UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa |
|
42-1447959 |
(State of Incorporation) |
|
(I.R.S. Employer Identification No.) |
|
|
|
5000 Westown Parkway, Suite 440 |
|
50266 |
West Des Moines, Iowa |
|
(Zip Code) |
(Address of principal executive offices) |
|
|
|
|
|
Registrants telephone number, including area code |
|
(515) 221-0002 |
|
|
(Telephone) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
|
Name of each exchange on which registered |
Common Stock, par value $1 |
|
New York Stock Exchange |
|
|
|
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1
Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer o |
|
Accelerated filer x |
|
Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)
Yes o No x
APPLICABLE TO CORPORATE ISSUERS:
Shares of common stock outstanding at October 31, 2007: 56,885,720
EXPLANATORY NOTE
We are amending our Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 as filed with the Securities and Exchange Commission on November 2, 2007 to restate our consolidated financial statements as of September 30, 2007 and for the three and nine months ended September 30, 2007 and the related disclosures. We identified an error in the calculation of the policy benefit reserves for our index annuities in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. See Note 2, Restatement of Unaudited Consolidated Financial Statements of the notes to the unaudited consolidated financial statements for a discussion of the effect of the restatements. We have also restated our unaudited consolidated financial statements as of June 30, 2007 and for the three and six months ended June 30, 2007 and the related disclosures for this error. This Form 10-Q/A does not reflect events that occurred after the November 2, 2007 filing date of the Quarterly Report on Form 10-Q that was originally filed or modify or update the disclosures presented in the original Form 10-Q, except to reflect the matters described above. Other events occurring after the filing of the original Form 10-Q or other disclosures necessary to reflect subsequent events have been addressed in our reports filed with the Securities and Exchange Commission subsequent to the filing of the original Form 10-Q.
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
|
|
September 30, |
|
|
|
||
|
|
2007 |
|
December 31, |
|
||
|
|
(Unaudited) |
|
2006 |
|
||
|
|
As Restated |
|
|
|
||
|
|
|
|
|
|
||
Assets |
|
|
|
|
|
||
Investments: |
|
|
|
|
|
||
Fixed maturity securities: |
|
|
|
|
|
||
Available for sale, at fair value (amortized cost: 2007 -$5,037,465; 2006 - $4,297,182) |
|
$ |
4,885,762 |
|
$ |
4,177,029 |
|
Held for investment, at amortized cost (fair value: 2007 -$4,929,991; 2006 - $4,871,237) |
|
5,290,679 |
|
5,128,146 |
|
||
Equity securities, available for sale, at fair value (cost: 2007 -$98,618; 2006 - $46,000) |
|
89,839 |
|
45,512 |
|
||
Mortgage loans on real estate |
|
1,827,050 |
|
1,652,757 |
|
||
Derivative instruments |
|
350,364 |
|
381,601 |
|
||
Policy loans |
|
421 |
|
419 |
|
||
Total investments |
|
12,444,115 |
|
11,385,464 |
|
||
|
|
|
|
|
|
||
Cash and cash equivalents |
|
9,237 |
|
29,949 |
|
||
Coinsurance deposits - related party |
|
1,738,058 |
|
1,841,720 |
|
||
Accrued investment income |
|
86,704 |
|
68,323 |
|
||
Deferred policy acquisition costs |
|
1,219,709 |
|
1,088,890 |
|
||
Deferred sales inducements |
|
545,285 |
|
427,554 |
|
||
Deferred income taxes |
|
86,136 |
|
73,831 |
|
||
Income taxes recoverable |
|
7,678 |
|
4,526 |
|
||
Other assets |
|
48,944 |
|
69,866 |
|
||
Total assets |
|
$ |
16,185,866 |
|
$ |
14,990,123 |
|
3
AMERICAN
EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS (Continued)
Dollars in thousands, except per share data)
|
|
September 30, |
|
|
|
||
|
|
2007 |
|
December 31, |
|
||
|
|
(Unaudited) |
|
2006 |
|
||
|
|
As Restated |
|
|
|
||
Liabilities and Stockholders Equity |
|
|
|
|
|
||
Liabilities: |
|
|
|
|
|
||
Policy benefit reserves: |
|
|
|
|
|
||
Traditional life and accident and health insurance products |
|
$ |
106,074 |
|
$ |
93,632 |
|
Annuity and single premium universal life products |
|
14,317,921 |
|
13,114,299 |
|
||
Other policy funds and contract claims |
|
123,817 |
|
128,579 |
|
||
Other amounts due to related parties |
|
41,285 |
|
45,504 |
|
||
Notes payable |
|
264,092 |
|
266,383 |
|
||
Subordinated debentures |
|
268,299 |
|
268,489 |
|
||
Amounts due under repurchase agreements |
|
306,657 |
|
385,973 |
|
||
Other liabilities |
|
146,629 |
|
92,198 |
|
||
Total liabilities |
|
15,574,774 |
|
14,395,057 |
|
||
|
|
|
|
|
|
||
Stockholders equity: |
|
|
|
|
|
||
Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding: 2007 - 53,862,054 shares (excluding 3,023,666 treasury shares); 2006 - 53,500,926 shares (excluding 2,664,448 treasury shares) |
|
53,862 |
|
53,501 |
|
||
Additional paid-in capital |
|
388,932 |
|
389,644 |
|
||
Unallocated common stock held by ESOP: 2007 - 650,000 shares |
|
(7,001 |
) |
|
|
||
Accumulated other comprehensive loss |
|
(49,365 |
) |
(38,769 |
) |
||
Retained earnings |
|
224,664 |
|
190,690 |
|
||
Total stockholders equity |
|
611,092 |
|
595,066 |
|
||
Total liabilities and stockholders equity |
|
$ |
16,185,866 |
|
$ |
14,990,123 |
|
See accompanying notes to unaudited consolidated financial statements
4
