unwaivering commitment
. . . with rock solid service as our cornerstone.
2012 American Equity Investment Life Holding Company
Annual Report & Form 10-K
American Equity Investment Life Holding Company
West Des Moines, Iowa 50266
515-221-0002 | 888-221-1234
www.american-equity.com
AEL-AR-12
SHAREHOLDER INFORMATION
To learn more about American Equity Investment Life
Holding Company, you can request news releases,
annual reports in printed format, financial supplements,
and forms 10-K and 10-Q at no cost by contacting:
Julie L. LaFollette
Director of Investor Relations
6000 Westown Parkway
West Des Moines, IA 50266
515-273-3602 | Fax 515-221-9989
jlafollette@american-equity.com
Debra J. Richardson
Executive Vice President and Corporate Secretary
6000 Westown Parkway
West Des Moines, IA 50266
515-273-3602 | Fax 515-221-9989
drichardson@american-equity.com
Stock Listing
American Equity is listed on the New York Stock
Exchange under the ticker symbol AEL.
Website
American Equity’s website, www.american-equity.com,
is continuously updated and includes Company-
issued news releases, conference calls, stock price and
dividend information, quarterly reports, SEC filings,
management presentations and more.
Annual Shareholders Meeting
Thursday, June 6, 2013
3:30 pm CDT
AEL Headquarters
Corporate Headquarters
American Equity Investment Life Holding Company
6000 Westown Parkway
West Des Moines, IA 50266
515-221-0002 | Toll-free 888-221-1234
www.american-equity.com
Stock Transfer Agent and Registrar
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, RI 02940-3078
877-282-1169
www.computershare.com
Independent Registered
Public Accounting Firm
KPMG LLP
2500 Ruan Center
Des Moines, IA 50309
515-288-7465
Other Certifications
American Equity submitted its CEO Certification to the
New York Stock Exchange in 2012. Additionally,
American Equity filed as an exhibit to its 2012 annual
report on Form 10-K, CEO/CFO Certifications with the
Securities and Exchange Commission as required under
Section 302 of the Sarbanes-Oxley Act.
outstanding service
has been the cornerstone
of American Equity’s success from
the company’s inception.
Executive Chairman’s Letter from David J. Noble
Despite a year of low interest rates and new competition in
the annuities marketplace, it was still the third-best year in
our company’s 17-year history!
Industry-leading service
American Equity continues to be recognized as a leader
in the annuity industry. And for one primary reason: our
unwavering commitment to service—to our agents,
policyholders and shareholders. In fact, outstanding service
has always been the cornerstone of American Equity’s
success from the company’s inception.
We’ve been able to set such high standards for service
because of our people . . . approximately 400 in our offices
in West Des Moines, Iowa and Pell City, Alabama nearly 100
of whom have been with the company for more than 10
years and many others from the beginning. A management
team that has been working together within our company,
and predecessor organizations, for two decades or more.
And more than 24,000 independent agents who
appreciate that American Equity treats them with respect
and responds promptly to their needs.
I strongly believe our company owes its success not to our
policy forms, industry trends or other outside factors. Our
people really do make the difference. They are far above
average in their ability and in their dedication to bringing
their best to work every day. That’s why I’m confident
American Equity will continue to be an industry leader in
the years ahead.
Ninth straight annual
dividend increase
For the ninth consecutive year, American Equity has
raised our annual dividend, to 15 cents per share. We are
capitalists—plain and simple—and believe our shareholders
deserve to be compensated fairly for their confidence in our
company. What’s more, our research shows that we are the
only annuity company in the world where our agents have
a true stock option plan. Likewise, our employees receive
shares of company stock as part of American Equity’s
Employee Stock Ownership Plan (ESOP). They most
certainly have a major stake in our success as well.
A stable management team
When our late President and CEO Wendy Waugaman passed
away in June, we had a succession plan that enabled our
management team to respond smoothly and quickly. In fact,
the newly realigned team, headed by Chief Executive Officer
John Matovina and insurance company President Ronald
Grensteiner, was in place and working toward our goals in
just seven days. I’m proud of the way our leaders stepped
up—to assure that American Equity’s growth and progress
continues uninterrupted.
2012 was a year of conquering challenges for our company. And
2013 promises to offer additional challenges. But as you may know,
overcoming challenges is something I enjoy—and have throughout my
career. That’s how American Equity has grown, and how it will
grow from today’s $35 billion company to one double that size in the
foreseeable future. I sincerely appreciate all of the support we receive
daily from our employees, agents, shareholders, customers and other
friends of American Equity. Thank you, everybody!
D.J. Noble | Executive Chairman
3
John Matovina
Ronald Grensteiner
Subscribing to a Singular Vision
When David Noble established American Equity in 1995, he brought with him a
core leadership team who had already experienced years . . . in some cases, decades . . .
of working together. These leaders shared his vision of what American Equity was
to become.
Mr. Noble’s objective was singular: to establish a company that provides “ sleep
insurance” for its policyholders . . . retirement savings and investment products that
can assure a lifetime income, while avoiding the risk to principal inherent in many other
types of retirement vehicles, such as stocks and stock-based funds.
“Today, more than 400,000 policyholders look to us to provide products that can offer
a guaranteed return on their savings,” comments John Matovina, CEO of American
Equity Investment Life Holding Company. “And that’s what they receive from their
ownership in an American Equity fixed indexed annuity.
“When Mr. Noble started the business,” Mr. Matovina continued, “service was a top
priority. And it still is. Today, we’re bigger, stronger, more efficient. But we’ve never
deviated from his original vision to provide unparalleled service—to our agents,
policyholders and shareholders.”
2012: ‘Solid and Satisfying’
“Last year was not a record-breaker for American Equity, but it was still the
third biggest year in company history,” reports Ronald Grensteiner, President
of American Equity Investment Life Insurance Company.
