environment of low interest rates affects and may continue to negatively affect our results of operations and financial condition.
Prolonged periods of low interest rates may have a negative impact on our ability to sell our fixed index annuities as consumers look for other savings instruments with potentially higher yields to fund retirement. In times of low interest rates, such as we have been experiencing since 2010 and which we expect to continue to experience in 2013, it is difficult to offer attractive rates and benefits to customers while maintaining profitability, which may limit sales growth of interest sensitive products.
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Sustained declines in interest rates may subject us to lower returns on our invested assets, and we have had to and may have to continue to reinvest the cash we receive from premiums and interest or return of principal on our investments in instruments with yields less than those we currently own. This may reduce our future net investment income and compress the spread on our annuity products. Further, borrowers may prepay fixed maturity securities in order to borrow at lower market rates. Any related prepayment fees are recorded in net investment income and may create income statement volatility.
An environment of rising interest rates may materially affect our liquidity and financial condition.
Periods of rising interest rates may cause increased policy surrenders, withdrawals and requests for policy loans on deferred annuity products, as policyholders seek investments with higher returns, commonly referred to as disintermediation. This may lead to net cash outflows and the resulting liquidity demands may require us to sell investment assets when the prices of those assets are adversely affected by the increase in interest rates, which may result in realized investment losses. Further, a portion of our investment portfolio consists of commercial mortgage loans and privately placed securities, which are relatively illiquid, thus increasing our liquidity risk in the event of disintermediation. We may also be required to accelerate the amortization of deferred policy acquisition costs and deferred sales inducements related to surrendered contracts, which would adversely affect our results of operations.
During such times, we may offer higher crediting rates on new sales of annuity products and increase crediting rates on existing annuity products to maintain or enhance product competitiveness. We may not be able to purchase enough higher yielding assets necessary to fund higher crediting rates and maintain our desired spread, which could result in lower profitability on our in force business. In rising interest rate environments, especially when interest rates are rapidly rising, it may be difficult to position our products to offer attractive rates and benefits to customers while maintaining profitability, which may limit sales growth of interest sensitive products.
Our valuation of fixed maturity and equity securities may include methodologies, estimates and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition.
Fixed maturity securities and equity securities are reported at fair value in our consolidated balance sheets. During periods of market disruption including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. Prices provided by independent broker quotes or independent pricing services that are used in the determination of fair value can vary significantly for a particular security. There may be certain asset classes that were trading in active markets with significant observable data that become illiquid due to the current financial environment. As such, valuations may include inputs and assumptions that are less observable or require greater judgment as well as valuation methods that require greater judgment. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported in our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.
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Defaults on commercial mortgage loans and volatility in performance may adversely affect our business, financial condition and results of operations.
Commercial mortgage loans face heightened delinquency and default risk due to recent economic conditions which have had a negative impact on the performance of the underlying collateral, resulting in declining values and an adverse impact on the obligors of such instruments. An increase in the default rate of our commercial mortgage loan investments could have an adverse effect on our business, financial condition and results of operations. In addition, environmental conditions at properties securing our commercial loans may impair the value of our collateral or prevent us from foreclosing on some properties.
In addition, the carrying value of commercial mortgage loans is negatively impacted by such factors. The carrying value of commercial mortgage loans is stated at outstanding principal less any loan loss allowances recognized. Considerations in determining allowances include, but are not limited to, the following: (i) declining debt service coverage ratios and increasing loan to value ratios; (ii) bankruptcy filings of major tenants or affiliates of the borrower on the property; (iii) catastrophic events at the property; and (iv) other subjective events or factors, including whether the terms of the debt will be restructured. There can be no assurance that management's assessment of loan loss allowances on commercial mortgage loans will not change in future periods, which could lead to investment losses.
We remain vulnerable to market uncertainty and continued financial instability of national, state and local governments. Continued difficult conditions in the global capital markets and economy could deteriorate in the near future and affect our financial position and our level of earnings from our operations.
Recovery from the most recent recession in the United States has proven to be slow and long-term. High unemployment rates and lower average household income levels have emerged as continued lagging indicators of a slow economic recovery. The continuing market uncertainty has directly and materially affected our investment portfolio. One of the strategies used by the U.S. government to stimulate the economy has been to keep interest rates low and increase the supply of United States dollars. While these strategies have appeared to be somewhat successful, any future economic downturn or market disruption could negatively impact our ability to invest funds.
Specifically, if market conditions deteriorate in 2013 or beyond:
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The principal sources of our liquidity are annuity deposits, investment income and proceeds from the sale, maturity and call of investments. Additional sources of liquidity in normal markets also include a variety of short and long-term instruments, including long-term debt and capital securities.
Governmental initiatives intended to improve global and local economies that have been adopted may not be effective and, in any event, may be accompanied by other initiatives, including new capital requirements or other regulations, that could materially affect our results of operations, financial condition and liquidity in ways that we cannot predict.
We are subject to extensive laws and regulations that are administered and enforced by a number of different regulatory authorities including state insurance regulators, the National Association of Insurance Commissioners ("NAIC"), the SEC and the New York Stock Exchange. Some of these authorities are or may in the future consider enhanced or new regulatory requirements intended to prevent future economic crises or otherwise assure the stability of institutions under their supervision. These authorities may also seek to exercise their supervisory or enforcement authority in new or more robust ways. All of these possibilities, if they occurred, could affect the way we conduct our business and manage our capital, and may require us to satisfy increased capital requirements, any of which in turn could materially affect our results of operations, financial condition and liquidity.
We face competition from companies that have greater financial resources, broader arrays of products, higher ratings and stronger financial performance, which may impair our ability to retain existing customers, attract new customers and maintain our profitability and financial strength.
We operate in a highly competitive industry. Many of our competitors are substantially larger and enjoy substantially greater financial resources, higher ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships. Our annuity products compete with index, fixed rate and variable annuities sold by other insurance companies and also with mutual fund products, traditional bank investments and other retirement funding alternatives offered by asset managers, banks and broker-dealers. Our insurance products compete with those of other insurance companies, financial intermediaries and other institutions based on a number of factors, including premium rates, policy terms and conditions, service provided to distribution channels and policyholders, ratings by rating agencies, reputation and commission structures.
While we compete with numerous other companies, we view the following as our most significant competitors:
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Our ability to compete depends in part on returns and other benefits we make available to our policyholders through our annuity contracts. We will not be able to accumulate and retain assets under management for our products if our investment results underperform the market or the competition, since such underperformance likely would result in asset withdrawals and reduced sales.
We compete for distribution sources for our products. We believe that our success in competing for distributors depends on our financial strength, the services we provide to and the relationships we develop with these distributors, as well as offering competitive commission structures. Our distributors are generally free to sell products from whichever providers they wish, which makes it important for us to continually offer distributors products and services they find attractive. If our products or services fall short of distributors' needs, we may not be able to establish and maintain satisfactory relationships with distributors of our annuity and life insurance products. Our ability to compete in the past has also depended in part on our ability to develop innovative new products and bring them to market more quickly than our competitors. In order for us to compete in the future, we will need to continue to bring innovative products to market in a timely fashion. Otherwise, our revenues and profitability could suffer.
Our reinsurance program involves risks because we remain liable with respect to the liabilities ceded to reinsurers if the reinsurers fail to meet the obligations assumed by them.
Our life insurance subsidiaries cede certain policies to other insurance companies through reinsurance agreements. American Equity Life has entered into two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust") covering $1.0 billion of policy benefit reserves at March 31, 2013 and into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in Bermuda, covering $1.9 billion of policy benefit reserves at March 31, 2013. Since Athene is an unauthorized reinsurer, the annuity deposits that have been ceded to Athene are held in a trust on a funds withheld basis. The funds withheld are required to remain at a value that is sufficient to support the current balance of policy benefit liabilities of the ceded business on a statutory basis. If the value of the funds withheld would ever reach a point where it is less than the amount of the ceded policy benefit liabilities on a statutory basis, Athene is required to either establish a letter of credit or deposit securities to the funds withheld for the amount of any shortfall. We remain liable with respect to the policy liabilities ceded to EquiTrust and Athene should either fail to meet the obligations assumed by them.
In addition, we have entered into other types of reinsurance contracts including indemnity reinsurance and financing arrangements. Should any of these reinsurers fail to meet the obligations assumed under such contracts, we remain liable with respect to the liabilities ceded.
Further, no assurances can be made that reinsurance will remain continuously available to us to the same extent and on the same terms as are currently available. If we were unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we would have to accept an increase in our net liability exposure, reduce the amount of business we write, or develop other alternatives to reinsurance.
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We may experience volatility in net income due to the application of fair value accounting to our derivative instruments.
All of our derivative instruments, including certain derivative instruments embedded in other contracts, are recognized in the balance sheet at their fair values and changes in fair value are recognized immediately in earnings. This impacts certain revenues and expenses we report for our fixed index annuity business as follows:
The application of fair value accounting for derivatives and embedded derivatives in future periods to our fixed index annuity business may cause substantial volatility in our reported net income.
We may face unanticipated losses if there are significant deviations from our assumptions regarding the probabilities that our annuity contracts will remain in force from one period to the next.
The expected future profitability of our annuity products is based in part upon expected patterns of premiums, expenses and benefits using a number of assumptions, including those related to the probability that a policy or contract will remain in force, or persistency, and mortality. Since no insurer can precisely determine persistency or mortality, actual results could differ significantly from assumptions, and deviations from estimates and assumptions could have a material adverse effect on our business, financial condition or results of operations. For example, actual persistency that is lower than our assumptions could have an adverse impact on future profitability, especially in the early years of a policy or contract primarily because we would be required to accelerate the amortization of expenses we deferred in connection with the acquisition of the policy.
In addition, we set initial crediting rates for our annuity products based upon expected claims and payment patterns, using assumptions for, among other factors, mortality rates of our policyholders. The long-term profitability of these products depends upon how our actual experience compares with our pricing assumptions. For example, if mortality rates are lower than our pricing assumptions, we could be required to make more payments under certain annuity contracts in addition to what we had projected.
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If our estimated gross profits change significantly from initial expectations we may be required to expense our deferred policy acquisition costs and deferred sales inducements in an accelerated manner, which would reduce our profitability.
Deferred policy acquisition costs represent costs that vary with and primarily relate to the acquisition of new business. Deferred sales inducements are contract enhancements such as first-year premium and interest bonuses that are credited to policyholder account balances. These costs are capitalized when incurred and are amortized over the life of the contracts. Current amortization of these costs is generally in proportion to expected gross profits from interest margins and, to a lesser extent, from surrender charges. Unfavorable experience with regard to expected expenses, investment returns, mortality or withdrawals may cause acceleration of the amortization of these costs resulting in an increase of expenses and lower profitability.
If we do not manage our growth effectively, our financial performance could be adversely affected; our historical growth rates may not be indicative of our future growth.
We have experienced rapid growth since our formation in December 1995. We intend to continue to grow by recruiting new independent agents, increasing the productivity of our existing agents, expanding our insurance distribution network, developing new products, expanding into new product lines, and continuing to develop new incentives for our sales agents. Future growth will impose significant added responsibilities on our management, including the need to identify, recruit, maintain and integrate additional employees, including management. There can be no assurance that we will be successful in expanding our business or that our systems, procedures and controls will be adequate to support our operations as they expand. In addition, due to our rapid growth and resulting increased size, it may be necessary to expand the scope of our investing activities to asset classes in which we historically have not invested or have not had significant exposure. If we are unable to adequately manage our investments in these classes, our financial condition or operating results in the future could be less favorable than in the past. Further, we have utilized reinsurance in the past to support our growth. The future availability and cost of reinsurance is uncertain. Our failure to manage growth effectively, or our inability to recruit, maintain and integrate additional qualified employees and independent agents, could have a material adverse effect on our business, financial condition or results of operations. In addition, due to our rapid growth, our historical growth rates are not likely to accurately reflect our future growth rates or our growth potential. We cannot assure you that our future revenues will increase or that we will continue to be profitable.