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
(Unaudited)
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
September 30, |
|
September 30, |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
Restated |
|
|
|
Restated |
|
|
|
||||
Revenues: |
|
|
|
|
|
|
|
|
|
||||
Traditional life and accident and health insurance premiums |
|
$ |
3,344 |
|
$ |
3,313 |
|
$ |
9,591 |
|
$ |
10,048 |
|
Annuity and single premium universal life product charges |
|
12,576 |
|
10,756 |
|
33,023 |
|
29,096 |
|
||||
Net investment income |
|
183,732 |
|
173,272 |
|
528,809 |
|
504,839 |
|
||||
Realized gains (losses) on investments |
|
325 |
|
(273 |
) |
921 |
|
16 |
|
||||
Change in fair value of derivatives |
|
(10,709 |
) |
72,280 |
|
79,755 |
|
60,026 |
|
||||
Total revenues |
|
189,268 |
|
259,348 |
|
652,099 |
|
604,025 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Benefits and expenses: |
|
|
|
|
|
|
|
|
|
||||
Insurance policy benefits and change in future policy benefits |
|
2,360 |
|
1,947 |
|
6,390 |
|
6,614 |
|
||||
Interest credited to account balances |
|
165,821 |
|
86,572 |
|
449,915 |
|
272,025 |
|
||||
Amortization of deferred sales inducements |
|
565 |
|
920 |
|
16,528 |
|
16,595 |
|
||||
Change in fair value of embedded derivatives |
|
(19,829 |
) |
113,925 |
|
(11,476 |
) |
65,368 |
|
||||
Interest expense on notes payable |
|
4,039 |
|
4,175 |
|
12,178 |
|
17,989 |
|
||||
Interest expense on subordinated debentures |
|
5,673 |
|
5,796 |
|
16,876 |
|
16,116 |
|
||||
Interest expense on amounts due under repurchase agreements |
|
4,764 |
|
10,997 |
|
11,842 |
|
25,328 |
|
||||
Amortization of deferred policy acquisition costs |
|
9,013 |
|
11,479 |
|
60,948 |
|
67,597 |
|
||||
Other operating costs and expenses |
|
11,582 |
|
9,527 |
|
37,076 |
|
29,638 |
|
||||
Total benefits and expenses |
|
183,988 |
|
245,338 |
|
600,277 |
|
517,270 |
|
||||
Income before income taxes |
|
5,280 |
|
14,010 |
|
51,822 |
|
86,755 |
|
||||
Income tax expense |
|
1,837 |
|
4,593 |
|
17,848 |
|
30,454 |
|
||||
Net income |
|
$ |
3,443 |
|
$ |
9,417 |
|
$ |
33,974 |
|
$ |
56,301 |
|
|
|
|
|
|
|
|
|
|
|
||||
Earnings per common share |
|
$ |
0.06 |
|
$ |
0.17 |
|
$ |
0.60 |
|
$ |
1.01 |
|
Earnings per common share - assuming dilution |
|
$ |
0.06 |
|
$ |
0.16 |
|
$ |
0.58 |
|
$ |
0.94 |
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited consolidated financial statements
5
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(Dollars in thousands)
(Unaudited)
|
|
|
|
|
|
Unallocated |
|
Accumulated |
|
|
|
|
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Balance at December 31, 2005 |
|
$ |
53,936 |
|
$ |
380,698 |
|
$ |
|
|
$ |
(27,306 |
) |
$ |
112,030 |
|
$ |
519,358 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Net income for period |
|
|
|
|
|
|
|
|
|
56,301 |
|
56,301 |
|
||||||
Change in net unrealized investment gains/losses |
|
|
|
|
|
|
|
(13,168 |
) |
|
|
(13,168 |
) |
||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
43,133 |
|
||||||
Conversion of $360 of subordinated debentures |
|
44 |
|
316 |
|
|
|
|
|
|
|
360 |
|
||||||
Share-based compensation |
|
|
|
114 |
|
|
|
|
|
|
|
114 |
|
||||||
Issuance of 268,195 shares of common stock under compensation plans, including excess income tax benefits |
|
269 |
|
1,639 |
|
|
|
|
|
|
|
1,908 |
|
||||||
Balance at September 30, 2006 |
|
$ |
54,249 |
|
$ |
382,767 |
|
$ |
|
|
$ |
(40,474 |
) |
$ |
168,331 |
|
$ |
564,873 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Balance at December 31, 2006 |
|
$ |
53,501 |
|
$ |
389,644 |
|
$ |
|
|
$ |
(38,769 |
) |
$ |
190,690 |
|
$ |
595,066 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Net income for period, restated |
|
|
|
|
|
|
|
|
|
33,974 |
|
33,974 |
|
||||||
Change in net unrealized investment gains/losses |
|
|
|
|
|
|
|
(10,596 |
) |
|
|
(10,596 |
) |
||||||
Total comprehensive income, restated |
|
|
|
|
|
|
|
|
|
|
|
23,378 |
|
||||||
Conversion of $280 of subordinated debentures |
|
34 |
|
246 |
|
|
|
|
|
|
|
280 |
|
||||||
Acquisition of 359,218 shares of common stock |
|
(359 |
) |
(3,969 |
) |
|
|
|
|
|
|
(4,328 |
) |
||||||
Acquisition of 650,000 shares of common stock by ESOP |
|
|
|
|
|
(7,001 |
) |
|
|
|
|
(7,001 |
) |
||||||
Share-based compensation |
|
|
|
3,196 |
|
|
|
|
|
|
|
3,196 |
|
||||||
Issuance of 63,000 shares of common stock under compensation plans, including excess income tax benefits |
|
63 |
|
438 |
|
|
|
|
|
|
|
501 |
|
||||||
Net issuance of 622,779 shares of common stock under stock option and warrant agreement |
|
623 |
|
(623 |
) |
|
|
|
|
|
|
|
|
||||||
Balance at September 30, 2007, as restated |
|
$ |
53,862 |
|
$ |
388,932 |
|
$ |
(7,001 |
) |
$ |
(49,365 |
) |
$ |
224,664 |
|
$ |
611,092 |
|
Total comprehensive income for the third quarter of 2007 was $20.3 million and was comprised of net income of $3.5 million and a decrease in net unrealized depreciation of available for sale fixed maturity securities and equity securities of $16.9 million.
Total comprehensive income for the third quarter of 2006 was $63.5 million and was comprised of net income of $9.4 million and a decrease in net unrealized depreciation of available for sale fixed maturity securities and equity securities of $54.1 million.
See accompanying notes to unaudited consolidated financial statements.