Today, American Equity is a $35 billion enterprise. In the next few years, “we’ll be
working to become a $70 billion company. That’s our stretch goal, and we expect to
achieve it,” Grensteiner adds. We have a solid corps of more than 24,000 independent
agents selling our annuity products, with more than 900 achieving Gold Eagle status this
year. They see the value of American Equity, our company and our product offerings.
And our approximately 400 employees are awesome. They take pride in what they do,
and they come to work wanting to do their best every day.
“I think we’re in a great place as we begin our 18th year,” Grensteiner continues.
“Throughout our history, we’ve been able to maintain our service culture. It’s what
has led to the marketplace success American Equity enjoys today.”
Ninth Consecutive Dividend Increase
“If we run the companies right, our shareholders will be well taken care of,” Executive
Chairman David Noble said as 2012 came to a close.
With that in mind, American Equity announced a 25 percent increase in its annual
dividend rate on shares of the company’s common stock, to 15 cents per share, payable
to shareholders of record December 3, 2012.
“American Equity is one of the great growth stories,” comments Ted Johnson,
Chief Financial Officer. “We’ve enjoyed solid performance in spite of a variety of
difficult economic conditions in recent years. It speaks of the company’s conservative
investment philosophy. More than 98 percent of our bond portfolio is in investment-
grade securities.”
Ted Johnson
4
When Mr. Noble
started the business. . .
service was a
top priority.
And it still is.
Financial Results
Operating Income (OI) for American Equity Investment
Life Holding Company (AEL on the New York Stock
Exchange) was $110.2 million for 2012. This compares
to $133.7 million for the previous year. While 2012
was not itself a record-breaking year, it still compares
favorably with the three previous years, all record setters.
Annuity sales for 2012 totaled $3.9 billion.
The 2012 investment spread margin over the cost of
money (from policyholder annuity deposits) was 2.70
percent, a 10% decrease from 2011’s 3.03 percent
margin. Book value per outstanding common share was
$27.46 at the end of 2012.
Detailed results can be found in the Financial Statements
on subsequent pages of this 2012 Annual Report and
Form 10-K.
A.M. Best Notes Continuing
Financial Strength
American Equity Investment Life Holding Company
continues to earn A.M. Best Company’s affirmation of
our financial strength with an A- (“Excellent”) rating.*
In affirming its rating, A.M. Best cited American Equity’s
more than adequate level of risk-adjusted capitalization;
consistently positive GAAP (Generally Accepted Accounting
Principles) operating results; our leadership position within
the fixed indexed annuity segment; and good asset/liability
management program including the hedging of risks
associated with the company’s fixed indexed annuity business.
* A.M. Best uses 15 rating categories ranging from A++ to F
and measures performance in the areas of Investment Quality,
Capital Adequacy, Policy Reserves, Cost Control and Management
Experience. An A- rating from A.M. Best is its third-highest rating.
FINANCIAl HIGHlIGHTS
(dollars in thousands, except for per share data)
2012
2011
2010
2009
2008
Total assets
$35,133,478
$30,874,719
$26,426,763
$21,312,004
$17,081,740
Total stockholders’ equity
$1,720,237
$1,408,679
$938,047
$754,623
$496,844
Total annuity deposits
$3,946,932
$5,090,114
$4,668,719
$3,677,558
$2,289,006
Net income
Operating income(a)
Per Share Data
Earnings per common share—
assuming dilution
Operating income(a) per common
share—assuming dilution
$57,798
$110,187
$0.89
$1.69
$86,248
$42,933
$68,530
$15,947
$133,653
$108,947
$101,778
$72,472
$1.37
$0.68
$1.18
$0.30
$2.12
$1.70
$1.75
$1.30
$9.46
Book value per share
$27.46
$23.82
$16.07
$13.08
Non-GAAP Financial Measure(a)
Reconciliation of net income
to operating income
Net income
$57,798
$86,248
$42,933
$68,530
$15,947
Net realized gains/losses and net OTTI
losses on investments, net of offsets
Net effect of derivatives, embedded
derivatives and other index annuity,
net of offsets
Convertible debt extinguishment,
net of income taxes
Effect of counterparty
default, net of offsets
Litigation reserve,
net of offsets
Operating income
8,648
18,354
379
(1,339)
92,524
34,161
29,051
38,167
29,952
(31,038)
—
—
9,580
—
—
—
171
—
27,297
687
(5,702)
3,948
—
741
—
$110,187
$133,653
$108,947
$101,778
$72,472
(a) In addition to net income, we have consistently utilized operating income and operating income per common share—assuming dilution, non-GAAP financial
measures commonly used in the life insurance industry, as economic measures to evaluate our financial performance. Operating income equals net income adjusted
to eliminate the impact of net realized gains and 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 the net charge to recognize 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.
6
CoMpARISoN oF CuMulATIVe FIVe-yeAR ToTAl ReTuRN
$200
$180
$160
$140
$120
$100
$80
$60
$40
$20
$0
DEC
31/07
JUN
30/08
DEC
31/08
JUN
30/09
DEC
31/09
JUN
30/10
DEC
31/10
JUN
30/11
DEC
31/11
JUN
30/12
DEC
31/12
American Equity Investment Life Holding Co.
S&P 500 Index
S&P 500 Financials Index
CReDIT QuAlITy oF FIxeD
MATuRITy SeCuRITIeS
ToTAl ANNuITy DepoSITS
NAIC 1 62.9%
NAIC 2 35.2%
NAIC 3 1.7%
NAIC 4 0.2%
NAIC 5 —%
NAIC 6 —%
2008
2009
2010
2011
2012
$2.3
$3.7
$3.9
$4.7
$5.1
1
2
3
4
5
6
Billions of Dollars
ToTAl ASSeTS
$17.1
$21.3
$26.4
$30.9
$35.1
2
4
6
8 10 12 14 16 18 20 22 24 26 28 30 32 34 36
Billions of Dollars
2008
2009
2010
2011
2012
7
We Value our policyholders . . .
And We Show It!
Our customers (policyholders) appreciate that
American Equity fixed indexed annuities can
assure them a guaranteed income stream for life.