The loss of key employees could disrupt our operations.
Our success depends in part on the continued service of key executives and our ability to attract and retain additional executives and employees. We do not have employment agreements with our executive officers. The loss of key employees, or our inability to recruit and retain additional qualified personnel, could cause disruption in our business and prevent us from fully implementing our business strategies, which could materially and adversely affect our business, growth and profitability.
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Controls and disaster recovery plans surrounding our information technology could fail or security could be compromised, which could damage our business and adversely affect our financial condition and results of operations.
Our business is highly dependent upon the effective operation of our information technology (IT). We rely on IT throughout our business for a variety of functions, including processing claims and applications, providing information to policyholders and distributors, performing actuarial analyses and maintaining financial records. Despite the implementation of security and back-up measures, our IT may be vulnerable to physical or electronic intrusions, computer viruses or other attacks, programming errors and similar disruptive problems. The failure of controls and/or disaster recovery plans surrounding our IT for any reason could cause significant interruptions to our operations, which could result in a material adverse effect on our business, financial condition or results of operations.
We retain confidential information within our IT, and we rely on sophisticated commercial technologies to maintain the security of those systems. Anyone who is able to circumvent our security measures and penetrate our IT could access, view, misappropriate, alter, or delete any information in the systems, including personally identifiable policyholder information and proprietary business information. In addition, an increasing number of states and foreign countries require that persons be notified if a security breach results in the disclosure of personally identifiable customer information. Any compromise of the security of our computer systems that results in inappropriate disclosure of personally identifiable customer information could damage our reputation in the marketplace, deter people from purchasing our products, subject us to significant civil and criminal liability and require us to incur significant technical, legal and other expenses.
If we are unable to attract and retain national marketing organizations and independent agents, sales of our products may be reduced.
We distribute our annuity products through a variable cost distribution network which includes over 60 national marketing organizations and approximately 24,000 independent agents. We must attract and retain such marketers and agents to sell our products. Insurance companies compete vigorously for productive agents. We compete with other life insurance companies for marketers and agents primarily on the basis of our financial position, support services, compensation and product features. Such marketers and agents may promote products offered by other life insurance companies that may offer a larger variety of products than we do. Our competitiveness for such marketers and agents also depends upon the long-term relationships we develop with them. If we are unable to attract and retain sufficient marketers and agents to sell our products, our ability to compete and our revenues would suffer.
We may require additional capital to support our business and sustained future growth which may not be available when needed or may be available only on unfavorable terms.
Our long-term strategic capital requirements will depend on many factors including the accumulated statutory earnings of our life insurance subsidiaries and the relationship between the statutory capital and surplus of our life insurance subsidiaries and various elements of required capital. To support long-term capital requirements, we may need to increase or maintain the statutory capital and surplus of our life insurance subsidiaries through additional financings, which could include debt, equity, financing arrangements and/or other surplus relief transactions. Adverse market conditions have affected and continue to affect the availability
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and cost of capital. Such financings, if available at all, may be available only on terms that are not favorable to us. If we cannot maintain adequate capital, we may be required to limit growth in sales of new annuity products, and such action could adversely affect our business, financial condition or results of operations. See "Risks related to the notes."
Changes in state and federal regulation may affect our profitability.
We are subject to regulation under applicable insurance statutes, including insurance holding company statutes, in the various states in which our life insurance subsidiaries transact business. Our life insurance subsidiaries are domiciled in New York and Iowa. We are currently licensed to sell our products in 50 states and the District of Columbia. Insurance regulation is intended to provide safeguards for policyholders rather than to protect shareholders of insurance companies or their holding companies. As increased scrutiny has been placed upon the insurance regulatory framework, a number of state legislatures have considered or enacted legislative proposals that alter, and in many cases increase, state authority to regulate insurance companies and holding company systems.
Regulators oversee matters relating to trade practices, policy forms, claims practices, guaranty funds, types and amounts of investments, reserve adequacy, insurer solvency, minimum amounts of capital and surplus, transactions with related parties, changes in control and payment of dividends.
The NAIC and state insurance regulators continually reexamine existing laws and regulations. The NAIC may develop and recommend adoption of new or modify existing model laws and regulations. State insurance regulators may impose those recommended changes, or others, in the future.
Our life insurance subsidiaries are subject to state insurance regulations based on the NAIC's risk-based capital requirements which are intended to be used by insurance regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies for the purpose of initiating regulatory action. Our life insurance subsidiaries also may be required, under solvency or guaranty laws of most states in which they do business, to pay assessments up to certain prescribed limits to fund policyholder losses or liabilities for insolvent insurance companies.
Although the federal government does not directly regulate the insurance business, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation, securities regulation and federal taxation, can significantly affect the insurance business. In addition, legislation has been enacted which could result in the federal government assuming some role in the regulation of the insurance industry.
In July 2010, the Dodd-Frank Act was enacted and signed into law. The Dodd-Frank Act made extensive changes to the laws regulating the financial services industry and requires various federal agencies to adopt a broad range of new rules and regulations. Among other things, the Dodd-Frank Act imposes a comprehensive new regulatory regime on the over-the-counter ("OTC") derivatives marketplace. This legislation subjects swap dealers and "major swap participants" (as defined in the legislation and further clarified by the rulemaking) to substantial supervision and regulation, including capital standards, margin requirements, business conduct standards, recordkeeping and reporting requirements. It also requires central
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clearing for certain derivatives transactions that the U.S. Commodities Futures Trading Commission ("CFTC") determines must be cleared and are accepted for clearing by a "derivatives clearing organization" (subject to certain exceptions) and provides the CFTC with authority to impose position limits across markets. Many of the key concepts, definitions, processes and issues surrounding regulation of the OTC derivatives have been left to the relevant regulators to address and many of these regulations have yet to be proposed. The Dodd-Frank Act and any such regulations may subject us to additional restrictions on our hedging positions which may have an adverse effect on our ability to hedge risks associated with our business, including our fixed index annuity business, or on the cost of our hedging activity.
The Dodd-Frank Act also created a Financial Stability and Oversight Council ("FSOC"). The FSOC may designate by a 2/3 vote whether certain insurance companies and insurance holding companies pose a grave threat to the financial stability of the United States, in which case such companies would become subject to prudential regulation by the Board of Governors of the U.S. Federal Reserve (the "Federal Reserve Board") (including capital requirements, leverage limits, liquidity requirements and examinations). The Federal Reserve Board may limit such company's ability to enter into merger transactions, restrict its ability to offer financial products, require it to terminate one or more activities, or impose conditions on the manner in which it conducts activities.
The Dodd-Frank Act also established a Federal Insurance Office under the U.S. Treasury Department to monitor all aspects of the insurance industry and of lines of business other than certain health insurance, certain long-term care insurance and crop insurance. The director of the Federal Insurance Office has the ability to recommend that an insurance company or an insurance holding company be subject to heightened prudential standards. The Dodd-Frank Act also provides for the pre-emption of state laws in certain instances involving the regulation of reinsurance and other limited insurance matters. The Dodd-Frank Act requires extensive rule-making and other future regulatory action, which in some cases will take a period of years to implement. It is not possible at this time to assess the impact on our business of the establishment of the Federal Insurance Office and the FSOC. However, the regulatory framework at the state and federal level applicable to our insurance products is evolving. The changing regulatory framework could affect the design of such products and our ability to sell certain products. Any changes in these laws and regulations could materially and adversely affect our business, financial condition or results of operations.
We cannot predict the requirements of any regulations ultimately adopted under the Dodd-Frank Act, the effect that such regulations will have on financial markets or on our business, the additional costs associated with compliance with such regulations, or any changes to our operations that may be necessary to comply with the Dodd-Frank Act, any of which could have a material adverse effect on our business, results of operations, cash flows or financial condition.
Changes in federal income taxation laws, including any reduction in individual income tax rates, may affect sales of our products and profitability.
The annuity and life insurance products that we market generally provide the policyholder with certain federal income tax advantages. For example, federal income taxation on any increases in non-qualified annuity contract values (i.e. the "inside build-up") is deferred until it
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is received by the policyholder. With other savings investments, such as certificates of deposit and taxable bonds, the increase in value is generally taxed each year as it is realized. Additionally, life insurance death benefits are generally exempt from income tax.
From time to time, various tax law changes have been proposed that could have an adverse effect on our business, including the elimination of all or a portion of the income tax advantages described above for annuities and life insurance. If legislation were enacted to eliminate all or a portion of the tax deferral for annuities, such a change would have an adverse effect on our ability to sell non-qualified annuities. Non-qualified annuities are annuities that are not sold to a qualified retirement plan.
Beginning in 2013, distributions from non-qualified annuity policies will be considered "investment income" for purposes of the newly enacted Medicare tax on investment income contained in the Health Care and Education Reconciliation Act of 2010. As a result, in certain circumstances a 3.8% tax ("Medicare Tax") may be applied to some or all of the taxable portion of distributions from non-qualified annuities to individuals whose income exceeds certain threshold amounts. This new tax may have an adverse effect on our ability to sell non-qualified annuities to individuals whose income exceeds these threshold amounts.
We face risks relating to litigation, including the costs of such litigation, management distraction and the potential for damage awards, which may adversely impact our business.
We are occasionally involved in litigation, both as a defendant and as a plaintiff. In addition, state regulatory bodies, such as state insurance departments, the SEC, the Financial Industry Regulatory Authority, Inc. ("FINRA"), the Department of Labor and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, the Employee Retirement Income Security Act of 1974, as amended, and laws governing the activities of broker-dealers. Companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims. We are currently a defendant in a purported class action lawsuit involving allegations that generally attack the suitability of sales of deferred annuity products to persons over the age of 65. The plaintiffs in this lawsuit seek rescission and injunctive relief including restitution and disgorgement of profits on behalf of all class members; compensatory damages for breach of fiduciary duty and aiding and abetting of breach of fiduciary duty; unjust enrichment and constructive trust; and other pecuniary damages. See "BusinessLegal proceedings" for more information about this lawsuit.
A downgrade in our credit or financial strength ratings may increase our future cost of capital, reduce new sales, adversely affect relationships with distributors and increase policy surrenders and withdrawals.
Currently, our senior unsecured indebtedness carries a "bbb-" rating from A.M. Best Company, a "BB+" rating from Standard & Poor's and a "BB" rating from Fitch Ratings. Our ability to maintain such ratings is dependent upon the results of operations of our subsidiaries and our financial strength. If we fail to preserve the strength of our balance sheet and to maintain a capital structure that rating agencies deem suitable, it could result in a downgrade of the ratings applicable to our senior unsecured indebtedness. A downgrade would likely reduce the fair value of the common stock and may increase our future cost of capital.
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Financial strength ratings are important factors in establishing the competitive position of life insurance and annuity companies. In recent years, the market for annuities has been dominated by those insurers with the highest ratings. A ratings downgrade, or the potential for a ratings downgrade, could have a number of adverse effects on our business. For example, distributors and sales agents for life insurance and annuity products use the ratings as one factor in determining which insurer's annuities to market. A ratings downgrade could cause those distributors and agents to seek alternative carriers. In addition, a ratings downgrade could materially increase the number of policy or contract surrenders we experience, as well as our ability to obtain reinsurance or obtain reasonable pricing on reinsurance.
Financial strength ratings are measures of an insurance company's ability to meet contractholder and policyholder obligations and generally involve quantitative and qualitative evaluations by rating agencies of a company's financial condition and operating performance. Generally, rating agencies base their ratings upon information furnished to them by the insurer and upon their own investigations, studies and assumptions.