6
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
|
|
Nine Months Ended |
|
||||
|
|
2007 |
|
2006 |
|
||
|
|
Restated |
|
|
|
||
Operating activities |
|
|
|
|
|
||
Net income |
|
$ |
33,974 |
|
$ |
56,301 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
||
Adjustments related to interest sensitive products: |
|
|
|
|
|
||
Interest credited to account balances |
|
449,915 |
|
272,025 |
|
||
Amortization of deferred sales inducements |
|
16,528 |
|
16,595 |
|
||
Annuity and single premium universal life product charges |
|
(33,023 |
) |
(29,096 |
) |
||
Change in fair value of embedded derivatives |
|
(11,476 |
) |
65,368 |
|
||
Increase in traditional life and accident and health insurance reserves |
|
6,522 |
|
8,475 |
|
||
Policy acquisition costs deferred |
|
(177,006 |
) |
(159,382 |
) |
||
Amortization of deferred policy acquisition costs |
|
60,948 |
|
67,597 |
|
||
Amortization of discount on contingent convertible notes |
|
795 |
|
6,185 |
|
||
Provision for depreciation and other amortization |
|
953 |
|
1,611 |
|
||
Amortization of discount and premium on investments |
|
(193,069 |
) |
(185,847 |
) |
||
Realized gains on investments |
|
(921 |
) |
(16 |
) |
||
Change in fair value of derivatives |
|
(79,755 |
) |
(60,026 |
) |
||
Deferred income taxes |
|
(6,599 |
) |
22,001 |
|
||
Share-based compensation |
|
3,196 |
|
114 |
|
||
Changes in other operating assets and liabilities: |
|
|
|
|
|
||
Accrued investment income |
|
(18,381 |
) |
(21,144 |
) |
||
Income taxes recoverable |
|
(3,152 |
) |
(11,161 |
) |
||
Other assets |
|
493 |
|
(809 |
) |
||
Other policy funds and contract claims |
|
(4,762 |
) |
3,306 |
|
||
Other amounts due to related parties |
|
(17,095 |
) |
6,231 |
|
||
Other liabilities |
|
(23,728 |
) |
(50,274 |
) |
||
Net cash provided by operating activities |
|
4,357 |
|
8,054 |
|
||
|
|
|
|
|
|
||
Investing activities |
|
|
|
|
|
||
Sales, maturities, or repayments of investments: |
|
|
|
|
|
||
Fixed maturity securities - available for sale |
|
78,287 |
|
213,831 |
|
||
Fixed maturity securities - held for investment |
|
28,147 |
|
|
|
||
Equity securities, available for sale |
|
18,133 |
|
19,162 |
|
||
Mortgage loans on real estate |
|
131,340 |
|
71,218 |
|
||
Derivative instruments |
|
368,101 |
|
145,299 |
|
||
Acquisition of investments: |
|
|
|
|
|
||
Fixed maturity securities - available for sale |
|
(737,169 |
) |
(503,119 |
) |
||
Fixed maturity securities - held for investment |
|
|
|
(176,169 |
) |
||
Equity securities, available for sale |
|
(70,605 |
) |
(5,980 |
) |
||
Mortgage loans on real estate |
|
(305,633 |
) |
(408,447 |
) |
||
Derivative instruments |
|
(243,857 |
) |
(173,695 |
) |
||
Policy loans |
|
(2 |
) |
(51 |
) |
||
Purchases of property, furniture and equipment |
|
(683 |
) |
(188 |
) |
||
Net cash used in investing activities |
|
(733,941 |
) |
(818,139 |
) |
||
7
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)
|
|
Nine Months Ended |
|
||||
|
|
2007 |
|
2006 |
|
||
|
|
Restated |
|
|
|
||
Financing activities |
|
|
|
|
|
||
Receipts credited to annuity and single premium universal life policyholder account balances |
|
$ |
1,610,780 |
|
$ |
1,448,260 |
|
Coinsurance deposits - related party |
|
144,354 |
|
137,419 |
|
||
Return of annuity and single premium universal life policyholder account balances |
|
(972,797 |
) |
(1,220,369 |
) |
||
Financing fees incurred and deferred |
|
|
|
(1,389 |
) |
||
Repayments of notes payable |
|
(3,086 |
) |
(3,072 |
) |
||
Increase (decrease) in amounts due under repurchase agreements |
|
(79,316 |
) |
303,143 |
|
||
Proceeds from issuance of subordinated debentures |
|
|
|
40,000 |
|
||
Acquisition of common stock |
|
(11,329 |
) |
|
|
||
Excess tax benefits realized from exercise of stock options |
|
148 |
|
769 |
|
||
Proceeds from issuance of common stock |
|
353 |
|
1,139 |
|
||
Checks in excess of cash balance |
|
19,765 |
|
32,974 |
|
||
Net cash provided by financing activities |
|
708,872 |
|
738,874 |
|
||
Decrease in cash and cash equivalents |
|
(20,712 |
) |
(71,211 |
) |
||
|
|
|
|
|
|
||
Cash and cash equivalents at beginning of period |
|
29,949 |
|
112,395 |
|
||
Cash and cash equivalents at end of period |
|
$ |
9,237 |
|
$ |
41,184 |
|
|
|
|
|
|
|
||
Supplemental disclosures of cash flow information |
|
|
|
|
|
||
Cash paid during period for: |
|
|
|
|
|
||
Interest expense |
|
$ |
36,366 |
|
$ |
48,053 |
|
Income taxes |
|
26,600 |
|
17,138 |
|
||
|
|
|
|
|
|
||
Non-cash financing and investing activities: |
|
|
|
|
|
||
Premium and interest bonuses deferred as sales inducements |
|
125,481 |
|
100,954 |
|
||
Conversion of subordinated debentures |
|
280 |
|
360 |
|
||
Subordinated debentures issued to subsidiary trusts for common equity securities of the subsidiary trust |
|
|
|
1,238 |
|
||
|
|
|
|
|
|
||
See accompanying notes to unaudited consolidated financial statements. |
|
|
|
|
|
8
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
1. Organization and Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying unaudited consolidated financial statements of American Equity Investment Life Holding Company (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Companys financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three-month and nine-month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand the Companys financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
Reclassifications
Certain amounts in the unaudited consolidated financial statements for the periods ended September 30, 2006 have been reclassified to conform to the financial statement presentation for the periods ended September 30, 2007.
Adopted Accounting Pronouncements
In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred policy acquisition costs and deferred sales inducements on internal replacements of insurance contracts other than those specifically described in Statement of Financial Accounting Standards (SFAS) No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning January 1, 2007. Retrospective application of SOP 05-1 to previously issued financial statements is not permitted. There was no impact on the unaudited consolidated financial statements upon the adoption of SOP 05-1.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Under FIN 48, a tax benefit can be recognized in the financial statements if it is more likely than not that the position will be sustained upon examination by taxing authorities who have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective and was adopted by the Company on January 1, 2007. The Company has no unrecognized tax benefits at January 1, 2007 or September 30, 2007. The Companys policy is to record the interest and penalties on tax obligations on the income tax expense line in the consolidated statements of income. There was no impact on the unaudited consolidated financial statements upon the adoption of FIN 48. As of September 30, 2007, the tax years that remain subject to examination for U.S. federal taxes and applicable state jurisdictions are tax years ended December 31, 2003 through December 31, 2006.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140). SFAS 155
9
simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event beginning on January 1, 2007. There was no impact on the unaudited consolidated financial statements upon adoption.
New Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. SFAS 157 is effective beginning on January 1, 2008. The Company is continuing to evaluate SFAS 157 but does not believe that it will have a material impact on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be reported at fair value. Unrealized gains and losses on items for which the fair value option is elected shall be reported in net income. SFAS 159 also requires additional disclosures that are intended to facilitate comparisons between entities that choose different measurement attributes for similar assets and liabilities and between assets and liabilities in the financial statements of an entity that selects different measurement attributes for similar assets and liabilities. SFAS 159 is effective beginning on January 1, 2008. The Company is currently evaluating the impact SFAS 159 will have on the consolidated financial statements.
2. Restatement of Unaudited Consolidated Financial Statements
The previously issued unaudited financial statements for the quarter ended September 30, 2007 have been restated. The restatement reflects the correction of an error in the calculation of policy benefit reserves for index annuities in accordance with SFAS 133 that occurred during the quarters ended June 30, 2007 and September 30, 2007. The impact of this error was an understatement of annuity reserves by $29.7 million at September 30, 2007, which is reflected in change in fair value of embedded derivatives. For annuity products, deferred sales inducements and deferred policy acquisition costs are amortized in proportion to expected gross profits. This increase in reserves decreased gross profits and therefore the amortization of deferred sales inducements and deferred policy acquisition costs was adjusted. The impact to net income was a decrease of $3.9 million and $7.9 million for the three and nine month periods ended September 30, 2007, respectively. The impact of the restatement on the financial statements is as follows:
10
|
|
Three Months Ended September 30, 2007 |
|
Nine Months Ended September 30, 2007 |
|
|||||||||||||||||||||||
|
|
As |
|
Adjustments |
|
As |
|
As |
|
Adjustments |
|
As |
|
|||||||||||||||
|
|
(Dollars in thousands, except per share data) |
|
|||||||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Traditional life and accident and health insurance premiums |
|
$ |
3,344 |
|
$ |
|
|
$ |
3,344 |
|
$ |
9,591 |
|
$ |
|
|
$ |
9,591 |
|
|||||||||
Annuity and single premium universal life product charges |
|
12,576 |
|
|
|
12,576 |
|
33,023 |
|
|
|
33,023 |
|
|||||||||||||||
Net investment income |
|
183,732 |
|
|
|
183,732 |
|
528,809 |
|
|
|
528,809 |
|
|||||||||||||||
Realized gains on investments |
|
325 |
|
|
|
325 |
|
921 |
|
|
|
921 |
|
|||||||||||||||
Change in fair value of derivatives |
|
(10,709 |
) |
|
|
(10,709 |
) |
79,755 |
|
|
|
79,755 |
|
|||||||||||||||
Total revenues |
|
189,268 |
|
|
|
189,268 |
|
652,099 |
|
|
|
652,099 |
|
|||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Benefits and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Insurance policy benefits and change in future policy benefits |
|
2,360 |
|
|
|
2,360 |
|
6,390 |
|
|
|
6,390 |
|
|||||||||||||||
Interest credited to account balances |
|
165,821 |
|
|
|
165,821 |
|
449,915 |
|
|
|
449,915 |
|
|||||||||||||||
Amortization of deferred sales inducements |
|
3,412 |
|
2,847 |
|
565 |
|
21,957 |
|
5,429 |
|
16,528 |
|
|||||||||||||||
Change in fair value of embedded derivatives |
|
(34,935 |
) |
(15,106 |
) |
(19,829 |
) |
(41,161 |
) |
(29,685 |
) |
(11,476 |
) |
|||||||||||||||
Interest expense on notes payable |
|
4,039 |
|
|
|
4,039 |
|
12,178 |
|
|
|
12,178 |
|
|||||||||||||||
Interest expense on subordinated debentures |
|
5,673 |
|
|
|
5,673 |
|
16,876 |
|
|
|
16,876 |
|
|||||||||||||||
Interest expense on amounts due under repurchase agreements |
|
4,764 |
|
|
|
4,764 |
|
11,842 |
|
|
|
11,842 |
|
|||||||||||||||
Amortization of deferred policy acquisition costs |
|
15,237 |
|
6,224 |
|
9,013 |
|
73,095 |
|
12,147 |
|
60,948 |
|
|||||||||||||||
Other operating costs and expenses |
|
11,582 |
|
|
|
11,582 |
|
37,076 |
|
|
|
37,076 |
|
|||||||||||||||
Total benefits and expenses |
|
177,953 |
|
(6,035 |
) |
183,988 |
|
588,168 |
|
(12,109 |
) |
600,277 |
|
|||||||||||||||
Income before income taxes |
|
11,315 |
|
(6,035 |
) |
5,280 |
|
63,931 |
|
(12,109 |
) |
51,822 |
|
|||||||||||||||
Income tax expense |
|
3,918 |
|
(2,081 |
) |
1,837 |
|
22,018 |
|
(4,170 |
) |
17,848 |
|
|||||||||||||||
Net income |
|
$ |
7,397 |
|
$ |
(3,954 |
) |
3,443 |
|
$ |
41,913 |
|
$ |
(7,939 |
) |
33,974 |
|
|||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
Earnings per common share |
|
$ |
0.13 |
|
$ |
(0.07 |
) |
$ |
0.06 |
|
$ |
0.74 |
|
$ |
(0.14 |
) |
$ |
0.60 |
|
|||||||||
Earnings per common share - assuming dilution |
|
$ |
0.13 |
|
$ |
(0.07 |
) |
$ |
0.06 |
|
$ |
0.71 |
|
$ |
(0.13 |
) |
$ |
0.58 |
|
|||||||||
11
|
|
As of September 30, 2007 |
|
||||||||||||
|
|
As previously |
|
Adjustments |
|
As restated |
|
||||||||
|
|
(Dollars in thousands) |
|
||||||||||||
Assets |
|
|
|
|
|
|
|
||||||||
Investments: |
|
|
|
|
|
|
|
||||||||
Fixed maturity securities: |
|
|
|
|
|
|
|
||||||||
Available for sale, at fair value (amortized cost: 2007 - $5,037,465; 2006 - $4,297,182) |