And we, in turn, appreciate our customers.
Nothing demonstrates that more than American
Equity Client Appreciation Events, held since
2010 in cities throughout the U.S. The day
begins with a meeting and coffee for our
independent agents. Then policyholders from
the area, and their Gold Eagle agents, join us for
a program and luncheon.
Along with thanking our customers and agents
for the confidence they’ve placed in us and our
annuity products, senior executives of American
Equity present a brief program in which they
recount company history, discussing where
American Equity is today and what we believe
the future may hold. Following the luncheon,
policyholders have the opportunity to talk one-
on-one with members of American Equity’s
management team.
Since inception, we have held more than
55 Client Appreciation Events and more than
11,300 policyholders and agents have been
thanked, in person, for their business. We
plan to continue the Client Appreciation
series into 2013.
The background of the company
and the information received from
Mr. Grensteiner through his talk
and slide presentation was very
good and most comforting to know
that our small investment is
being carefully taken care
of and watched for our
future retirement years.
–l. West
love your honesty,
integrity and great
support. Both as a firm and
as an individual.
–R. Garuda
Thank you and
your staff for all
that you do in facing
the challenges of making our
money work for us in this
difficult economy.
–B. essington
8
More Than 900 Agents earn
“Gold eagle” Rank
“Gold Eagle” is our designation for those independent
agents who produce more than $1 million in sales of
American Equity annuity products in a single calendar year.
In 2012, 945 agents achieved Gold Eagle status. To each of
these outstanding sales professionals, we offer our sincere
gratitude and congratulations.
We are thankful for your
excellent staff who keep
everything sailing in the right direction.
–e. Halls
In Memoriam
Wendy C. Waugaman, President and Chief Executive Officer
of American Equity Investment Life Holding Company and
member of the Board of Directors, passed away June 18, 2012.
Wendy was dedicated to the long-term success of American
Equity. She was appointed President and CEO in 2009.
Previously she had served as Chief Financial Officer and
General Counsel since 1999. Before joining American Equity,
she was outside counsel for the company beginning with its
inception in 1995.
Wendy played a major leadership role in the annuity industry’s
successful fight to invalidate SEC Rule 151A, which would have
expanded the SEC’s jurisdiction to include regulatory oversight
of fixed indexed annuities (FIAs). It also would have required
every sales agent selling FIAs to have a securities license as well
as an insurance license.
All of us at American Equity were deeply saddened by the loss of our
respected colleague and friend.
With Wendy’s passing, John M. Matovina, who has been affiliated with David Noble for more than 35 years,
assumed the position of Chief Executive Officer for American Equity Investment Life Holding Company.
9
American equity Investment life Holding Company
Board of Directors
D. J. Noble
John M. Matovina
Debra J. Richardson
Joyce A. Chapman
Executive Chairman
Chief Executive
Officer
Executive Vice
President and
Corporate Secretary
Retired Banking
Executive and
Community Volunteer
Alexander M. Clark
James M. Gerlach
Robert L. Hilton
Robert L. Howe
Senior Managing
Director Griffin
Financial Group
Retired Executive
Vice President
Insurance Consultant
Consultant and
Retired Deputy Director
Iowa Insurance Division
David S. Mulcahy
Gerard D. Neugent
A.J. Strickland
Harley A. Whitfield, Sr.
Chairman
Monarch Materials
Group, Inc.
President and COO
Knapp Properties, Inc.
Professor of Strategic
Management
University of Alabama
Attorney, Of Counsel
Whitfield & Eddy, PLC
10
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(cid:2) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
or
(cid:3) 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
(State or other jurisdiction of Incorporation)
6000 Westown Parkway
West Des Moines, Iowa
(Address of principal executive offices)
42-1447959
(I.R.S. Employer Identification No.)
50266
(Zip Code)
Registrant’s telephone number, including area code: (515) 221-0002
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes (cid:2) No (cid:3)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Act. Yes (cid:3) No (cid:2)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for 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 (cid:2) No (cid:3)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit and post such files). Yes (cid:2) No (cid:3)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:3)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a
smaller reporting company. See the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer’’ and ‘‘smaller reporting company’’
in Rule 12b-2 of the Exchange Act.
Large accelerated filer (cid:3)
Smaller reporting company (cid:3)
Accelerated filer (cid:2)
Non-accelerated filer (cid:3)
(Do not check if a
smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes (cid:3) No (cid:2)
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was
$630,528,409 based on the closing price of $11.01 per share, the closing price of the common stock on the New York Stock
Exchange on June 30, 2012.
Shares of common stock outstanding as of February 28, 2013: 63,362,834
Documents incorporated by reference: Portions of the registrant’s definitive proxy statement for the annual meeting of
shareholders to be held June 6, 2013, which will be filed within 120 days after December 31, 2012, are incorporated by reference
into Part III of this report.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2012
TABLE OF CONTENTS
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Selected Consolidated Financial Data
Management's Discussion and Analysis of Financial Condition and Results of Operations
PART I.
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II.
Item 5.
Item 6.
Item 7.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III.
PART IV.
Item 15.
SIGNATURES
Consolidated Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
The information required by Items 10 through 14 is incorporated by reference from our definitive
proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after
December 31, 2012.
Exhibits, Financial Statement Schedules
Index to Consolidated Financial Statements and Schedules
Exhibit Index
Exhibit 12.1
Ratio of Earnings to Fixed Charges
Exhibit 21.2
Subsidiaries of American Equity Investment Life Holding Company
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
Exhibit 31.1
Certification
Exhibit 31.2
Certification
Exhibit 32.1
Certification
Exhibit 32.2
Certification
1
8
15
15
15
15
15
16
18
44
45
45
45
45
45
46
47
F-1
Item 1. Business
Introduction
PART I
We are a leader in the development and sale of fixed index and fixed rate annuity products. We were incorporated in the state of Iowa on
December 15, 1995. We are a full service underwriter of 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"). Our business consists primarily of the sale of fixed index and fixed
rate annuities and, accordingly, we have only one business segment. Our business strategy is to focus on growing our annuity business and earn
predictable returns by managing investment spreads and investment risk. We are currently licensed to sell our products in 50 states and the
District of Columbia. Throughout this report, unless otherwise specified or the context otherwise requires, all references to "American Equity",
the "Company", "we", "our" and similar references are to American Equity Investment Life Holding Company and its consolidated subsidiaries.