Ratings are based upon factors of concern to agents, policyholders and intermediaries and are not directed toward the protection of investors and are not recommendations to buy, sell or hold securities.
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We estimate that the net proceeds from this offering will be approximately $391.0 million after deducting underwriting discounts and commissions and our estimated expenses related to this offering. We intend to use the net proceeds of this offering (1) to pay the cash consideration required to purchase the September 2015 Notes and the December 2029 Notes tendered in connection with the Exchange Offers for any and all of our outstanding September 2015 Notes and December 2029 Notes if we commence the Exchange Offers, including the payment of any applicable accrued and unpaid interest on such September 2015 Notes and December 2029 Notes, (2) to repay all amounts outstanding under our existing revolving credit facility, (3) to pay related fees and expenses and (4) for general corporate purposes.
Affiliates of J.P. Morgan Securities LLC, Citigroup Global Markets Inc., Deutsche Bank Securities Inc. and SunTrust Robinson Humphrey, Inc., each an underwriter, are lenders under our existing revolving credit facility and will receive a portion of the net proceeds of this offering as repayment of amounts we have borrowed from them. See "Underwriting."
The following table sets forth our estimated sources and uses of funds:
(Dollars in thousands) |
||||||||
---|---|---|---|---|---|---|---|---|
Sources |
Uses |
|||||||
Notes offered hereby |
$400,000 | Repayment of September 2015 |
||||||
|
Notes, December 2029 |
|||||||
|
Notes and cash to balance sheet(1) |
$ | 376,000 | |||||
|
Repay borrowings under our existing revolving credit facility(2) |
15,000 | ||||||
|
Fees and expenses(3) |
$ | 9,000 | |||||
Total sources |
$400,000 | Total uses |
$ | 400,000 | ||||
(1) This figure assumes that all September 2015 Notes and December 2029 Notes are validly tendered (and not validly withdrawn) and accepted for exchange in the Exchange Offers. It includes the assumed aggregate principal amount of such September 2015 Notes and December 2029 Notes validly tendered (and not validly withdrawn) and accepted for exchange, accrued and unpaid interest thereon through the dates of completion of the Exchange Offers, payment of related premiums, fees and expenses and additional cash to our balance sheet. This also assumes the receipt of cash in the settlement of the hedge transactions we entered into at the time we issued the September 2015 Notes. As of March 31, 2013, the hedges had an estimated fair value of $71.2 million. For more information about the hedge transactions, see "Description of certain indebtednessSeptember 2015 notes." No assurance can be given as to the principal amount of September 2015 Notes and December 2029 Notes to be exchanged in the Exchange Offers. Our September 2015 Notes bear interest at a fixed rate of 3.50% per annum and have a final maturity of September 15, 2015. Our December 2029 Notes bear interest at a fixed rate of 5.25% per annum and have a final maturity of December 6, 2029 but may be put to the Company at the option of the holders thereof on December 15, 2014, December 15, 2019 and December 15, 2024. We are under no obligation to commence the Exchange Offers, and this offering of notes is not conditioned upon the commencement or completion of the Exchange Offers. Our decision to commence offers for the September 2015 Notes and December 2029 Notes will depend on market conditions and other factors. In the alternative or in addition, we may use the net proceeds of the offering of the notes to tender for, redeem or repurchase December 2029 Notes or our September 2015 Notes at a later date.
(2) During 2011, we entered into a $160.0 million revolving line of credit agreement for which the revolving period is three years. Based upon our current credit rating, the applicable margin is 2.00% for alternate base rate borrowings and 3.00% for adjusted LIBOR rate borrowings, and the commitment fee is 0.50%. In connection with the redemption of our December 2024 Notes (see "SummaryRecent developments"), on May 14, 2013 we drew $15.0 million on the existing revolving credit facility. As of May 31, 2013, we had outstanding borrowings under our existing revolving credit facility of $15.0 million. See "Description of certain indebtedness" for a detailed description of our existing revolving credit facility.
(3) Fees and expenses include estimated underwriting discounts related to the offering of notes pursuant to this prospectus supplement and estimated expenses associated therewith.
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The following table sets forth, as of March 31, 2013, our consolidated cash and cash equivalents and capitalization:
See "Use of proceeds." You should read this table in conjunction with "Use of proceeds," "Selected historical financial information," "Management's discussion and analysis of financial condition and results of operations," "Description of other indebtedness" and our consolidated financial statements and notes thereto, included elsewhere in this prospectus supplement.
|
As of March 31, 2013 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
Actual |
As adjusted for the redemption of the December 2024 notes(1) |
As further adjusted for the offering of the notes(2) |
|||||||
Cash and cash equivalents |
$ | 882,097 | $ | 868,854 | $ | 1,244,854 | ||||
Debt: |
||||||||||
September 2015 Notes(3) |
$ | 179,849 | $ | 179,849 | $ | 179,849 | ||||
December 2029 Notes(4) |
104,951 | 104,951 | 104,951 | |||||||
December 2024 Notes |
28,243 | | | |||||||
Notes offered hereby(5) |
| | 400,000 | |||||||
Subordinated debentures(6) |
245,913 | 245,913 | 245,913 | |||||||
Revolving credit facility, due 2014(7) |
| 15,000 | | |||||||
Total debt |
558,956 | 545,713 | 930,713 | |||||||
Stockholders' equity: |
||||||||||
Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding62,783,971 shares (excluding 4,779,535 treasury shares) |
62,784 | 63,001 | 63,001 | |||||||
Additional paid-in capital |
504,470 | 506,017 | 506,017 | |||||||
Unallocated common stock held by ESOP239,799 shares |
(2,266 | ) | (2,266 | ) | (2,266 | ) | ||||
Accumulated other comprehensive income |
661,663 | 661,663 | 661,663 | |||||||
Retained earnings |
503,578 | 503,477 | 503,477 | |||||||
Total stockholders' equity |
1,730,229 | 1,731,892 | 1,731,892 | |||||||
Total capitalization |
$ | 2,289,185 | $ | 2,277,605 | $ | 2,662,605 | ||||
(1) Adjusted for the redemption of the December 2024 Notes during the second quarter of 2013. See "SummaryRecent developments."
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(2) Adjusted for (i) the redemption of the December 2024 Notes, (ii) the sale of the notes, after deducting the underwriting discount and our estimated expenses related to the offering and (iii) the use of a portion of the net proceeds of the offering of the notes to repay outstanding amounts under our existing revolving credit facility but without giving effect to the Exchange Offers or the use of any remaining net proceeds of the offering of the notes. See footnotes (3) and (4) below. Pending the application of the remaining net proceeds of the offering of the notes, those net proceeds are included in cash and cash equivalents in the table. To the extent we commence and complete the Exchange Offers, our cash and cash equivalents would decrease in an amount equal to the aggregate principal amount of any September 2015 Notes or December 2029 Notes validly tendered (and not validly withdrawn) and accepted for exchange, together with accrued and unpaid interest thereon through the dates of completion of the Exchange Offers and payment of related premiums, fees and expenses. We would also use cash received in the settlement of the hedge transactions we entered into at the time we issued the September 2015 Notes to complete the Exchange Offers. As of March 31, 2013, the hedges had an estimated fair value of $71.2 million. For more information about the hedge transactions, see "Description of certain indebtednessSeptember 2015 notes." We are under no obligation to commence the Exchange Offers. As described in "Use of proceeds," in the alternative or in addition, we may use the net proceeds of the offering of the notes to tender for, redeem or repurchase September 2015 Notes or December 2029 Notes at a later date. If we choose to use the net proceeds to tender for, redeem or repurchase September 2015 Notes or December 2029 Notes at a later date, that portion of the net proceeds could remain on our balance sheet as cash for an unspecified period of time.
(3) Represents the principal amount of $200.0 million of 3.5% Convertible Senior Notes due 2015 less the unamortized discount of $20.2 million. To the extent we commence and complete the 2015 Exchange Offer, the principal amount of our September 2015 Notes would decrease in an amount equal to the aggregate principal amount of any September 2015 Notes validly tendered (and not validly withdrawn) and accepted for exchange.
(4) Represents the principal amount of $115.8 million of 5.25% Contingent Convertible Senior Notes due 2029, less the unamortized discount of $10.9 million. To the extent we commence and complete the 2029 Exchange Offer, the principal amount of our December 2029 Notes would decrease in an amount equal to the aggregate principal amount of any December 2029 Notes validly tendered (and not validly withdrawn) and accepted for exchange.
(5) Represents the principal amount of the notes.
(6) Represents the principal amount of $269.6 million of our subordinated debentures, less the unamortized discount of $23.7 million, which are described in "Description of certain indebtednessSubordinated debentures."
(7) In connection with the redemption of the December 2024 Notes, on May 14, 2013, we drew $15.0 million on our existing revolving credit facility. As of May 31, 2013, we had outstanding borrowings under our existing revolving credit facility of $15.0 million.
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Ratios of earnings to fixed charges
The following table sets forth our ratio of earnings to fixed charges for the periods indicated:
|
Three months ended March 31, |
Year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
Ratio of consolidated earnings to fixed charges |
1.1x | 1.1x | 1.1x | 1.1x | 1.1x | 1.2x | 1.3x | |||||||||||||||
Ratio of consolidated earnings to fixed charges, both excluding interest sensitive and index product benefits and amortization of deferred sales inducements |
4.8x | 2.5x | 3.0x | 3.9x | 2.7x | 3.7x | 2.6x | |||||||||||||||
The ratio of earnings to fixed charges is calculated by dividing consolidated earnings, as defined, by fixed charges, as defined. For this purpose, "consolidated earnings" consists of consolidated income/(loss) from continuing operations before income taxes plus fixed charges, and "fixed charges" consist of interest-sensitive and index product benefits and amortization of deferred sales inducements, interest expense, both expensed and capitalized (including amortization of debt discounts and deferred loan costs), and the representative interest portion of rent expense.
The ratio of consolidated earnings to fixed charges, both excluding interest-sensitive and index product benefits and amortization of deferred sales inducements, is calculated by dividing consolidated earnings, as defined, by fixed charges, as defined. For this purpose, "consolidated earnings" consists of consolidated income/(loss) from continuing operations before income taxes plus fixed charges, excluding interest-sensitive and index product benefits (which consists of interest we credit to policyholders) and amortization of deferred sales inducements. "Fixed charges" consist of interest expense, both expensed and capitalized (including amortization of debt discounts and deferred loan costs), and the representative interest portion of rent expense. The 3.0x ratio shown for the year ended December 31, 2012 updates and supersedes the 4.1x ratio set forth for that period in Exhibit 12.1 to our 2012 Form 10-K incorporated by reference into this prospectus supplement.
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Selected historical financial information
The following table sets forth our summary consolidated financial information as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008 and as of and for the three months ended March 31, 2013 and 2012. The information as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008 was derived from our audited annual consolidated financial statements. The information as of and for the three months ended March 31, 2013 and 2012 was derived from our unaudited interim consolidated financial statements and includes, in the opinion of management, all normal and recurring adjustments necessary to present fairly the information for such periods. The results for past periods are not necessarily indicative of results that may be expected for future periods. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013. You should read the following summary consolidated financial information together with "Management's discussion and analysis of financial condition and results of operations" and our audited consolidated financial statements and unaudited consolidated financial statements, including the related notes, included elsewhere in this prospectus supplement.