|
$ |
4,885,762 |
|
$ |
|
|
$ |
4,885,762 |
|
|||||
Held for investment, at amortized cost (fair value: 2007 - $4,929,991; 2006 - $4,871,237) |
|
5,290,679 |
|
|
|
5,290,679 |
|
||||||||
Equity securities, available for sale, at fair value (cost: 2007 - $98,618; 2006 - $46,000) |
|
89,839 |
|
|
|
89,839 |
|
||||||||
Mortgage loans on real estate |
|
1,827,050 |
|
|
|
1,827,050 |
|
||||||||
Derivative instruments |
|
350,364 |
|
|
|
350,364 |
|
||||||||
Policy loans |
|
421 |
|
|
|
421 |
|
||||||||
Total investments |
|
12,444,115 |
|
|
|
12,444,115 |
|
||||||||
|
|
|
|
|
|
|
|
||||||||
Cash and cash equivalents |
|
9,237 |
|
|
|
9,237 |
|
||||||||
Coinsurance deposits - related party |
|
1,738,058 |
|
|
|
1,738,058 |
|
||||||||
Accrued investment income |
|
86,704 |
|
|
|
86,704 |
|
||||||||
Deferred policy acquisition costs |
|
1,207,562 |
|
12,147 |
|
1,219,709 |
|
||||||||
Deferred sales inducements |
|
539,856 |
|
5,429 |
|
545,285 |
|
||||||||
Deferred income taxes |
|
81,966 |
|
4,170 |
|
86,136 |
|
||||||||
Income taxes recoverable |
|
7,678 |
|
|
|
7,678 |
|
||||||||
Other assets |
|
48,944 |
|
|
|
48,944 |
|
||||||||
Total assets |
|
$ |
16,164,120 |
|
$ |
21,746 |
|
$ |
16,185,866 |
|
|||||
|
|
|
|
|
|
|
|
||||||||
Liabilities: |
|
|
|
|
|
|
|
||||||||
Policy benefit reserves: |
|
|
|
|
|
|
|
||||||||
Traditional life and accident and health insurance products |
|
$ |
106,074 |
|
$ |
|
|
$ |
106,074 |
|
|||||
Annuity and single premium universal life products |
|
14,288,236 |
|
29,685 |
|
14,317,921 |
|
||||||||
Other policy funds and contract claims |
|
123,817 |
|
|
|
123,817 |
|
||||||||
Other amounts due to related parties |
|
41,285 |
|
|
|
41,285 |
|
||||||||
Notes payable |
|
264,092 |
|
|
|
264,092 |
|
||||||||
Subordinated debentures |
|
268,299 |
|
|
|
268,299 |
|
||||||||
Amounts due under repurchase agreements |
|
306,657 |
|
|
|
306,657 |
|
||||||||
Other liabilities |
|
146,629 |
|
|
|
146,629 |
|
||||||||
Total liabilities |
|
15,545,089 |
|
29,685 |
|
15,574,774 |
|
||||||||
|
|
|
|
|
|
|
|
||||||||
Stockholders equity: |
|
|
|
|
|
|
|
||||||||
Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding: 2007 - 53,862,054 shares (excluding 3,023,666 treasury shares); 2006 - 53,500,926 shares (excluding 2,664,448 treasury shares) |
|
53,862 |
|
|
|
53,862 |
|
||||||||
Additional paid-in capital |
|
388,932 |
|
|
|
388,932 |
|
||||||||
Unallocated common stock held by ESOP: 2007 - 650,000 shares |
|
(7,001 |
) |
|
|
(7,001 |
) |
||||||||
Accumulated other comprehensive loss |
|
(49,365 |
) |
|
|
(49,365 |
) |
||||||||
Retained earnings |
|
232,603 |
|
(7,939 |
) |
224,664 |
|
||||||||
Total stockholders equity |
|
619,031 |
|
(7,939 |
) |
611,092 |
|
||||||||
Total liabilities and stockholders equity |
|
$ |
16,164,120 |
|
$ |
21,746 |
|
$ |
16,185,866 |
|
|||||
12
|
|
Nine Months Ended September 30, 2007 |
|
|||||||
|
|
As previously |
|
Adjustments |
|
As restated |
|
|||
|
|
(Dollars in thousands) |
|
|||||||
Operating activities |
|
|
|
|
|
|
|
|||
Net income |
|
$ |
41,913 |
|
$ |
(7,939 |
) |
$ |
33,974 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
|
|||
Adjustments related to interest sensitive products: |
|
|
|
|
|
|
|
|||
Interest credited to account balances |
|
449,915 |
|
|
|
449,915 |
|
|||
Amortization of deferred sales inducements |
|
21,957 |
|
(5,429 |
) |
16,528 |
|
|||
Annuity and single premium universal life product charges |
|
(33,023 |
) |
|
|
(33,023 |
) |
|||
Change in fair value of embedded derivatives |
|
(41,161 |
) |
29,685 |
|
(11,476 |
) |
|||
Increase in traditional life and accident and health insurance reserves |
|
6,522 |
|
|
|
6,522 |
|
|||
Policy acquisition costs deferred |
|
(177,006 |
) |
|
|
(177,006 |
) |
|||
Amortization of discount on contingent convertible notes |
|
795 |
|
|
|
795 |
|
|||
Amortization of deferred policy acquisition costs |
|
73,095 |
|
(12,147 |
) |
60,948 |
|
|||
Provision for depreciation and other amortization |
|
953 |
|
|
|
953 |
|
|||
Amortization of discount and premiums on investments |
|
(193,069 |
) |
|
|
(193,069 |
) |
|||
Realized gains on investments |
|
(921 |
) |
|
|
(921 |
) |
|||
Change in fair value of derivatives |
|
(79,755 |
) |
|
|
(79,755 |
) |
|||
Deferred income taxes |
|
(2,429 |
) |
(4,170 |
) |
(6,599 |
) |
|||
Share-based compensation |
|
3,196 |
|
|
|
3,196 |
|
|||
Changes in other operating assets and liabilities: |
|
|
|
|
|
|
|
|||
Accrued investment income |
|
(18,381 |
) |
|
|
(18,381 |
) |
|||
Income taxes recoverable |
|
(3,152 |
) |
|
|
(3,152 |
) |
|||
Other assets |
|
493 |
|
|
|
493 |
|
|||
Other policy funds and contract claims |
|
(4,762 |
) |
|
|
(4,762 |
) |
|||
Other amounts due to related parties |
|
(17,095 |
) |
|
|
(17,095 |
) |
|||
Other liabilities |
|
(23,728 |
) |
|
|
(23,728 |
) |
|||
Net cash provided by operating activities |
|
4,357 |
|
|
|
4,357 |
|
|||
|
|
|
|
|
|
|
|
|||
Investing activities |
|
|
|
|
|
|
|
|||
Sales, maturities, or repayments of investments: |
|
|
|
|
|
|
|
|||
Fixed maturity securities - available for sale |
|
78,287 |
|
|
|
78,287 |
|
|||
Fixed maturity securities - held for investment |
|
28,147 |
|
|
|
28,147 |
|
|||
Equity securities, available for sale |
|
18,133 |
|
|
|
18,133 |
|
|||
Mortgage loans on real estate |