Investor related information, including periodic reports filed on Forms 10-K, 10-Q and 8-K and all amendments to such reports may be found
on our internet website at www.american-equity.com as soon as reasonably practicable after such reports are filed with the Securities and Exchange
Commission ("SEC"). In addition, we have available on our website our: (i) code of business conduct and ethics; (ii) audit committee charter;
(iii) compensation committee charter; (iv) nominating/corporate governance committee charter; (v) disclosure committee charter; and
(vi) corporate governance guidelines. The information incorporated herein by reference is also electronically accessible from the SEC's website
at www.sec.gov.
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 AnnuitySpecs.com, total industry sales of fixed index annuities increased 6% to $25.5 billion for the first three quarters of 2012
from $24.1 billion for the first three quarters of 2011, and increased 0.13% to $32.4 billion in 2011 from $32.3 billion in 2010. Our wide range
of fixed index and fixed rate annuity products has enabled us to enjoy favorable growth during volatile equity and bond markets.
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:
Enhance our Current Independent Agency Network. We believe that our successful relationships with approximately 60 national
marketing organizations represent a significant competitive advantage. Our objective is to improve the productivity and efficiency of
our core distribution channel by focusing our marketing and recruiting efforts on those independent agents capable of selling $1 million
or more of annuity premium annually. This level of production qualifies them for our Gold Eagle program which was introduced at
the beginning of 2007. We believe the Gold Eagle program has been effective as evidenced by the number of qualified Gold Eagle
agents ranging from 945 to as many as 1,227 during the last three calendar years. Our Gold Eagle agents account for 59% of total
production in 2012 and 57 % of total production in 2011 and 2010. Gold Eagle qualifiers receive a combination of cash and equity-
based incentives as motivation for producing business for us. The equity-based incentive compensation component of our Gold Eagle
program is unique in our industry and distinguishes us from our competitors. Our continuing focus on relationships and efficiency
will ultimately reduce our independent agents to a core group of professional annuity producers. We will also be alert to opportunities
to establish relationships with national marketing organizations and agents not presently associated with us and will strive to provide
all of our marketers with the highest quality service possible.
Continue to Introduce Innovative and Competitive Products. We intend to be at the forefront of the fixed index and fixed rate annuity
industry in developing and introducing innovative and new competitive products. We were one of the first companies to offer a fixed
index annuity that allows a choice among interest crediting strategies which includes both equity and bond indices as well as a traditional
fixed rate strategy. We were also one of the first companies to include a living income benefit rider with our fixed index annuities.
We enhanced our living income benefit rider to provide policyholders with protection against inflation. We believe that our continued
focus on anticipating and being responsive to the product needs of our independent agents and policyholders will lead to increased
customer loyalty, revenues and profitability.
Use our Expertise to Achieve Targeted Spreads on Annuity Products. Historically, we have had a successful track record in achieving
the targeted spreads on our annuity products. This historical success has been challenged in the current extended low interest rate
environment. However, we intend to continue to leverage our experience and expertise in managing the investment spread during a
range of interest rate environments to achieve, or work towards achieving, our targeted spreads.
1
Maintain our Profitability Focus and Improve Operating Efficiency. We are committed to improving our profitability by advancing
the scope and sophistication of our investment management and spread capabilities and continuously seeking out efficiencies within
our operations. We have implemented competitive incentive programs for our national marketing organizations, agents and employees
to stimulate performance.
Take Advantage of the Growing Popularity of Index Products. We believe that the growing popularity of fixed index annuity products
that allow equity and bond market participation without the risk of loss of the premium deposit presents an attractive opportunity to
grow our business. We intend to capitalize on our reputation as a leading provider of fixed index annuities in this expanding segment
of the annuity market.
Focus on High Quality Service to Agents and Policyholders. We have maintained high quality personal service as one of our highest
priorities since the inception of our business and continue to strive for an unprecedented level of timely and accurate service to both
our agents and policyholders. We believe this is one of our strongest competitive advantages.
Expand our Distribution Channels. We formed Eagle Life with the vision of developing a network of broker-dealer firms and
registered investment advisors to distribute 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.
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 fiscal years are as follows:
Year Ended December 31,
2012
2011
2010
Deposits
Collected
Deposits
as a % of
Total
Deposits
Collected
Deposits
as a % of
Total
(Dollars in thousands)
Deposits
Collected
Deposits
as a % of
Total
$
2,225,902
56% $
2,839,295
56% $
2,401,891
1,208,324
3,434,226
348,049
164,657
31%
87%
9%
4%
1,377,987
4,217,282
567,229
305,603
27%
83%
11%
6%
1,551,007
3,952,898
544,193
171,628
51%
33%
84%
12%
4%
$
3,946,932
100% $
5,090,114
100% $
4,668,719
100%
Product Type
Fixed index annuities:
Index strategies
Fixed strategy
Fixed rate annuities
Single premium immediate annuities
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%, 95% and 95% of our fixed index annuity sales for 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 commission
paid to the agent or the surrender charges on the policy 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. Caps generally range from 1%
to 13.5% and participation rates generally range from 10% to 100%. In addition, some products have an "asset fee" ranging from 1.5% to 5%,
which is deducted from annual interest to be credited. For products with asset fees, if the annual appreciation in the index does not exceed the
asset fee, the policyholder's index credit is zero. The minimum guaranteed contract values are equal to 87.5% of the premium collected plus
interest credited at an annual rate ranging from 1% to 3.5%.