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|
Three months ended March 31, |
Year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
|
(unaudited) |
|
|
|
|
|
||||||||||||||||
Consolidated statements of operations data: |
||||||||||||||||||||||
Revenues: |
||||||||||||||||||||||
Traditional life insurance premiums |
$ | 2,698 | $ | 3,222 | $ | 12,877 | $ | 12,151 | $ | 11,982 | $ | 12,654 | $ | 12,512 | ||||||||
Annuity product charges |
21,481 | 19,393 | 89,006 | 76,189 | 69,075 | 63,358 | 52,671 | |||||||||||||||
Net investment income |
329,690 | 326,910 | 1,286,923 | 1,218,780 | 1,036,106 | 932,172 | 822,077 | |||||||||||||||
Change in fair value of derivatives |
373,962 | 259,161 | 221,138 | (114,728 | ) | 168,862 | 216,896 | (372,009 | ) | |||||||||||||
Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses |
10,585 | (6,076 | ) | (6,454 | ) | (18,641 | ) | 23,726 | 51,279 | 5,555 | ||||||||||||
Net OTTI losses recognized in operations |
(3,237 | ) | (2,881 | ) | (14,932 | ) | (33,976 | ) | (23,867 | ) | (86,771 | ) | (192,648 | ) | ||||||||
Gain (loss) on extinguishment of debt |
| | | | (292 | ) | (675 | ) | 9,746 | |||||||||||||
Total revenues |
735,179 | 599,729 | 1,588,558 | 1,139,775 | 1,285,592 | 1,188,913 | 337,904 | |||||||||||||||
Benefits and expenses: |
||||||||||||||||||||||
Insurance policy benefits and change in future policy benefits |
1,735 | 2,117 | 8,075 | 7,870 | 8,251 | 8,889 | 8,972 | |||||||||||||||
Interest sensitive and index product benefits |
225,809 | 139,123 | 818,087 | 775,757 | 733,218 | 347,883 | 205,131 | |||||||||||||||
Amortization of deferred sales inducements |
28,831 | 16,710 | 87,157 | 71,781 | 59,873 | 39,999 | 30,705 | |||||||||||||||
Change in fair value of embedded derivatives |
363,272 | 359,066 | 286,899 | (105,194 | ) | 130,950 | 529,508 | (210,753 | ) | |||||||||||||
Interest expense on notes payable and subordinated debentures |
10,257 | 10,581 | 41,937 | 45,610 | 37,031 | 30,672 | 39,218 | |||||||||||||||
Interest expense on amounts due under repurchase agreements |
| | | 30 | | 534 | 8,207 | |||||||||||||||
Amortization of deferred policy acquisition costs |
46,230 | 34,284 | 164,919 | 143,478 | 136,388 | 88,009 | 126,738 | |||||||||||||||
Other operating costs and expenses |
19,520 | 21,713 | 95,495 | 67,529 | 114,615 | 57,255 | 52,633 | |||||||||||||||
Total benefits and expenses |
695,654 | 583,594 | 1,502,569 | 1,006,861 | 1,220,326 | 1,102,749 | 260,851 | |||||||||||||||
Income before income taxes |
39,525 | 16,135 | 85,989 | 132,914 | 65,266 | 86,164 | 77,053 | |||||||||||||||
Income tax expense |
13,494 | 5,664 | 28,191 | 46,666 | 22,333 | 17,634 | 61,106 | |||||||||||||||
Net income |
$ | 26,031 | $ | 10,471 | $ | 57,798 | $ | 86,248 | $ | 42,933 | $ | 68,530 | $ | 15,947 | ||||||||
Non-GAAP financial measures (unaudited)(a): |
||||||||||||||||||||||
Reconciliation of net income to Operating Income: |
||||||||||||||||||||||
Net income |
$ | 26,031 | $ | 10,471 | $ | 57,798 | $ | 86,248 | $ | 42,933 | $ | 68,530 | $ | 15,947 | ||||||||
Net realized (gains) losses and net OTTI losses on investments, net of offsets(b) |
(2,804 | ) | 3,547 | 8,648 | 18,354 | 379 | (1,339 | ) | 92,524 | |||||||||||||
Net effect of derivatives and embedded derivatives, net of offsets(b) |
10,237 | 15,742 | 34,161 | 29,051 | 38,167 | 29,952 | (31,038 | ) | ||||||||||||||
Convertible debt extinguishment, net of income taxes |
| | | | 171 | 687 | (5,702 | ) | ||||||||||||||
Effect of counterparty default, net of offsets |
| | | | | 3,948 | 741 | |||||||||||||||
Litigation reserve, net of offsets(b) |
| | 9,580 | | 27,297 | | | |||||||||||||||
Operating Income(c) |
$ | 33,464 | $ | 29,760 | $ | 110,187 | $ | 133,653 | $ | 108,947 | $ | 101,778 | $ | 72,472 | ||||||||
S-48
|
As of and for the three months ended March 31, | As of and for the year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
|
(unaudited) |
|
|
|
|
|
||||||||||||||||
Consolidated balance sheet data: |
||||||||||||||||||||||
Total investments |
$ | 29,245,856 | $ | 24,034,739 | $ | 27,537,210 | $ | 24,383,451 | $ | 19,816,931 | $ | 15,374,110 | $ | 12,719,605 | ||||||||
Total assets |
36,852,969 | 33,038,533 | 35,133,478 | 30,874,719 | 26,426,763 | 21,312,004 | 17,081,740 | |||||||||||||||
Policy benefit reserves |
32,937,308 | 29,255,621 | 31,773,988 | 28,118,716 | 23,655,807 | 19,336,221 | 15,809,539 | |||||||||||||||
Notes payable |
313,043 | 300,567 | 309,869 | 297,608 | 330,835 | 316,468 | 247,750 | |||||||||||||||
Subordinated debentures |
245,913 | 268,574 | 245,869 | 268,593 | 268,435 | 268,347 | 268,209 | |||||||||||||||
Accumulated other comprehensive income (loss) ("AOCI") |
661,663 | 408,747 | 686,807 | 457,229 | 81,820 | (30,456 | ) | (147,376 | ) | |||||||||||||
Total stockholders' equity |
1,730,229 | 1,373,584 | 1,720,237 | 1,408,679 | 938,047 | 754,623 | 496,844 | |||||||||||||||
Statutory financial data: |
||||||||||||||||||||||
Life subsidiaries' statutory capital and surplus and asset valuation reserve |
1,769,118 | 1,676,839 | 1,741,637 | 1,655,205 | 1,456,679 | 1,239,674 | 1,011,682 | |||||||||||||||
Life subsidiaries' statutory net gain from operations before income taxes and realized capital gains (losses) |
44,403 | 35,632 | 182,057 | 344,538 | 322,133 | 253,146 | 129,046 | |||||||||||||||
Life subsidiaries' statutory net income (loss) |
25,441 | 12,034 | 79,644 | 167,925 | 172,865 | 116,895 | (7,073 | ) | ||||||||||||||
Other data (unaudited): |
||||||||||||||||||||||
Adjusted Debt to total capitalization ratio(d) |
19.3% | 22.1% | 20.0% | 22.3% | 26.2% | 27.7% | 29.5% | |||||||||||||||
Debt to total capitalization ratio(d) |
34.3% | 37.1% | 35.0% | 37.3% | 41.2% | 42.7% | 44.5% | |||||||||||||||
Risk-based capital (RBC) ratio(e) |
330% | 343% | 332% | 346% | 339% | 337% | 347% | |||||||||||||||
Ratio of consolidated earnings to fixed charges(f) |
1.1x | 1.1x | 1.1x | 1.1x | 1.1x | 1.2x | 1.3x | |||||||||||||||
Ratio of consolidated earnings to fixed charges, both excluding interest-sensitive and index product benefits and amortization of deferred sales inducements(f) |
4.8x | 2.5x | 3.0x | 3.9x | 2.7x | 3.7x | 2.6x | |||||||||||||||
|
Twelve months ended March 31, |
Year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
Other data (unaudited) (continued): |
||||||||||||||||||||||
Operating Income Return on Average Equity Excluding Average AOCI(g) |
11.2% | 14.3% | 11.1% | 14.8% | 13.3% | 14.2% | 11.1% | |||||||||||||||
Net Income Return on Average Equity Excluding Average AOCI(g) |
7.2% | 7.0% | 5.8% | 9.5% | 5.2% | 9.6% | 2.4% | |||||||||||||||
(a) In addition to net income, we have consistently utilized Operating Income, a non-GAAP financial measure commonly used in the life insurance industry, as an economic measure to evaluate our financial performance. Operating Income equals net income adjusted to eliminate the impact of net realized gains (losses) on investments, including net OTTI losses recognized in operations and related deferred tax asset valuation allowance, fair value changes in derivatives and embedded derivatives, (gain) loss on extinguishment of convertible debt, the counterparty default on expired call options and litigation reserves. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of Operating Income together with net income provides information that may enhance an investor's understanding of our underlying results and profitability.
Operating Income is not a substitute for net income determined in accordance with GAAP. The adjustments made to derive Operating Income are important to understanding our overall results from operations, and, if evaluated without proper context, Operating Income possesses material limitations:
S-49
Therefore, our management and board of directors also separately review net realized investment gains (losses) and analyses of our net investment income, including impacts related to OTTI write-downs, in connection with their review of our investment portfolio. In addition, our management and board of directors examine net income as part of their review of our overall financial results. The adjustments made to net income to arrive at Operating Income for the three months ended March 31, 2013 and 2012 and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008 are set forth in the table above.
(b) The adjustments to net income to arrive at Operating Income are presented net of related adjustments to amortization of deferred sales inducements ("DSI") and deferred policy acquisition costs ("DAC") and net of income taxes, as set forth in the table below (unaudited):
|
Three months ended March 31, |
Year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
Net realized (gains) losses and net OTTI losses on investments, net of offsets: |
||||||||||||||||||||||
Net realized (gains) losses on investments, including OTTI |
$ | (7,348 | ) | $ | 8,957 | $ | 21,386 | $ | 52,617 | $ | 141 | $ | 35,492 | $ | 187,094 | |||||||
Amortization of DAC and DSI |
3,093 | (3,450 | ) | (7,989 | ) | (24,117 | ) | 446 | (19,056 | ) | (97,223 | ) | ||||||||||
Income taxes |
1,451 | (1,960 | ) | (4,749 | ) | (10,146 | ) | (208 | ) | (17,775 | ) | 2,653 | ||||||||||
|
$ | (2,804 | ) | $ | 3,547 | $ | 8,648 | $ | 18,354 | $ | 379 | $ | (1,339 | ) | $ | 92,524 | ||||||
Net effect of derivatives and embedded derivatives, net of offsets: |
||||||||||||||||||||||
Change in fair value of derivatives and embedded derivatives |
$ | 35,680 | $ | 59,050 | $ | 151,695 | $ | 125,721 | $ | 146,682 | $ | 130,467 | $ | (106,168 | ) | |||||||
Amortization of DAC and DSI |
(20,240 | ) | (34,663 | ) | (98,306 | ) | (80,858 | ) | (87,545 | ) | (84,093 | ) | 58,124 | |||||||||
Income taxes |
(5,203 | ) | (8,645 | ) | (19,228 | ) | (15,812 | ) | (20,970 | ) | (16,422 | ) | 17,006 | |||||||||
|
$ | 10,237 | $ | 15,742 | $ | 34,161 | $ | 29,051 | $ | 38,167 | $ | 29,952 | $ | (31,038 | ) | |||||||
Litigation reserve, net of offsets: |
||||||||||||||||||||||
Litigation reserve recorded in other operating costs |
$ | | $ | | $ | 17,532 | $ | | $ | 48,000 | $ | | $ | | ||||||||
Amortization of DAC and DSI |
| | (2,656 | ) | | (5,712 | ) | | | |||||||||||||
Income taxes |
| | (5,296 | ) | | (14,991 | ) | | | |||||||||||||
|
$ | | $ | | $ | 9,580 | $ | | $ | 27,297 | $ | | $ | | ||||||||
(c) Operating Income reflects the following expenses and adjustments for the periods indicated:
(d) The Adjusted Debt to total capitalization ratio is calculated by dividing Adjusted Debt by total capitalization excluding AOCI. Adjusted Debt is the sum of notes payable and the portion of the total subordinated debentures payable to statutory trusts outstanding (qualifying trust preferred securities) that exceeds 15% of total capitalization excluding AOCI. The debt to total capitalization ratio is calculated by dividing the sum of notes payable and subordinated debentures by total capitalization excluding AOCI.