|
131,340 |
|
|
|
131,340 |
|
|||
Derivative instruments |
|
368,101 |
|
|
|
368,101 |
|
|||
Acquisition of investments: |
|
|
|
|
|
|
|
|||
Fixed maturity securities - available for sale |
|
(737,169 |
) |
|
|
(737,169 |
) |
|||
Equity securities, available for sale |
|
(70,605 |
) |
|
|
(70,605 |
) |
|||
Mortgage loans on real estate |
|
(305,633 |
) |
|
|
(305,633 |
) |
|||
Derivative instruments |
|
(243,857 |
) |
|
|
(243,857 |
) |
|||
Policy loans |
|
(2 |
) |
|
|
(2 |
) |
|||
Purchases of property, furniture and equipment |
|
(683 |
) |
|
|
(683 |
) |
|||
Net cash used in investing activities |
|
(733,941 |
) |
|
|
(733,941 |
) |
|||
13
|
|
Nine Months Ended September 30, 2007 |
|
|||||||
|
|
As previously |
|
Adjustments |
|
As restated |
|
|||
|
|
(Dollars in thousands) |
|
|||||||
Financing activities |
|
|
|
|
|
|
|
|||
Receipts credited to annuity and single premium universal life policyholder account balances |
|
$ |
1,610,780 |
|
$ |
|
|
$ |
1,610,780 |
|
Coinsurance deposits - related party |
|
144,354 |
|
|
|
144,354 |
|
|||
Return of annuity and single premium universal life policyholder account balances |
|
(972,797 |
) |
|
|
(972,797 |
) |
|||
Repayments of notes payable |
|
(3,086 |
) |
|
|
(3,086 |
) |
|||
Decrease in amounts due under repurchase agreements |
|
(79,316 |
) |
|
|
(79,316 |
) |
|||
Acquisition of common stock |
|
(11,329 |
) |
|
|
(11,329 |
) |
|||
Excess tax benefits realized from exercise of stock options |
|
148 |
|
|
|
148 |
|
|||
Proceeds from issuance of common stock |
|
353 |
|
|
|
353 |
|
|||
Checks in excess of cash balance |
|
19,765 |
|
|
|
19,765 |
|
|||
Net cash provided by financing activities |
|
708,872 |
|
|
|
708,872 |
|
|||
Decrease in cash and cash equivalents |
|
(20,712 |
) |
|
|
(20,712 |
) |
|||
|
|
|
|
|
|
|
|
|||
Cash and cash equivalents at beginning of period |
|
29,949 |
|
|
|
29,949 |
|
|||
Cash and cash equivalents at end of period |
|
$ |
9,237 |
|
$ |
|
|
$ |
9,237 |
|
3. Contingencies
In recent years, 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. The Company is currently a defendant in several purported class action lawsuits alleging improper sales practices. In these lawsuits, the plaintiffs are seeking returns of premiums and other compensatory and punitive damages. No class has been certified in any of the pending cases at this time. Although the Company has denied all allegations in these lawsuits and intends to vigorously defend against them, the lawsuits are in the early stages of litigation and neither their outcomes nor a range of possible outcomes can be determined at this time. However, the Company does not believe that these lawsuits will have a material adverse effect on its business, financial condition or results of operations.
In addition, the Company is from time to time subject to other legal proceedings and claims in the ordinary course of business, none of which management believes is likely to have a material adverse effect on the Companys financial position, results of operations or cash flows. There can be no assurance that such litigation, or any future litigation, will not have a material adverse effect on the Companys financial position, results of operations or cash flows.
4. Retirement and Share-based Compensation Plans
During the first quarter of 2007, the Company established the 2007 Independent Insurance Agent Stock Option Plan (the Plan). Under this Plan, agents of American Equity Investment Life Insurance Company may receive grants of options to acquire shares of the Companys common stock based upon their individual sales during 2007. The Plan authorizes grants of options to agents for up to 2,500,000 shares of the Companys common stock. As of September 30, 2007, there are no grants of options under the Plan.
The Company established the American Equity Investment Employee Stock Ownership Plan (ESOP) effective July 1, 2007. The principal purpose of the ESOP is to provide each eligible employee with an equity interest in the Company. Employees become eligible once they have completed a minimum of six months of service. The Companys contribution to the ESOP is determined by the Board of Directors.
In August 2007, the Company issued a loan to the ESOP in the amount of $7.0 million to purchase 650,000 shares of common stock of the Company from David J. Noble, Chairman and Chief Executive Officer of the Company. The loan is to be repaid over a period of 20 years with annual interest payments due on December 31 of each year. Principal payments in the amount of $1.7 million are due on December 31, 2012, 2017, and 2022 with the final principal payment due on August 31, 2027. The loan is eliminated in the consolidated financial statements. The shares purchased by the ESOP were pledged as collateral for this debt and are reported as unallocated common stock held by ESOP, a contra-equity account in stockholders equity. For each plan year in which a payment or prepayment of principal or interest is made, the Company will release from the pledge the number of shares determined under the principal and interest method. Dividends on unallocated shares held by the ESOP will be used to repay indebtedness. As of September 30, 2007, there has been no allocation of shares or contributions to the ESOP by the Company.