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 guaranteed rate on our fixed rate deferred annuities ranges from 1% to 4% and the initial guaranteed rate on our multi-year rate guaranteed
policies ranges from 1.8% to 5%.
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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. As of December 31, 2012, crediting rates on our outstanding fixed rate deferred annuities generally ranged from 1.6%
to 5%. The average crediting rate on our outstanding fixed rate deferred annuities at December 31, 2012 was 3.13%.
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. The implicit interest
rate on our outstanding SPIAs averaged 2.38% at December 31, 2012.
Withdrawal Options—Fixed Index and Fixed Rate Annuities
Policyholders are typically permitted penalty-free withdrawals 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 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 December 31, 2012. 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 years ended December 31, 2012, 2011 and 2010.
Investments/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 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 credited 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.
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 Operations—Financial Condition—Investments, Quantitative and Qualitative
Disclosures About Market Risk and note 3 to our audited consolidated financial statements.
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.
Our independent agents and agencies range in profile from national sales organizations to personal producing general agents. 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
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incentives to those agents selling $1 million or more of annuity premium annually. We also have favorable relationships with our national
marketing organizations, which have enabled us to efficiently sell through an expanded number of independent agents.
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 are alert
for 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. For additional information regarding our equity-based programs for our leading national
marketers and independent agents, see note 11 to our consolidated financial statements. We generally do not enter into exclusive arrangements
with these marketing organizations.
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 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%).
Competition and Ratings
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 fixed index, fixed rate and variable annuities sold by other insurance companies and also with mutual fund products, traditional
bank investments and other investment and retirement funding alternatives offered by asset managers, banks, and broker-dealers. Our insurance
products compete with products of other insurance companies, financial intermediaries and other institutions based on a number of features,
including crediting rates, policy terms and conditions, service provided to distribution channels and policyholders, ratings, reputation and broker
compensation.
The sales agents for our products use the ratings assigned to an insurer by independent rating agencies as one factor in determining which insurer's
annuity to market. In recent years, the market for annuities has been dominated by those insurers with the highest ratings. The degree to which
ratings adjustments have affected and will affect our sales and persistency is unknown. Following is a summary of American Equity Life's
financial strength ratings:
Financial Strength Rating
Outlook Statement
A.M. Best Company
January 2011—current
November 2008—January 2011
August 2006—October 2008
Standard & Poor's
October 2011—Current
September 2010—October 2011
July 2010—September 2010
July 2008—July 2010
A-
A-
A-
BBB+
BBB+
BBB+
BBB+
Stable
Negative
Stable
Stable
Positive
Stable
Negative
Financial strength ratings 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 policyholders, agents and intermediaries and are not
directed toward the protection of investors and are not recommendations to buy, sell or hold securities.
In addition to the financial strength ratings, rating agencies use an "outlook statement" to indicate a medium or long-term trend which, if continued,
may lead to a rating change. A positive outlook indicates a rating may be raised and a negative outlook indicates a rating may be lowered. A
stable outlook is assigned when ratings are not likely to be changed. Outlook statements should not be confused with expected stability of the
insurer's financial or economic performance. A rating may have a "stable" outlook to indicate that the rating is not expected to change, but a
"stable" outlook does not preclude a rating agency from changing a rating at any time without notice.
In January 2013, A.M. Best affirmed its rating outlook on the U.S. life/annuity sector as stable, which has been A.M. Best's outlook on our
industry since 2010. In November 2012, Standard & Poor's issued its outlook on the U.S. life insurance sector as cautious, which changed from
their stable outlook since late 2010. Broad economic uncertainties such as the low interest rate environment, relatively high unemployment and
potential low sales of life insurance products are listed by Standard & Poor's for their modification to a cautious outlook from their prior stable
outlook. We believe the rating agencies think the economic recovery will continue to be slow, which may leave the potential for further credit
losses, and low interest rates will put pressure on life insurers' earnings. The rating agencies have heightened the level of scrutiny they apply
to insurance companies, increased the frequency and scope of their credit reviews, and may adjust upward the capital and other requirements
employed in the rating agency models for maintenance of certain ratings levels.
4
A.M. Best Company ratings currently range from "A++" (Superior) to "F" (In Liquidation), and include 16 separate ratings categories. Within
these categories, "A++" (Superior) and "A+" (Superior) are the highest, followed by "A" (Excellent) and "A-" (Excellent) then followed by "B
++" (Good) and "B+" (Good). Publications of A.M. Best Company indicate that the "A-" rating is assigned to those companies that, in A.M.
Best Company's opinion, have demonstrated an excellent ability to meet their ongoing obligations to policyholders.
Standard & Poor's insurer financial strength ratings currently range from "AAA (extremely strong)" to "R (under regulatory supervision)", and
include 21 separate ratings categories, while "NR" indicates that Standard & Poor's has no opinion about the insurer's financial strength. Within
these categories, "AAA" and "AA" are the highest, followed by "A" and "BBB". Publications of Standard & Poor's indicate that an insurer rated
"BBB" is regarded as having good financial security characteristics, but is more likely to be affected by adverse business conditions than are
higher rated insurers.
A.M. Best Company and Standard & Poor's review their ratings of insurance companies from time to time. There can be no assurance that any
particular rating will continue for any given period of time or that it will not be changed or withdrawn entirely if, in their judgment, circumstances
so warrant. If our ratings were to be negatively adjusted for any reason, we could experience a material decline in the sales of our products and
the persistency of our existing business.
Reinsurance
Coinsurance
American Equity Life has two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of our
fixed index and fixed rate annuities issued from August 1, 2001 through December 31, 2001, 40% of those contracts issued during 2002 and
2003, and 20% of those contracts issued from January 1, 2004 to July 31, 2004. The business reinsured under these agreements may not be
recaptured. Coinsurance deposits (aggregate policy benefit reserves transferred to EquiTrust under these agreements) were $1.0 billion and
$1.1 billion at December 31, 2012 and 2011, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to
EquiTrust should EquiTrust fail to meet the obligations it has coinsured. EquiTrust has received a financial strength rating of "B+" (Good) with
a stable outlook from A.M. Best Company. None of the coinsurance deposits with EquiTrust are deemed by management to be uncollectible.