S-50
In addition to total debt in accordance with GAAP, we use Adjusted Debt, a non-GAAP financial measure, as an alternate measure of our leverage. Adjusted Debt is the sum of notes payable and the portion of total subordinated debentures payable to statutory trusts outstanding that exceeds 15% of total capitalization excluding AOCI. Because rating agencies and certain analysts and investors give equity credit to a portion of our subordinated debentures in analyzing our leverage and financial condition, we use Adjusted Debt as a supplemental measure in evaluating our leverage.
Total capitalization excluding AOCI, a non-GAAP financial measure, is the sum of total debt and total stockholders' equity minus AOCI. Since AOCI fluctuates from quarter to quarter due to unrealized changes in the fair value of available for sale investments, we believe that total capitalization excluding AOCI provides useful supplemental information in evaluating our total capitalization.
In addition, our existing revolving credit facility requires us to maintain a ratio of Adjusted Debt to total capitalization excluding AOCI below a specified level. We also use these measures, therefore, in evaluating our leverage and ongoing compliance with our existing revolving credit facility.
The table below demonstrates how we calculate adjusted debt and sets forth a reconciliation of our adjusted debt to our total debt for the periods indicated, as well as the components for the calculation of the debt to total capitalization ratio and the Adjusted Debt to total capitalization ratio (unaudited):
|
As of March 31, | As of December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
Notes payable |
$ | 313,043 | $ | 300,567 | $ | 309,869 | $ | 297,608 | $ | 330,835 | $ | 316,468 | $ | 247,750 | ||||||||
Portion of total subordinated debentures payable to statutory trusts outstanding that exceeds 15% of total capitalization excluding AOCI (A) |
1,785 | 38,477 | 7,494 | 40,945 | 50,110 | 62,863 | 94,182 | |||||||||||||||
Adjusted Debt |
314,828 | 339,044 | 317,363 | 338,553 | 380,945 | 379,331 | 341,932 | |||||||||||||||
Remaining portion of total subordinated debentures (B) |
244,128 | 230,097 | 238,375 | 227,648 | 218,325 | 205,484 | 174,027 | |||||||||||||||
Total subordinated debentures (A+B) |
245,913 | 268,574 | 245,869 | 268,593 | 268,435 | 268,347 | 268,209 | |||||||||||||||
Total debt |
558,956 | 569,141 | 555,738 | 566,201 | 599,270 | 584,815 | 515,959 | |||||||||||||||
Total stockholders' equity |
1,730,229 | 1,373,584 | 1,720,237 | 1,408,679 | 938,047 | 754,623 | 496,844 | |||||||||||||||
Total capitalization |
2,289,185 | 1,942,725 | 2,275,975 | 1,974,880 | 1,537,317 | 1,339,438 | 1,012,803 | |||||||||||||||
AOCI |
661,663 | 408,747 | 686,807 | 457,229 | 81,820 | (30,456 | ) | (147,376 | ) | |||||||||||||
Total capitalization excluding AOCI |
$ | 1,627,522 | $ | 1,533,978 | $ | 1,589,168 | $ | 1,517,651 | $ | 1,455,497 | $ | 1,369,894 | $ | 1,160,179 | ||||||||
(e) The risk-based capital (RBC) ratio is calculated by dividing total adjusted statutory capital by regulatory required capital. Total adjusted statutory capital is calculated based on a formula specified by the NAIC that includes American Equity Life's statutory capital and surplus and asset valuation reserve and certain other adjustments. For more information about American Equity Life's statutory capital and surplus, see Note 12 to our audited consolidated financial statements included in this prospectus supplement.
The table below sets forth the components for our calculation of the RBC ratio (unaudited):
|
As of March 31, | As of December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
American Equity Life's statutory capital and surplus and asset valuation reserve |
$ | 1,769,201 | $ | 1,676,839 | $ | 1,741,638 | $ | 1,655,205 | $ | 1,456,679 | $ | 1,239,674 | $ | 1,011,684 | ||||||||
Regulatory required capital |
536,501 | 488,808 | 524,928 | 479,023 | 430,064 | 367,517 | 291,888 | |||||||||||||||
(f) For information on how we calculate these ratios, see "Ratio of earnings to fixed charges" in this prospectus supplement.
(g) Return on Average Equity Excluding Average AOCI is calculated by dividing net income and Operating Income for the trailing twelve months by average equity excluding AOCI. We use Return on Average Equity Excluding Average AOCI as a supplemental measure of evaluating the net income and Operating Income we generate as a percentage of our equity. In that calculation, we use average equity over the applicable twelve-month period to mitigate the effects of fluctuations in our equity during that period. In addition, we exclude AOCI because AOCI fluctuates from quarter to quarter due to unrealized changes in the fair value of available for sale investments. We believe that Return on Average Equity Excluding Average AOCI provides useful supplemental information regarding our financial performance to analysts and investors.
S-51
The table demonstrates how we calculate Average Equity Excluding Average AOCI for the periods indicated (unaudited):
|
Twelve months ended March 31, |
Year ended December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
2013 |
2012 |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||||||
Average Stockholders' Equity: |
||||||||||||||||||||||
Average equity including average AOCI |
$ | 1,551,907 | $ | 1,167,380 | $ | 1,564,458 | $ | 1,173,363 | $ | 846,335 | $ | 625,734 | $ | 559,085 | ||||||||
Average AOCI |
535,205 | 238,163 | 572,018 | 269,525 | 25,682 | (88,916 | ) | (93,152 | ) | |||||||||||||
Average equity excluding average AOCI |
1,016,702 | 929,217 | 992,440 | 903,838 | 820,653 | 714,650 | 652,237 | |||||||||||||||
Net income |
73,358 | 65,376 | 57,798 | 86,248 | 42,933 | 68,530 | 15,947 | |||||||||||||||
Operating Income |
113,891 | 132,839 | 110,187 | 133,653 | 108,947 | 101,778 | 72,472 | |||||||||||||||
Return on Average Equity Excluding Average AOCI: |
||||||||||||||||||||||
Net income |
7.2% | 7.0% | 5.8% | 9.5% | 5.2% | 9.6% | 2.4% | |||||||||||||||
Operating Income |
11.2% | 14.3% | 11.1% | 14.8% | 13.3% | 14.2% | 11.1% | |||||||||||||||
S-52
Management's discussion and analysis
of financial condition and results of operations
Management's discussion and analysis reviews our consolidated financial position at December 31, 2012 and 2011, our unaudited consolidated financial position at March 31, 2013, our consolidated results of operations for the three years in the period ended December 31, 2012, and our unaudited consolidated results of operations for the three months ended March 31, 2013 and 2012, and where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with our audited and unaudited consolidated financial statements, the notes thereto and selected consolidated financial data, included elsewhere in this prospectus supplement.
Our business and profitability
We are a leader in the development and sale of fixed index and fixed rate annuity products. We sell fixed index and fixed rate annuities and life insurance in all 50 states and the District of Columbia. Our business consists primarily of the sale of fixed index and fixed rate annuities, and our annuity sales for each of the year ended December 31, 2012 and the twelve months ended March 31, 2013, before coinsurance, were $3.9 billion. Our strategy is focused on growing our annuity business and earning returns by managing investment spreads and investment risk. We had an investment portfolio of $29.2 billion as of March 31, 2013. For the year ended December 31, 2012, we generated total revenues of $1,588.6 million, Operating Income of $110.2 million and net income of $57.8 million. See "Summary consolidated financial information" for a reconciliation of Operating Income, which is a non-GAAP financial measure, to net income.
We underwrite our fixed annuity and life insurance products through our wholly-owned life insurance subsidiaries, American Equity Investment Life Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York and Eagle Life Insurance Company ("Eagle Life"). We market those products through a distribution network of approximately 60 national marketing organizations and, through them, approximately 24,000 independent agents.
We specialize in the sale of individual annuities (primarily deferred annuities), and, to a lesser extent, we also sell life insurance policies. Under U.S. generally accepted accounting principles ("GAAP"), premium collections for deferred annuities are reported as deposit liabilities instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liabilities for policyholder account balances and not as expenses.
Sources of revenues and components of expenses
Our sources of revenues for products accounted for as deposit liabilities are net investment income, surrender and other charges deducted from the account balances of policyholders, net realized gains (losses) on investments and changes in fair value of derivatives. Components of expenses for products accounted for as deposit liabilities are interest-sensitive and index product benefits (primarily interest credited to account balances), changes in fair value of embedded derivatives, amortization of deferred sales inducements and deferred policy acquisition costs, other operating costs and expenses and income taxes.
S-53
Business drivers
Our business model contemplates continued growth in invested assets and Operating Income while maintaining a high quality investment portfolio that will not experience significant losses from impairments of invested assets. Growth in invested assets is predicated on a continuation of our high sales achievements of the last four years while at the same time maintaining a high level of retention of the funds received. The economic and personal investing environments continue to be conducive for high sales levels as retirees and others look to put their money in instruments that will protect their principal and provide them with consistent cash flow sources in their retirement years. We are committed to maintaining a high quality investment portfolio with limited exposure to below investment grade securities and other riskier assets.
Our profitability depends in large part upon the amount of assets under our management, investment spreads we earn on our policyholder account balances, our ability to manage our investment portfolio to maximize returns and minimize risks such as interest rate changes and defaults or impairment of investments, our ability to manage interest rates credited to policyholders and costs of the options purchased to fund the annual index credits on our fixed index annuities, our ability to manage the costs of acquiring new business (principally commissions to agents and bonuses credited to policyholders) and our ability to manage our operating expenses.
Managing our investment spread
Earnings from products accounted for as deposit liabilities are primarily generated from the excess of net investment income earned over the interest credited or the cost of providing index credits to the policyholder, or the "investment spread." Our investment spread is summarized as follows:
|
Three months ended March 31, |
Year ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2013 |
2012 |
2012 |
2011 |
2010 |
|||||||||
Average yield on invested assets |
5.01% | 5.61% | 5.28% | 5.80% | 6.06% | |||||||||
Aggregate cost of money |
2.33% | 2.68% | 2.58% | 2.77% | 2.91% | |||||||||
Aggregate investment spread |
2.68% | 2.93% | 2.70% | 3.03% | 3.15% | |||||||||
Impact of: |
||||||||||||||
Investment yieldadditional prepayment income |
0.08% | 0.07% | 0.06% | % | (0.04)% | |||||||||
Cost of money benefit of over hedging |
0.03% | 0.01% | 0.01% | 0.06% | 0.10% | |||||||||
Our investment spread in 2012 and the first quarter of 2013 has been impacted by shortfalls in investment income from excess liquidity resulting from a lag in the reinvestment of proceeds of government agency bonds called for redemption. The callable government agency securities have been a cornerstone of our investment portfolio since our formation. Through the years they have provided very acceptable yields that met our spread requirements without any risk-based capital charges. We have been through several cycles of calls on these securities and each time we have reinvested a portion of the call redemption proceeds into new callable government agency securities. This kept cash balances low but perpetuated the call risk. However, in the current interest rate environment, we have been reluctant to reinvest the call
S-54
redemption proceeds in government agency securities and only purchased $948.9 million in 2012 compared to $4.3 billion in calls. Consequently, we have been managing excess cash and other short-term investments throughout 2012 and into the first quarter of 2013. We ended the first quarter of 2013 with $1.3 billion in excess cash and other short-term investments compared to $2.2 billion at the end of 2012. Our progress in reducing the excess cash and other short-term investments is likely to be interrupted in the second quarter of 2013 as we had $678 million in government agency securities called in April. While high levels of excess cash and other short-term investments may persist for several more quarters, the average quarterly balances should decline in second half of 2013 due to reinvestment of year end cash and other short-term investments into longer term securities. Subsequent to the April calls, there is no exposure to callable securities for the remainder of 2013. See "Results of operations for the three months ended March 31, 2013 and 2012Net investment income" and "Results of operations for the three years ended December 31, 2012Net investment income" for additional information regarding our excess liquidity.