14
5. Earnings Per Share
The following table sets forth the computation of earnings per common share and earnings per common share - assuming dilution:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
(Dollars in thousands, except per share data) |
|
||||||||||
Numerator: |
|
|
|
|
|
|
|
|
|
||||
Net income - numerator for earnings per common share, restated |
|
$ |
3,443 |
|
$ |
9,417 |
|
$ |
33,974 |
|
$ |
56,301 |
|
Interest on convertible subordinated debentures (net of income tax benefit) |
|
262 |
|
266 |
|
790 |
|
802 |
|
||||
Numerator for earnings per common share - assuming dilution, restated |
|
$ |
3,705 |
|
$ |
9,683 |
|
$ |
34,764 |
|
$ |
57,103 |
|
|
|
|
|
|
|
|
|
|
|
||||
Denominator: |
|
|
|
|
|
|
|
|
|
||||
Weighted average common shares outstanding (1) |
|
56,878,490 |
|
55,683,681 |
|
56,898,868 |
|
55,627,532 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
||||
Convertible subordinated debentures |
|
2,766,034 |
|
2,807,363 |
|
2,778,011 |
|
2,820,929 |
|
||||
Stock options |
|
129,069 |
|
838,124 |
|
404,466 |
|
990,672 |
|
||||
Deferred compensation agreements |
|
|
|
984,945 |
|
|
|
1,149,507 |
|
||||
Denominator for earnings per common share - assuming dilution |
|
59,773,593 |
|
60,314,113 |
|
60,081,345 |
|
60,588,640 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Earnings per common share, as reported |
|
$ |
0.13 |
|
$ |
0.17 |
|
$ |
0.74 |
|
$ |
1.01 |
|
Earnings per common share, restated |
|
$ |
0.06 |
|
$ |
|
|
$ |
0.60 |
|
$ |
|
|
Earnings per common share - assuming dilution, as reported |
|
$ |
0.13 |
|
$ |
0.16 |
|
$ |
0.71 |
|
$ |
0.94 |
|
Earnings per common share - assuming dilution, restated |
|
$ |
0.06 |
|
$ |
|
|
$ |
0.58 |
|
$ |
|
|
(1) Weighted average common shares outstanding include shares vested under the NMO Deferred Compensation Plan and exclude unallocated shares held by the ESOP.
Potentially dilutive common shares representing 31,500 shares and 25,000 shares of common stock for the three months ended September 30, 2007 and 2006, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been antidilutive.
15
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements discussion and analysis reviews our unaudited consolidated financial position at September 30, 2007, and the unaudited consolidated results of operations for the periods ended September 30, 2007 and 2006, and where appropriate, factors that may affect future financial performance. This analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q, and the audited consolidated financial statements, notes thereto and selected consolidated financial data appearing in our Annual Report on Form 10-K for the year ended December 31, 2006.
All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the Securities and Exchange Commission (SEC), press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as anticipate, believe, plan, estimate, expect, intend, and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things:
· general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the fair value of our investments and the lapse rate and profitability of policies;
· customer response to new products and marketing initiatives;
· changes in Federal income tax laws and regulations which may affect the relative income tax advantages of our products;
· increasing competition in the sale of annuities;
· regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products and regulation of the sale, underwriting and pricing of products;
· the risk factors or uncertainties listed from time to time in our private placement memorandums or filings with the SEC
Overview
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 for products accounted for as deposit liabilities are net investment income, surrender charges deducted from the account balances of policyholders in connection with withdrawals, realized gains and losses on investments and changes in fair value of derivatives. Components of expenses for products accounted for as deposit liabilities are interest credited to account balances, changes in fair value of embedded derivatives, amortization of deferred policy acquisition costs and deferred sales inducements, other operating costs and expenses and income taxes.
16
Annuity deposits by product type collected during the three months and nine months ended September 30, 2007 and 2006, were as follows:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
Product Type |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
(Dollars in thousands) |
|
||||||||||
Index annuities: |
|
|
|
|
|
|
|
|
|
||||
Index strategies |
|
$ |
419,696 |
|
$ |
219,533 |
|
$ |
1,176,547 |
|
$ |
914,552 |
|
Fixed strategy |
|
113,810 |
|
126,324 |
|
392,182 |
|
466,946 |
|
||||
|
|
533,506 |
|
345,857 |
|
1,568,729 |
|
1,381,498 |
|
||||
Fixed rate annuities: |
|
|
|
|
|
|
|
|
|
||||
Single-year rate guaranteed |
|
9,746 |
|
17,966 |
|
37,840 |
|
62,029 |
|
||||
Multi-year rate guaranteed |
|
539 |
|
2,051 |
|
4,211 |
|
4,733 |
|
||||
|
|
10,285 |
|
20,017 |
|
42,051 |
|
66,762 |
|
||||
Total before coinsurance ceded |
|
543,791 |
|
365,874 |
|
1,610,780 |
|
1,448,260 |
|
||||
Coinsurance ceded |
|
386 |
|
490 |
|
1,461 |
|
2,324 |
|
||||
Net after coinsurance ceded |
|
$ |
543,405 |
|
$ |
365,384 |
|
$ |
1,609,319 |
|
$ |
1,445,936 |
|
Net annuity deposits after coinsurance ceded increased 49% during the three months ended September 30, 2007 and 11% during the nine months ended September 30, 2007 compared to the same periods in 2006. We attribute these increases to the reinstatement of our A.M. Best Company financial strength rating to A- (Excellent) from B++ (Very Good) on August 3, 2006, certain product initiatives and agent incentives introduced in 2007 and more rational pricing from certain competitors. Our A.M. Best Company financial strength rating is a key element of our competitive position in the index and fixed annuity market. The outlook for our current rating is stable. We believe the rating upgrade has enhanced our competitive position and improved our prospects for sales increases in future periods. However, the degree to which this rating upgrade will effect future sales is unknown.
Earnings from products accounted for as deposit liabilities are primarily generated from the excess of net investment income earned over the interest credited to the policyholder, or the investment spread. In the case of index annuities, the investment spread consists of net investment income in excess of the cost of the options purchased to fund the index-based component of the policyholders return and amounts credited as a result of minimum guarantees.
Our investment spread is summarized as follows:
|
|
Nine Months Ended |
|
||
|
|
2007 |
|
2006 |
|
|
|
|
|
|
|
Average yield on invested assets |
|
6.09 |
% |
6.13 |
% |
Cost of money: |
|
|
|
|
|
Aggregate |
|
3.44 |
% |
3.43 |
% |
Average net cost of money for index annuities |
|
3.42 |
% |
3.28 |
% |
Average crediting rate for fixed rate annuities: |
|
|
|
|
|
Annually adjustable |
|
3.28 |
% |
3.25 |
% |
Multi-year rate guaranteed |
|
4.18 |
% |
4.94 |
% |
|
|
|
|
|
|
Investment spread: |
|
|
|
|
|
Aggregate |
|
2.65 |
% |
2.70 |
% |
Index annuities |
|
2.67 |
% |
2.85 |
% |
Fixed rate annuities: |
|
|
|
|
|
Annually adjustable |
|
2.81 |
% |
2.88 |
% |
Multi-year rate guaranteed |
|
1.91 |
% |
1.19 |
% |
The cost of money and average crediting rates are computed based upon policyholder account balances and do not include the impact of amortization of deferred sales inducements. See Critical Accounting Policies - Deferred Policy Acquisition Costs and Deferred Sales Inducements included in Managements Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2006. With respect to our index annuities, the cost of money includes the average crediting rate on
17
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 Policies - Derivative Instruments - Index Products included in Managements Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2006.