Effective July 1, 2009, we entered into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life
reinsurer domiciled in Bermuda. One agreement ceded 20% of certain of our fixed index annuities issued from January 1, 2009 through March 31,
2010. The business reinsured under this agreement is not eligible for recapture until the end of the month following seven years after the date
of issuance of the policy. The other agreement cedes 80% of our multi-year rate guaranteed annuities issued on or after July 1, 2009. The
business reinsured under this agreement may not be recaptured. Coinsurance deposits (aggregate policy benefit reserves transferred to Athene
under these agreements) were $1.9 billion and $1.7 billion at December 31, 2012 and 2011, respectively. We remain liable to policyholders with
respect to the policy liabilities ceded to Athene should Athene fail to meet the obligations it has coinsured. The annuity deposits that have been
ceded to Athene are being held in a trust on a funds withheld basis. American Equity Life is named as the sole beneficiary of the trust. 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 account 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 in a trust for the amount of any
shortfall. None of the coinsurance deposits with Athene are deemed by management to be uncollectible.
Financing Arrangements
American Equity Life has three reinsurance transactions with Hannover Life Reassurance Company of America, ("Hannover"), which are treated
as reinsurance under statutory accounting practices and as financing arrangements under U.S. generally accepted accounting principles ("GAAP").
The statutory surplus benefits under these agreements are eliminated under GAAP and the associated charges are recorded as risk charges and
included in other operating costs and expenses in the consolidated statements of operations. The transactions became effective October 1, 2005
(the "2005 Hannover Transaction"), December 31, 2008 (the "2008 Hannover Transaction") and March 31, 2011 (the "2011 Hannover
Transaction"). The 2008 Hannover Transaction and the 2011 Hannover Transaction terminate after the the final year of surplus reduction (see
following discussion of each agreement), and the statutory surplus benefit is reduced over a five year period and is eliminated upon termination.
The 2011 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided $49.2
million in net pretax statutory surplus benefit at inception in 2011. Pursuant to the terms of this agreement, pretax statutory surplus was reduced
by $11.8 million and $9.2 million in 2012 and 2011, respectively, and is expected to be reduced as follows: 2013—$11.3 million, 2014—$10.8
million, and 2015—$10.3 million. These amounts include risk charges equal to 1.25% of the pretax statutory surplus benefit as of the end of
each calendar quarter.
The 2008 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided $29.5
million in net pretax statutory surplus benefit in 2008. Pursuant to the terms of this agreement, pretax statutory surplus was reduced by $6.8
million and $6.7 million in 2012 and 2011, respectively, and is expected to be reduced as follows: 2013—$6.9 million. These amounts include
risk charges equal to 1.25% of the pretax statutory surplus benefit as of the end of each calendar quarter.
5
The 2005 Hannover Transaction is a yearly renewable term reinsurance agreement for statutory purposes covering 47% of waived surrender
charges related to penalty free withdrawals and deaths on certain business. The agreement has been amended several times to include policy
forms that were not in existence at the time this agreement became effective. We may recapture the risks reinsured under this agreement as of
the end of any quarter. However, the agreement, as amended, makes it punitive to us if we do not recapture the business ceded prior to January
1, 2016. The reserve credit recorded on a statutory basis by American Equity Life was $180.3 million and $162.5 million at December 31, 2012
and 2011, respectively. We pay quarterly reinsurance premiums under this agreement with an experience refund calculated on a quarterly basis
resulting in a risk charge equal to approximately 5.8% of the weighted average statutory reserve credit.
Indemnity Reinsurance
Consistent with the general practice of the life insurance industry, American Equity Life enters into agreements of indemnity reinsurance with
other insurance companies in order to reinsure portions of the coverage provided by its annuity, life and accident and health insurance products.
Indemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to diversify its
risks. Indemnity reinsurance does not discharge the original insurer's primary liability to the insured.
The maximum loss retained by us on all life insurance policies we have issued was $0.1 million or less as of December 31, 2012. American
Equity Life's reinsured business under indemnity reinsurance agreements is primarily ceded to two reinsurers. Reinsurance related to life and
accident and health insurance that was ceded by us to these reinsurers was immaterial.
During 2007, American Equity Life entered into reinsurance agreements with Ace Tempest Life Reinsurance Ltd and Hannover to cede to each
50% of the risk associated with our living income benefit rider on certain fixed index annuities issued in 2007. The amounts ceded under these
agreements were immaterial as of and for the years ended December 31, 2012 and 2011.
We believe the assuming companies will be able to honor all contractual commitments, based on our periodic review of their financial statements,
insurance industry reports and reports filed with state insurance departments.
Regulation
Life insurance companies are subject to regulation and supervision by the states in which they transact business. State insurance laws establish
supervisory agencies with broad regulatory authority, including the power to:
•
•
•
•
•
•
•
•
•
•
•
•
•
grant and revoke licenses to transact business;
regulate and supervise trade practices and market conduct;
establish guaranty associations;
license agents;
approve policy forms;
approve premium rates for some lines of business;
establish reserve requirements;
prescribe the form and content of required financial statements and reports;
determine the reasonableness and adequacy of statutory capital and surplus;
perform financial, market conduct and other examinations;
define acceptable accounting principles for statutory reporting;
regulate the type and amount of permitted investments; and
limit the amount of dividends and surplus note payments that can be paid without obtaining regulatory approval.
Our life subsidiaries are subject to periodic examinations by state regulatory authorities. The New York Insurance Department is currently
performing its usual tri-annual financial exam of American Equity Investment Life Insurance Company of New York for the period ending
December 31, 2010. This exam is anticipated to be completed in 2013.