The cost of money for fixed index annuities and average crediting rates for fixed rate annuities are computed based upon policyholder account balances and do not include the impact of amortization of deferred sales inducements. See "Critical accounting policiesDeferred policy acquisition costs and deferred sales inducements." With respect to our fixed index annuities, the cost of money includes the average crediting rate on amounts allocated to the fixed rate strategy, expenses we incur to fund the annual index credits and, where applicable, minimum guaranteed interest credited. Proceeds received upon expiration or early termination of call options purchased to fund annual index credits are recorded as part of the change in fair value of derivatives, and are largely offset by an expense for interest credited to annuity policyholder account balances. See "Critical accounting policiesPolicy liabilities for fixed index annuities" and "Financial conditionDerivative instruments."
In response to the continuing low interest rate environment, we implemented reductions of policyholder crediting rates for new annuities and existing annuities in the fourth quarter of 2011. Rates on new sales were reduced 0.40% - 0.50% beginning with applications received after October 7, 2011. Renewal rate adjustments began taking effect on November 15, 2011 and continued to take effect on the policy anniversary dates over the twelve months following that date. Rates on new sales were again reduced by approximately 0.25% beginning with applications received after December 5, 2012. As of March 31, 2013, our base rates for new sales ranged from 1.10% to 1.25%, and our base rates for renewals ranged from 1.60% to 3.15%, subject to minimum guaranteed rates. Our 2013 and 2012 spread results reflect the benefit from these reductions; however, the reductions in cost of money were partially offset by continued lower yields available on investments including reinvestment of proceeds from calls of the callable bonds in our investment portfolio. We expect this low interest rate environment to extend at least through 2014 as the United States Federal Reserve has publicly stated their current policy of maintaining downward pressure on longer-term interest rates to support mortgage markets and help make broader financial conditions more accommodative.
S-55
Results of operations for the three months ended March 31, 2013 and 2012
Annuity deposits by product type collected during the three months ended March 31, 2013 and 2012, were as follows:
|
Three months ended March 31, |
||||||
---|---|---|---|---|---|---|---|
Product type |
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Fixed index annuities: |
|||||||
Index strategies |
$ | 604,641 | $ | 488,126 | |||
Fixed strategy |
243,129 | 289,354 | |||||
|
847,770 | 777,480 | |||||
Fixed rate annuities: |
|||||||
Single-year rate guaranteed |
19,910 | 34,487 | |||||
Multi-year rate guaranteed |
47,256 | 121,665 | |||||
Single premium immediate annuities |
14,980 | 45,813 | |||||
|
82,146 | 201,965 | |||||
Total before coinsurance ceded |
929,916 | 979,445 | |||||
Coinsurance ceded |
42,607 | 98,779 | |||||
Net after coinsurance ceded |
$ | 887,309 | $ | 880,666 | |||
Annuity deposits before coinsurance ceded decreased 5% during the first quarter of 2013 compared to the same period in 2012. We attribute this in part to the low interest rate environment which appears to have made prospective policyholders less willing to commit funds to fixed index annuities. We attribute the continuing significant sales of our products to factors including the highly competitive rates of our products, our continued strong relationships with our national marketing organizations and field force of licensed, independent insurance agents, the increased attractiveness of safe money products in volatile markets, lower interest rates on competing products, such as bank certificates of deposit, and product enhancements, including a new generation of guaranteed income withdrawal benefit riders. The extent to which this trend will be sustained in future periods is uncertain.
Net income, in general, has been positively impacted by the growth in the volume of business in force and the investment spread earned on this business. The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 13% to $28.1 billion during first quarter of 2013 compared to $24.8 billion for the same period in 2012. Our investment spread measured in dollars was $161.1 million during first quarter of 2013 compared to $154.9 million during the same period in 2012. As previously mentioned, our investment spread has been negatively impacted by both the extended low interest rate environment and our excess liquidity due to calls of our United States government agency securities (see "Net investment income" below).
Operating Income, a non-GAAP financial measure (see reconciliation to net income in "SummarySummary consolidated financial data"), increased 12% to $33.5 million in the first quarter of 2013 compared to $29.8 million for the same period in 2012.
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In addition to net income, we have consistently utilized Operating Income, a non-GAAP financial measure commonly used in the life insurance industry, as an economic measure to evaluate our financial performance. Operating Income equals net income adjusted to eliminate the impact of net realized gains (losses) on investments including net other than temporary impairment ("OTTI") losses recognized in operations and fair value changes in derivatives and embedded derivatives. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of Operating Income together with net income provides information that may enhance an investor's understanding of our underlying results and profitability.
Operating Income is not a substitute for net income determined in accordance with GAAP. The adjustments made to derive Operating Income are important to understanding our overall results from operations and, if evaluated without proper context, Operating Income possesses material limitations. As an example, we could produce a low level of net income in a given period, despite strong operating performance, if in that period we experience significant net realized losses from our investment portfolio. We could also produce a high level of net income in a given period, despite poor operating performance, if in that period we generate significant net realized gains from our investment portfolio. As an example of another limitation of Operating Income, it does not include the decrease in cash flows expected to be collected as a result of credit loss from OTTI. Therefore, our management and board of directors also separately review net realized investment gains (losses) and analyses of our net investment income, including impacts related to OTTI write-downs, in connection with their review of our investment portfolio. In addition, our management and board of directors examine net income as part of their review of our overall financial results.
The adjustments made to net income to arrive at Operating Income for the three months ended March 31, 2013 and 2012 are set forth in the table that follows:
|
Three months ended March 31, |
||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Reconciliation of net income to Operating Income: |
|||||||
Net income |
$ | 26,031 | $ | 10,471 | |||
Net realized (gains) losses and net OTTI losses on investments, net of offsets |
(2,804 | ) | 3,547 | ||||
Net effect of derivatives and embedded derivatives, net of offsets |
10,237 | 15,742 | |||||
Operating Income |
33,464 | 29,760 | |||||
Net realized gains/losses on investments and net impairment losses recognized in operations fluctuate from period to period based upon changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments. The amounts disclosed in the reconciliation above are net of related adjustments in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes.
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Amounts attributable to the fair value accounting for fixed index annuity derivatives and embedded derivatives fluctuate from year to year based upon changes in the fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in the interest rates used to discount the embedded derivative liability. The amounts disclosed in the reconciliation above are net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and income taxes. The significant changes in the impact from the item disclosed in the reconciliation above relate primarily to changes in the interest rates used to discount the embedded derivative liabilities.
Revenues
Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for lifetime income benefit riders) increased 11% to $21.5 million in the first quarter of 2013 compared to $19.4 million for the same period in 2012. These increases were primarily attributable to increases in the amounts of fees assessed for lifetime income benefit riders, which were $10.0 million in the first quarter of 2013 compared to $7.7 million for the same period in 2012. The increases in these fees are attributable to a larger volume of business in force subject to the fees. The weighted average per policy fees assessed for lifetime income benefit riders was 0.53% and 0.51% for the three months ended March 31, 2013 and 2012, respectively. Fund values on policies with lifetime income benefit riders being assessed these fees increased from $1.5 billion during the three months ended March 31, 2012 to $1.9 billion during the three months ended March 31, 2013. See "Interest sensitive and index product benefits" below for the corresponding expense recognized on lifetime income benefit riders. Surrender charges decreased by $0.2 million for the three months ended March 31, 2013. This decrease was primarily attributable to reductions in withdrawals subject to a surrender charge. Withdrawals from annuity and single premium universal life policies subject to surrender charges were $78.0 million in the first quarter of 2013 compared to $89.8 million for the same period in 2012. The lower amount of withdrawals was influenced by the continuing low interest rate environment. The average surrender charge collected on withdrawals subject to a surrender charge was 14.5% in the first quarter of 2013 compared to 12.9% for the same period in 2012.
Net investment income increased 1% to $329.7 million in the first quarter of 2013 compared to $326.9 million for the same period in 2012. This increase was principally attributable to the growth in our annuity business and a corresponding increase in our invested assets. Average invested assets excluding derivative instruments (on an amortized cost basis) increased 13% to $26.4 billion for the first quarter of 2013 compared to $23.4 billion for the same period in 2012. The average yield earned on average invested assets was 5.01% for the first quarter of 2013 compared to 5.61% for the same period in 2012.
The decrease in yield earned on average invested assets was attributable to lower yields on investments purchased in 2012 and the first quarter of 2013. In addition, net investment income and average yield were negatively impacted by a lag in reinvestment of proceeds from bonds called for redemption during the periods into new assets causing excess liquidity held in low yielding cash and other short-term investments. The average balance held in cash and short-term investments was $1.8 billion and $0.8 billion for the three months ended March 31, 2013 and 2012, respectively. The average yield on our cash and short-term investments during the first quarter of 2013 and 2012 was 0.33% and 0.11%, respectively. Additionally, net investment income and average yield were positively impacted by prepayment and fee income
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received, resulting in additional net investment income of $5.0 million and $3.8 million for the three months ended March 31, 2013 and 2012, respectively.
Change in fair value of derivatives (principally call options purchased to fund annual index credits on fixed index annuities) is affected by the performance of the indices upon which our options are based and the aggregate cost of options purchased. The components of change in fair value of derivatives are as follows:
|
Three months ended March 31, |
||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Call options: |
|||||||
Gain (loss) on option expiration |
$ | 58,826 | $ | (26,153 | ) | ||
Change in unrealized gain/loss |
285,828 | 267,673 | |||||
2015 notes hedges |
28,098 | 16,751 | |||||
Interest rate swaps |
733 | 890 | |||||
Interest rate caps |
477 | | |||||
|
$ | 373,962 | $ | 259,161 | |||
The differences between the change in fair value of derivatives between periods for call options are primarily due to the performance of the indices upon which our call options are based. A substantial portion of our call options are based upon the S&P 500 Index with the remainder based upon other equity and bond market indices. The range of index appreciation (after applicable caps, participation rates and asset fees) for options expiring during the three months ended March 31, 2013 and 2012 is as follows:
|
Three months ended March 31, |
||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
S&P 500 Index: |
|||||||
Point-to-point strategy |
1.5% - 8.1% | 0.0% - 7.0% | |||||
Monthly average strategy |
0.0% - 8.0% | 0.0% - 10.2% | |||||
Monthly point-to-point strategy |
0.0% - 11.4% | 0.0% - 3.3% | |||||
Fixed income (bond index) strategies |
0.1% - 8.0% | 4.0% - 10.0% | |||||
The change in fair value of derivatives is also influenced by the aggregate costs of options purchased. The aggregate cost of options has increased primarily due to an increased amount of fixed index annuities in force. The aggregate cost of options is also influenced by the amount of policyholder funds allocated to the various indices and market volatility which affects option pricing. See "Critical accounting policiesPolicy liabilities for fixed index annuities."
Concurrently with the issuance of our 3.5% Convertible Senior Notes Due 2015 (the "2015 notes"), we entered into hedge transactions (the "2015 notes hedges") to provide the cash needed to meet our cash obligations in excess of the principal amount of the 2015 notes upon conversion of the 2015 notes. The fair value of the 2015 notes hedges changes based upon
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changes in the price of our common stock, interest rates, stock price volatility, dividend yield and the time to expiration of the 2015 notes hedges. Similarly, the fair value of the conversion option obligation to the holders of the 2015 notes changes based upon these same factors and the conversion option obligation is accounted for as an embedded derivative liability with changes in fair value reported in "Change in fair value of embedded derivatives." The amount for the change in fair value of the 2015 notes hedges equals the amount of the change in the related embedded derivative liabilities, and there is an offsetting expense in the change in fair value of embedded derivatives. See Note 9 to our audited consolidated financial statements for a discussion of the 2015 notes hedges.