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, defaults or impairment of assets, our ability to manage interest rates credited to policyholders and costs of the options purchased to fund the annual index credits on our index annuities, our ability to manage the costs of acquiring new business (principally commissions to agents and first year bonuses credited to policyholders) and our ability to manage our operating expenses.
Results of Operations
Three and Nine Months Ended September 30, 2007 and 2006
Net income decreased 63% to $3.4 million for the third quarter of 2007 and 40% to $34.0 million for the nine months ended September 30, 2007 compared to $9.4 million and $56.3 million for the same periods in 2006. The comparability of the amounts is impacted by (i) the application of Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) to our index annuity business which we estimate increased net income by $12.1 million for the third quarter of 2007 and $13.4 million for the nine months ended September 30, 2007 compared to decreases of $9.4 million and $4.2 million for the same periods in 2006 and (ii) the application of SFAS 133 to our contingent convertible senior notes which we estimate decreased net income by $0.2 million for the third quarter of 2007 and $0.5 million for the nine months ended September 30, 2007 compared to a decrease of $0.1 million and an increase of $5.3 million for the same periods in 2006. Excluding these amounts, net income for the third quarter of 2007 and the nine months ended September 30, 2007 would have been $15.5 million and $47.3 million, respectively, compared to $19.0 million and $55.2 million for the same periods in 2006. These decreases were principally due to higher amortization of deferred policy acquisition costs and deferred sales inducements and increased operating expenses as discussed below.
Annuity and single premium universal life product charges (surrender charges assessed against policy withdrawals and mortality and expense charges assessed against single premium universal life policyholder account balances) increased 17% to $12.6 million for the third quarter of 2007 and 13% to $33.0 million for the nine months ended September 30, 2007 compared to $10.8 million and $29.1 million for the same periods in 2006. The increases were principally due to increases in policy withdrawals subject to surrender charges due to growth in the volume and aging of the business in force. Withdrawals from annuity and single premium universal life policies subject to surrender charges were $81.1 million and $76.4 million for the three months ended September 30, 2007 and 2006, respectively, and $225.6 million and $200.9 million for the nine months ended September 30, 2007 and 2006, respectively. The average surrender charge collected on withdrawals subject to a surrender charge was 15.4% for the third quarter of 2007 and 14.5% for the nine months ended September 30, 2007 compared to 13.9% and 14.3% for the same periods in 2006.
Net investment income increased 6% to $183.7 million in the third quarter of 2007 and 5% to $528.8 million for the nine months ended September 30, 2007 compared to $173.3 million and $504.8 million for the same periods in 2006. These increases were principally attributable to the growth in our annuity business and corresponding increases in our invested assets, offset by decreases in the average yield earned on investments. Average invested assets (on an amortized cost basis) increased to $11.6 billion for the nine months ended September 30, 2007 compared to $11.0 billion for the nine months ended September 30, 2006, while the average yield earned on average invested assets was 6.09% for the nine months ended September 30, 2007 compared to 6.13% for the same period in 2006. The decline in the yield earned on average invested assets is attributable to an overall decline in yield on the mix of assets owned in the respective periods.
18
Realized gains (losses) on investments fluctuate from period to period due to changes in the interest rate and economic environment and the timing of the sale of investments. Realized gains and losses on investments include gains and losses on the sale of securities as well as losses recognized when the fair value of a security is written down in recognition of an other than temporary impairment. The components of realized gains (losses) on investments for the three months and nine months ended September 30, 2007 and 2006 are set forth as follows:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
(Dollars in thousands) |
|
||||||||||
Available for sale fixed maturity securities: |
|
|
|
|
|
|
|
|
|
||||
Gross realized gains |
|
$ |
277 |
|
$ |
1,046 |
|
$ |
689 |
|
$ |
4,045 |
|
Gross realized losses |
|
|
|
|
|
|
|
(3,053 |
) |
||||
Write downs (other than temporary impairments) |
|
|
|
(1,337 |
) |
|
|
(1,337 |
) |
||||
|
|
277 |
|
(291 |
) |
689 |
|
(345 |
) |
||||
Equity securities: |
|
|
|
|
|
|
|
|
|
||||
Gross realized gains |
|
48 |
|
18 |
|
232 |
|
461 |
|
||||
Gross realized losses |
|
|
|
|
|
|
|
(100 |
) |
||||
|
|
48 |
|
18 |
|
232 |
|
361 |
|
||||
|
|
$ |
325 |
|
$ |
(273 |
) |
$ |
921 |
|
$ |
16 |
|
Change in fair value of derivatives (principally call options purchased to fund annual index credits on 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 for the three months and nine months ended September 30, 2007 and 2006 are set forth as follows:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
(Dollars in thousands) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
||||
Call options: |
|
|
|
|
|
|
|
|
|
||||
Change in unrealized gain (loss) |
|
$ |
(78,403 |
) |
$ |
75,350 |
|
$ |
(93,352 |
) |
$ |
42,528 |
|
Gain on option expiration or early termination |
|
68,670 |
|
(3,070 |
) |
173,499 |
|
17,498 |
|
||||
Interest rate swaps |
|
(976 |
) |
|
|
(392 |
) |
|
|
||||
|
|
$ |
(10,709 |
) |
$ |
72,280 |
|
$ |
79,755 |
|
$ |
60,026 |
|
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 for options expiring during the three months and nine months ended September 30, 2007 and 2006 is as follows:
|
|
Three Months Ended |
|
Nine Months Ended |
|
||||
|
|
September 30, |
|
September 30, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
S&P 500 Index |
|
|
|
|
|
|
|
|
|
Point-to-point strategy |
|
9.0% - 22.7% |
|
1.4% - 9.6% |
|
6.9% - 24.4% |
|
1.4% - 15.0% |
|
Monthly average strategy |
|
8.6% - 12.9% |
|
1.7% - 5.4% |
|
1.2% - 14.1% |
|