The payment of dividends or the distributions, including surplus note payments, by our life subsidiaries is subject to regulation by each subsidiary's
state of domicile's insurance department. Currently, American Equity Life may pay dividends or make other distributions without the prior
approval of the Iowa Insurance Commissioner, unless such payments, together with all other such payments within the preceding twelve months,
exceed the greater of (1) American Equity Life's statutory net gain from operations for the preceding calendar year, or (2) 10% of American
Equity Life's statutory surplus at the preceding December 31. For 2013, up to $99.2 million can be distributed as dividends by American Equity
Life without prior approval of the Iowa Insurance Commissioner. In addition, dividends and surplus note payments may be made only out of
earned surplus, and all surplus note payments are subject to prior approval by regulatory authorities. American Equity Life had $710.4 million
of statutory earned surplus at December 31, 2012.
Most states have also enacted regulations on the activities of insurance holding company systems, including acquisitions, extraordinary dividends,
the terms of surplus notes, the terms of affiliate transactions and other related matters. We are registered pursuant to such legislation in Iowa.
A number of state legislatures have also considered or have enacted legislative proposals that alter and, in many cases, increase the authority of
state agencies to regulate insurance companies and holding company systems.
Most states, including Iowa and New York where our life subsidiaries are domiciled, have enacted legislation or adopted administrative regulations
affecting the acquisition of control of insurance companies as well as transactions between insurance companies and persons controlling them.
The nature and extent of such legislation and regulations currently in effect vary from state to state. However, most states require administrative
approval of the direct or indirect acquisition of 10% or more of the outstanding voting securities of an insurance company incorporated in the
6
state. The acquisition of 10% of such securities is generally deemed to be the acquisition of "control" for the purpose of the holding company
statutes and requires not only the filing of detailed information concerning the acquiring parties and the plan of acquisition, but also administrative
approval prior to the acquisition. In many states, the insurance authority may find that "control" in fact does not exist in circumstances in which
a person owns or controls more than 10% of the voting securities.
Historically, the federal government has not directly regulated the business of insurance. However, 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. Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the
"Dodd-Frank Act") generally provides for enhanced federal supervision of financial institutions, including insurance companies in certain
circumstances, and financial activities that represent a systemic risk to financial stability or the U.S. economy. Under the Dodd-Frank Act, a
Federal Insurance Office has been established within the U.S. Treasury Department to monitor all aspects of the insurance industry and its
authority will likely extend to our business, although the Federal Insurance Office is not empowered with any general regulatory authority over
insurers. The director of the Federal Insurance Office serves in an advisory capacity to the newly established Financial Stability Oversight
Council and will have the ability to recommend that an insurance company be subject to heightened prudential standards by the Federal Reserve,
if it is determined that financial distress at the company could pose a threat to financial stability in the U.S. The Dodd-Frank Act also provides
for the preemption of state laws when inconsistent with certain international agreements.
State insurance regulators and the National Association of Insurance Commissioners ("NAIC") are continually reexamining existing laws and
regulations and developing new legislation for the passage by state legislatures and new regulations for adoption by insurance authorities.
Proposed laws and regulations or those still under development pertain to insurer solvency and market conduct and in recent years have focused
on:
•
•
•
•
•
•
•
•
insurance company investments;
risk-based capital ("RBC") guidelines, which consist of regulatory targeted surplus levels based on the relationship of statutory capital
and surplus, with prescribed adjustments, to the sum of stated percentages of each element of a specified list of company risk exposures;
the implementation of non-statutory guidelines and the circumstances under which dividends may be paid;
principles-based reserving;
product approvals;
agent licensing;
underwriting practices; and
life insurance and annuity sales practices.
The NAIC's RBC requirements 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. The RBC formula defines a minimum capital standard which
supplements low, fixed minimum capital and surplus requirements previously implemented on a state-by-state basis. Such requirements are not
designed as a ranking mechanism for adequately capitalized companies.
The NAIC's RBC requirements provide for four levels of regulatory attention depending on the ratio of a company's total adjusted capital to its
RBC. Adjusted capital is defined as the total of statutory capital and surplus, asset valuation reserve and certain other adjustments. Calculations
using the NAIC formula at December 31, 2012, indicated that American Equity Life's ratio of total adjusted capital to the highest level at which
regulatory action might be initiated was 332%.
Our life subsidiaries also may be 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. These assessments may be deferred or
forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future
premium taxes. Assessments related to business reinsured for periods prior to the effective date of the reinsurance are the responsibility of the
ceding companies.
Federal Income Tax
The annuity and life insurance products that we market generally provide the policyholder with a federal income tax advantage, as compared to
certain other savings investments such as certificates of deposit and taxable bonds, in that federal income taxation on any increases in the contract
values (i.e., the "inside build-up") of these products is deferred until it is received by the policyholder. With other savings investments, 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 advantage described above for annuities and life insurance. If legislation were enacted to eliminate 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 an individual retirement account or other 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 the entire 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.
7
Employees
As of December 31, 2012, we had 399 full-time employees. We have experienced no work stoppages or strikes and consider our relations with
our employees to be excellent. None of our employees are represented by a union.
ITEM 1A. RISK FACTORS
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.
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 governed by 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.
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.
8
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 withdrawal penalties 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.
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 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.
9
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, 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:
•
•
•
our investment portfolio could incur additional other than temporary impairments;
our commercial mortgage loans could experience a greater amount of loss;
due to potential downgrades in our investment portfolio, we could be required to raise additional capital to sustain our current business
in force and new sales of our annuity products, which may be difficult in a distressed market. If capital would be available, it may be
at terms that are not favorable to us;
• we may be required to limit growth in sales of our annuity products; and/or
•
our liquidity could be negatively affected and we could be forced to limit our operations and our business could suffer, as we need
liquidity to pay our policyholder benefits, operating expenses, dividends on our capital stock, and to service our debt obligations.
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 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.
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While we compete with numerous other companies, we view the following as our most significant competitors:
Security Benefit Life;
• Allianz Life Insurance Company of North America;
• Aviva USA;
•
• Great American Life Insurance Company;
• Midland National Life Insurance Company; and
• North American Company for Life and Health Insurance.