Net realized gains (losses) on investments, excluding OTTI losses include gains and losses on the sale of securities and impairment losses on mortgage loans on real estate, which fluctuate from year to year due to changes in the interest rate and economic environment and the timing of the sale of investments, as well as gains (losses) recognized on real estate owned due to any sales and impairments on long-lived assets. The components of net realized gains (losses) on investments are set forth in the table that follows:
|
Three months ended March 31, |
||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Available for sale fixed maturity securities: |
|||||||
Gross realized gains |
$ | 13,015 | $ | 1,018 | |||
Gross realized losses |
(2,187 | ) | (296 | ) | |||
|
10,828 | 722 | |||||
Equity securities: |
|||||||
Gross realized gains |
| 562 | |||||
Other investments: |
|||||||
Gain on sale of real estate |
589 | 1,445 | |||||
Loss on sale of real estate |
(466 | ) | | ||||
Impairment losses on real estate |
| (974 | ) | ||||
|
123 | 471 | |||||
Mortgage loans on real estate: |
|||||||
Increase in allowance for credit losses |
(366 | ) | (7,831 | ) | |||
|
$ | 10,585 | $ | (6,076 | ) | ||
See "Financial conditionInvestmentsMortgage loans on real estate" for additional discussion of allowance for credit losses on mortgage loans on real estate.
Net OTTI losses recognized in operations increased to $3.2 million in the first quarter of 2013 compared to $2.9 million for the same period in 2012. See "Financial ConditionInvestments" and Note 3 to our unaudited financial statements, included elsewhere in this prospectus supplement, for additional discussion of write-downs of securities for other than temporary impairments.
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Benefits and expenses
Interest sensitive and index product benefits increased to $225.8 million in the first quarter of 2013 compared to $139.1 million for the same period in 2012. The components of interest credited to account balances are summarized as follows:
|
Three months ended March 31, | ||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Index credits on index policies |
$ | 135,341 | $ | 50,658 | |||
Interest credited (including changes in minimum guaranteed interest for fixed index annuities) |
79,618 | 80,512 | |||||
Living income benefit rider |
10,850 | 7,953 | |||||
|
$ | 225,809 | $ | 139,123 | |||
The amount of index credits were attributable to changes in the appreciation of the underlying indices (see discussion above under "Change in fair value of derivatives") and the amount of funds allocated by policyholders to the respective index options. Total proceeds received upon expiration of the call options purchased to fund the annual index credits was $135.2 million for the three months ended March 31, 2013, compared to $50.9 million for the same period in 2012. The decrease in interest credited was due to a decrease in the average rate credited to the amount of annuity liabilities outstanding receiving a fixed rate of interest. The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 13% to $28.1 billion in the first quarter of 2013 compared to $24.8 billion during the same period in 2012. The increases in benefits recognized for living income benefit riders were due to increases in the number of policies with lifetime income benefit riders and correlate to the increase in fees discussed in "Annuity product charges."
Amortization of deferred sales inducements increased 73% to $28.8 million in the first quarter of 2013 compared to $16.7 million for the same period in 2012. In general, amortization of deferred sales inducements has been increasing each period due to the growth in our annuity business and the deferral of sales inducements incurred with respect to sales of premium bonus annuity products. The initial annuity deposit on these products is increased at issuance by a specified premium bonus ranging from 3% to 10%. Bonus products represented 97% of our net annuity deposits during the three months ended March 31, 2013, compared to 96% during the same period in 2012. The anticipated increase in amortization from these factors has been affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business, amortization associated with net realized gains (losses) on investments and net OTTI losses recognized in operations. Fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments, including the embedded derivative liabilities in our fixed index annuity contracts. The change in fair value of the embedded derivatives does not correspond to the change in fair value of the derivatives (purchased call options) because the purchased call options are one-year options while the options valued in the fair value of embedded derivatives cover the
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expected lives of the contracts, which typically exceeds ten years. Amortization of deferred sales inducements is summarized as follows:
|
Three months ended March 31, | ||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Amortization of deferred sales inducements before gross profit adjustments |
$ | 36,278 | $ | 33,468 | |||
Gross profit adjustments: |
|||||||
Fair value accounting for derivatives and embedded derivatives |
(8,771 | ) | (15,420 | ) | |||
Net realized gains (losses) on investments and net OTTI losses recognized in operations |
1,324 | (1,338 | ) | ||||
Amortization of deferred sales inducements after gross profit adjustments |
$ | 28,831 | $ | 16,710 | |||
Change in fair value of embedded derivatives primarily relates to fixed index annuity embedded derivatives and resulted from (i) changes in the expected index credits on the next policy anniversary dates, which are related to the change in fair value of the call options acquired to fund these index credits discussed above in "Change in fair value of derivatives"; (ii) changes in discount rates used in estimating our liability for policy growth; and (iii) the growth in the host component of the policy liability. See "Critical accounting policiesPolicy liabilities for fixed index annuities." The primary reasons for the decrease in the change in fair value of the fixed index annuity embedded derivatives during the first quarter of 2013 was an increase in the discount rate used in estimating our liability for policy growth offset by increases in the expected index credits that resulted from increases in the fair value of the call options acquired to fund these index credits. The changes for the three months ended March 31, 2013 and 2012 also include increases of $28.1 million and $16.8 million, respectively, in the fair value of the 2015 notes embedded conversion derivative. As discussed previously, these amounts were offset by comparable increases in the fair value of the 2015 notes hedges.
Interest expense on subordinated debentures decreased 16% to $3.0 million in the first quarter of 2013 compared to $3.6 million for the same period in 2012. The decrease is attributable to a decrease in the weighted average interest rates on outstanding subordinated debentures, which were 4.80% and 5.24% for the three months ended March 31, 2013 and 2012, respectively, and due to the redemption of $22 million principal amount of our 8% Convertible Junior Subordinated Debentures in July 2012. The weighted average interest rate fluctuates from period to period because $169.6 million principal amount of the subordinated debentures has floating rates of interest based upon the three-month London Interbank Offered Rate plus an applicable margin. See "Financial conditionLiabilities."
Amortization of deferred policy acquisition costs increased 35% to $46.2 million in the first quarter of 2013 compared to $34.3 million for the same period in 2012. In general, amortization of deferred policy acquisition costs has been increasing each period due to the growth in our annuity business and the deferral of policy acquisition costs incurred with respect to sales of annuity products. The anticipated increase in amortization from these factors has been affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business, amortization associated
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with net realized losses on investments and net OTTI losses recognized in operations. As discussed above, fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our fixed index annuity contracts.
Amortization of deferred policy acquisition costs is summarized as follows:
|
Three months ended March 31, | ||||||
---|---|---|---|---|---|---|---|
|
2013 |
2012 |
|||||
|
(Dollars in thousands) |
||||||
Amortization of deferred policy acquisition costs before gross profit adjustments |
$ | 55,930 | $ | 55,639 | |||
Gross profit adjustments: |
|||||||
Fair value accounting for derivatives and embedded derivatives |
(11,469 | ) | (19,243 | ) | |||
Net realized gains (losses) on investments and net OTTI losses recognized in operations |
1,769 | (2,112 | ) | ||||
Amortization of deferred policy acquisition costs after gross profit adjustments |
$ | 46,230 | $ | 34,284 | |||
Other operating costs and expenses decreased 10% to $19.5 million in the first quarter of 2013 compared to $21.7 million for the same period in 2012. The decrease was primarily due to decreases of $1.5 million in various state taxes, assessments and fees that vary period to period based in part on the amount of annuity deposits we collect and the amount and timing of assessments and fees we are charged by states in which we do business.
Income tax expense increased to $13.5 million in the first quarter of 2013 compared to $5.7 million for the same period in 2012. The change in income tax expense was primarily due to changes in income before income taxes. Income tax expense and the resulting effective tax rate are based upon two components of income before income taxes ("pretax income") that are taxed at different tax rates. Life insurance income is generally taxed at an effective rate of approximately 35.6% reflecting the absence of state income taxes for substantially all of the states that the life insurance subsidiaries do business in. The income for the parent company and other non-life insurance subsidiaries is generally taxed at an effective tax rate of 41.5% reflecting the combined federal / state income tax rates. The effective tax rates resulting from the combination of the income tax provisions for the life / non-life sources of income (loss) vary from period to period based primarily on the relative size of pretax income (loss) from the two sources. The effective tax rate for the three months ended March 31, 2013 and 2012 was 34.1% and 35.1%, respectively. The decrease in the effective tax rate in 2013 is due to sources of net investment income that are exempt from Federal income tax.
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Results of operations for the three years ended December 31, 2012
Annuity deposits by product type collected during 2012, 2011 and 2010, were as follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
Product type |
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Fixed index annuities: |
||||||||||
Index strategies |
$ | 2,225,902 | $ | 2,839,295 | $ | 2,401,891 | ||||
Fixed strategy |
1,208,324 | 1,377,987 | 1,551,007 | |||||||
|
3,434,226 | 4,217,282 | 3,952,898 | |||||||
Fixed rate annuities: |
||||||||||
Single-year rate guaranteed |
98,821 | 169,304 | 160,077 | |||||||
Multi-year rate guaranteed |
249,228 | 397,925 | 384,116 | |||||||
Single premium immediate annuities |
164,657 | 305,603 | 171,628 | |||||||
|
512,706 | 872,832 | 715,821 | |||||||
Total before coinsurance ceded |
3,946,932 | 5,090,114 | 4,668,719 | |||||||
Coinsurance ceded |
203,734 | 326,531 | 478,963 | |||||||
Net after coinsurance ceded |
$ | 3,743,198 | $ | 4,763,583 | $ | 4,189,756 | ||||
Annuity deposits before coinsurance ceded decreased 22% during 2012 compared to 2011 and increased 9% during 2011 compared to 2010. We attribute the relatively slower sales in part to the low interest rate environment which appears to have made prospective policyholders less willing to commit funds to fixed index annuities. We also attribute the 2012 decrease in annuity deposits to certain competitors who were more aggressive in their product pricing in the first half of 2012. The extent to which this will continue to affect our annuity deposits is uncertain. In addition, sales for 2011 benefited from higher demand in advance of a rate decrease implemented during that period. We attribute the continuing significant sales of our products to factors including the highly competitive rates of our products, our continued strong relationships with our national marketing organizations and field force of licensed, independent insurance agents, the increased attractiveness of safe money products in volatile markets, lower interest rates on competing products such as bank certificates of deposit and product enhancements including a new generation of guaranteed income withdrawal benefit riders. The extent to which this trend will be sustained in future periods is uncertain.
We entered into a $50 million "financing" reinsurance transaction in the first quarter of 2011 to help support sales growth in 2011 that provided an initial after tax statutory surplus benefit of $31.8 million. We believe our existing statutory capital and surplus and the statutory surplus we expect to generate internally through statutory earnings will support a higher level of new business growth than in previous years. However, while we have the capital resources to accept more business than was sold in 2012 and 2011, our capacity is not unlimited and sales growth must be matched with available resources to maintain desired financial strength ratings from credit rating agencies and in particular, A.M. Best Company. Should sales growth accelerate to levels that cannot be supported by internal capital generation, we would intend to obtain capital from external sources to facilitate such growth.
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Net income, in general, has been positively impacted by the growth in the volume of business in force and the investment spread earned on this business. The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 16% to $26.0 billion for the year ended December 31, 2012 compared to $22.4 billion in 2011 and 24% for the year ended December 31, 2011 compared to $18.1 billion in 2010. Our investment spread measured in dollars was $596.7 million, $585.9 million and $502.9 million for the years ended December 31, 2012, 2011 and 2010. As previously mentioned, our investment spread in 2012 has been negatively impacted by both the extended low interest rate environment and our excess liquidity due to calls of our United States government agency securities (see "Net investment income").
Net income was negatively affected by the prospective adoption on January 1, 2012, of an accounting standards update that defines the types of costs that are deferrable with policy acquisition. This resulted in $9.1 million of costs that were expensed as incurred during the year ended December 31, 2012, which under the accounting method in effect for the years ended December 31, 2011 and 2010 would have been capitalized as deferred policy acquisition costs and amortized in future periods. This change in accounting, including the impact on related amortization expense, resulted in a $5.8 million decrease in net income for the year ended December 31, 2012.
We periodically revise the key assumptions used in the calculation of amortization of deferred policy acquisition costs and deferred sales inducements retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of realized investment gains and losses) to be realized from a group of products are revised. The impact of unlocking on our results of operations, including the impact of account balance true ups and adjustments to future period assumptions for interest margins and surrenders, was as follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Increased (decreased) amortization of deferred sales inducements |
$ | (199 | ) | $ | (4,979 | ) | $ | 270 | ||
Increased (decreased) amortization of deferred policy acquisition costs |
3,738 | (9,132 | ) | 1,683 | ||||||
Increased (decreased) net income |
(2,243 | ) | 9,088 | (1,261 | ) | |||||
Net income for 2012 was positively impacted by a revision of assumptions used in determining liabilities for living income benefit riders. This revision was consistent with unlocking for deferred policy acquisition costs and deferred sales inducements. The impact decreased interest sensitive and index product benefits by $2.2 million and increased net income by $1.4 million for the year ended December 31, 2012.
In 2012, based upon developments in mediation discussions concerning potential settlement terms of a purported class action lawsuit, we established an estimated litigation liability of $17.5 million ($9.6 million after offsets for income taxes and adjustments to deferred policy acquisition costs and deferred sales inducements). See "BusinessLegal proceedings." In 2010, we recognized the cost to settle a class action lawsuit which included a settlement benefit to
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policyholders and attorneys' fees and expenses that aggregated $48 million. This decreased net income for the year ended December 31, 2010 by $27.3 million.
During 2011, we discovered a prior period error related to policy benefit reserves for our single premium immediate annuity products. We evaluated the materiality of the error from qualitative and quantitative perspectives and concluded it was not material to any prior periods. The correction of the error in 2011 is not material to the results of operations for the year ended December 31, 2011. Accordingly, we made an adjustment in the first quarter of 2011 which resulted in a decrease of policy benefit reserves and a decrease in interest sensitive and index product benefits of $4.2 million. On an after-tax basis, the adjustment resulted in a $2.7 million increase in net income for the year December 31, 2011.
Operating Income, a non-GAAP financial measure (see reconciliation to net income in "SummarySummary consolidated financial data") decreased 18% to $110.2 million in 2012 and increased 23% to $133.7 million in 2011 from $108.9 million in 2010.
The adjustments made to net income to arrive at Operating Income for the three months ended March 31, 2013 and 2012 are set forth in the table that follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Reconciliation of net income to Operating Income: |
||||||||||
Net income |
$ | 57,798 | $ | 86,248 | $ | 42,933 | ||||
Net realized (gains) losses and net OTTI losses on investments, net of offsets |
8,648 | 18,354 | 379 | |||||||
Net effect of derivatives and embedded derivatives, net of offsets |
34,161 | 29,051 | 38,167 | |||||||
Convertible debt extinguishment, net of taxes |
| | 171 | |||||||
Litigation reserve, net of offsets |
9,580 | | 27,297 | |||||||
Operating Income |
$ | 110,187 | $ | 133,653 | $ | 108,947 | ||||
Net realized gains (losses) on investments and net impairment losses recognized in operations fluctuate from year to year based upon changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments. The amounts disclosed in the reconciliation above are net of related reductions in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes.
Amounts attributable to the fair value accounting for fixed index annuity derivatives and embedded derivatives fluctuate from year to year based upon changes in the fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in the interest rates used to discount the embedded derivative liability. The amounts disclosed in the reconciliation above are net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and income taxes. The significant changes in the impact from the item disclosed in the reconciliation above relate primarily to changes in the interest rates used to discount the embedded derivative liabilities.
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The impact of unlocking on Operating Income, including the impact of account balance true ups and adjustments to future period assumptions for interest margins and surrenders, was as follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Increased (decreased) amortization of deferred sales inducements |
$ | 2,451 | $ | (7,301 | ) | $ | 305 | |||
Increased (decreased) amortization of deferred policy acquisition costs |
7,288 | (12,106 | ) | 1,430 | ||||||
Increased (decreased) Operating Income |
(6,285 | ) | 12,498 | (1,120 | ) | |||||
The revision of assumptions in 2012 used in determining liabilities for living income benefit riders had the same effect on Operating Income as it had on net income as discussed under "Net income" above.
Revenues
Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for living income benefit riders) increased 17% to $89.0 million in 2012 and 10% to $76.2 million in 2011 from $69.1 million in 2010. These increases were primarily attributable to increases in the amount of fees assessed for lifetime income benefit riders which were $43.8 million, $26.2 million and $13.5 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increases in these fees are attributable to a larger volume of business in force subject to the fee. The weighted average per policy fees assessed for lifetime income benefit riders were 0.54%, 0.47% and 0.45% during 2012, 2011 and 2010, respectively. Fund values on policies with lifetime income benefit riders being assessed these fees grew from $3.0 billion in December 31, 2010 to $5.6 billion in December 31, 2011 and to $8.1 billion in December 31, 2012. See "Interest sensitive and index product benefits" below for corresponding expense recognized on lifetime income benefit riders. Surrender charges decreased by $4.6 million and $5.6 million for the years ended December 31, 2012 and 2011, respectively. These decreases was primarily attributable to reductions in withdrawals subject to a surrender charge. Withdrawals from annuity and single premium universal life policies subject to surrender charges were $335.6 million, $378.9 million and $418.9 million for the years ended December 31, 2012, 2011 and 2010, respectively. The average surrender charge collected on withdrawals subject to a surrender charge was 13.4%, 13.1% and 13.2% for the years ended December 31, 2012, 2011 and 2010, respectively. Withdrawals have decreased in 2012 and 2011 due to the low interest rate environment which has made new annuity policies or other retirement savings products less attractive.
Net investment income increased 6% to $1,286.9 million in 2012 and 18% to $1,218.8 million in 2011 from $1,036.1 million in 2010. The increases were principally attributable to the growth in our annuity business and corresponding increases in our invested assets. Average invested assets excluding derivative instruments (on an amortized cost basis) increased 16% to $24.4 billion in 2012 and 23% to $21.0 billion in 2011 compared to $17.1 billion in 2010. The average yield earned on average invested assets was 5.28%, 5.80% and 6.06% for 2012, 2011 and 2010, respectively.
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The decrease in yield earned on average invested assets in 2012 and 2011 was attributable to lower yields on investments purchased in those periods. In addition, net investment income and average yield were negatively impacted by a lag in reinvestment of proceeds from bonds called for redemption during 2012, 2011 and 2010 into new assets causing excess liquidity held in low yielding cash and other short-term investments. The average cash and other short-term investments held was $1.7 billion, $387.0 million and $428.8 million in 2012, 2011 and 2010. The average yield on our cash and short-term investments in 2012 was 0.25%. Additionally, net investment income and average yield was positively impacted by prepayment and fee income received, resulting in additional net investment income in 2012 and 2010 of $14.8 million and $7.4 million, respectively. There was no prepayment and fee income impact for 2011.
Change in fair value of derivatives (principally call options purchased to fund annual index credits on fixed index annuities) is affected by the performance of the indices upon which our options are based and the aggregate cost of options purchased. The components of change in fair value of derivatives are as follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Call options: |
||||||||||
Gain on option expiration |
$ | 80,782 | $ | 155,359 | $ | 208,881 | ||||
Change in unrealized gain (loss) |
147,828 | (248,941 | ) | (67,078 | ) | |||||
2015 notes hedges |
(2,488 | ) | (21,002 | ) | 29,595 | |||||
Interest rate swaps |
(4,261 | ) | (144 | ) | (2,536 | ) | ||||
Interest rate caps |
(723 | ) | | | ||||||
|
$ | 221,138 | $ | (114,728 | ) | $ | 168,862 | |||
The differences between the change in fair value of derivatives between years for call options are primarily due to the performance of the indices upon which our call options are based. A substantial portion of our call options are based upon the S&P 500 Index with the remainder based upon other equity and bond market indices. The range of index appreciation (after applicable caps, participation rates and asset fees) for options expiring during these years is as follows:
|
Year ended December 31, | |||||
---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||
S&P 500 Index: |
||||||
Point-to-point strategy |
0.0% - 12.8% | 0.0% - 25.0% | 1.9% - 68.6% | |||
Monthly average strategy |
0.0% - 19.3% | 0.0% - 15.5% | 0.4% - 51.2% | |||
Monthly point-to-point strategy |
0.0% - 18.0% | 0.0% - 16.5% | 0.0% - 23.7% | |||
Fixed income (bond index) strategies |
1.6% - 10.0% | 1.3% - 10.0% | 0.0% - 13.5% | |||
Actual amounts credited to policyholder account balances may be less than the index appreciation due to contractual features in the fixed index annuity policies (caps, participation rates, and asset fees) which allow us to manage the cost of the options purchased to fund the annual index credits. The change in fair value of derivatives is also influenced by the aggregate costs of options purchased. The aggregate cost of options has increased primarily due to an
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increased amount of fixed index annuities in force. The aggregate cost of options is also influenced by the amount of policyholder funds allocated to the various indices and market volatility which affects option pricing. Costs for options purchased during the year ended December 31, 2012 and 2011 decreased compared to prior years due to lower volatility in equity markets and adjustments to caps, participation rates and asset fees.
Concurrently with the issuance of the 2015 notes, we entered into the 2015 notes hedges to provide the cash needed to meet our cash obligations in excess of the principal amount of the 2015 notes upon conversion of the 2015 notes. The amount for the change in fair value of the 2015 notes hedges equals the amount for the change in the related embedded derivative liabilities and there is an offsetting expense in the change in fair value of embedded derivatives.
Net realized gains (losses) on investments, excluding OTTI losses include gains and losses on the sale of securities and impairment losses on mortgage loans on real estate, which fluctuate from year to year due to changes in the interest rate and economic environment and the timing of the sale of investments, as well as gains (losses) recognized on real estate owned due to any sales and impairments on long-lived assets. The components of net realized gains (losses) on investments are set forth in the table that follows:
|
Year ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2012 |
2011 |
2010 |
|||||||
|
(Dollars in thousands) |
|||||||||
Available for sale fixed maturity securities: |
||||||||||
Gross realized gains |
$ | 10,906 | $ | 12,614 | $ | 27,755 | ||||
Gross realized losses |
(562 | ) | (1,423 | ) | (2,575 | ) | ||||
|
10,344 | 11,191 | 25,180 | |||||||
Equity securities: |
||||||||||
Gross realized gains |
562 | 966 | 14,384 | |||||||
Gross realized losses |
| | (71 | ) | ||||||
|
562 | 966 | 14,313 | |||||||
Mortgage loans on real estate: |
||||||||||
Increase in allowance for credit losses |
(16,832 | ) | (30,770 | ) | (15,225 | ) | ||||
Other investments: |
||||||||||
Gains on sale of real estate |
5,149 | 377 | | |||||||
Impairment losses |
(5,677 | ) | (405 | ) | (542 | ) | ||||
|
(528 | ) | (28 | ) | (542 | ) | ||||
|
$ | (6,454 | ) | $ |