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 under perform 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 covering $1.0 billion of policy benefit reserves at December 31, 2012 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 December 31, 2012. 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.
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:
• We must present the call options purchased to fund the annual index credits on our fixed index annuity products at fair value. The fair
value of the call options is based upon the amount of cash that would be required to settle the call options obtained from the counterparties
adjusted for the nonperformance risk of the counterparty. We record the change in fair value of these options as a component of our
revenues. The change in fair value of derivatives includes the gains or losses recognized at expiration of the option term or upon early
termination and changes in fair value for open positions.
•
The contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected life of
the applicable contracts. Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases
in equity market performance and changes in the interest rates used to discount the excess of the projected policy contract values over
the projected minimum guaranteed contract values. We record the change in fair value of these embedded derivatives as a component
of our benefits and expenses in our consolidated statements of operations.
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.
11
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.
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.
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.
12
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 included over 60 national marketing organizations and
over 20,000 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. For the purpose of supporting 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 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.
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 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.
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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 affect 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 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 note 13 to our
consolidated financial statements.
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 and a "BB+" rating from Standard & Poor's. 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.
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.
14
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.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease commercial office space in one building in West Des Moines, Iowa, for our principal offices under an operating lease that expires on
November 21, 2021. We also lease our office in Pell City, Alabama, pursuant to an operating lease that expires on December 31, 2013. We are
fully utilizing these facilities and believe both locations to be sufficient to house our operations for the foreseeable future.
Item 3. Legal Proceedings
See Note 13 of the Notes to Consolidated Financial Statements.
Item 4. Mine Safety Disclosures
None
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange ("NYSE") under the symbol AEL. The following table sets forth the high and
low prices of our common stock as quoted on the NYSE.
2012
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2011
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
Low
$13.09
$12.95
$12.41
$12.40
$13.93
$13.53
$13.22
$11.82
$10.13
$10.00
$10.62
$10.56
$11.27
$11.91
$8.01
$8.05
As of February 22, 2013, there were approximately 10,300 holders of our common stock. In 2012 and 2011, we paid an annual cash dividend
of $0.15 and $0.12, respectively, per share on our common stock. We intend to continue to pay an annual cash dividend on such shares so long
as we have sufficient capital and/or future earnings to do so. However, we anticipate retaining most of our future earnings, if any, for use in our
operations and the expansion of our business. Any further determination as to dividend policy will be made by our board of directors and will
depend on a number of factors, including our future earnings, capital requirements, financial condition and future prospects and such other factors
as our board of directors may deem relevant.
Since we are a holding company, our ability to pay cash dividends depends in large measure on our subsidiaries' ability to make distributions of
cash or property to us. Iowa insurance laws restrict the amount of distributions American Equity Life can pay to us without the approval of the
Iowa Insurance Commissioner. See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 12 of
the Notes to Consolidated Financial Statements, which are incorporated by reference in this Item 5.
Issuer Purchases of Equity Securities
There were no issuer purchases of equity securities for the quarter ended December 31, 2012.
In addition, in November 2011, our board of directors approved a share repurchase program authorizing us to repurchase up to 10,000,000 shares
of our common stock. As of December 31, 2012, no shares had been repurchased under this program.
15
Item 6. Selected Consolidated Financial Data
The summary consolidated financial and other data should be read in conjunction with Management's Discussion and Analysis of Financial
Condition and Results of Operations and our audited consolidated financial statements and related notes appearing elsewhere in this report. The
results for past periods are not necessarily indicative of results that may be expected for future periods.
Consolidated Statements of Operations Data:
Revenues
Annuity product charges
Net investment income
Change in fair value of derivatives
Net realized gains (losses) on investments, excluding
other than temporary impairment ("OTTI") losses
Net OTTI losses recognized in operations
Total revenues
Benefits and expenses
Interest sensitive and index product benefits
Change in fair value of embedded derivatives
Amortization of deferred sales inducements and
policy acquisition costs
Interest expense on notes payable and subordinated
debentures
Interest expense on amounts due under repurchase
agreements
Other operating costs and expenses
Total benefits and expenses
Income before income taxes
Income tax expense
Net income
Per Share Data:
Year ended December 31,
2012
2011
2010
2009
2008
(Dollars in thousands, except per share data)
$
89,006
$
76,189
$
69,075
$
63,358
$
1,286,923
221,138
(6,454)
(14,932)
1,218,780
(114,728)
(18,641)
(33,976)
1,036,106
168,862
23,726
(23,867)
932,172
216,896
51,279
(86,771)
1,588,558
1,139,775
1,285,592
1,188,913
818,087
286,899
775,757
(105,194)
733,218
130,950
347,883
529,508
52,671
822,077
(372,009)
5,555
(192,648)
337,904
205,131
(210,753)
252,076
215,259
192,261
128,008
157,443
41,937
—
95,495
1,502,569
85,989
28,191
57,798
45,610
30
67,529
1,006,861
132,914
46,666
86,248
37,031
—
114,615
1,220,326
65,266
22,333
42,933
30,672
534
57,255
1,102,749
86,164
17,634
68,530
39,218
8,207
52,633
260,851
77,053
61,106
15,947
0.30
0.30
0.07
Earnings per common share
$
Earnings per common share—assuming dilution
Dividends declared per common share
$
0.94
0.89
0.15
$
1.45
1.37
0.12
$
0.73
0.68
0.10
$
1.22
1.18
0.08
Non-GAAP Financial Measures (a):
Reconciliation of net income to operating income:
Net income
$
57,798
$
86,248
$
42,933
$
68,530
$
15,947
Net realized gains (losses) and net OTTI losses on
investments, net of offsets
Net effect of derivatives, embedded derivatives and
other index annuity, net of offsets
Convertible debt extinguishment, net of income taxes
Effect of counterparty default, net of offsets
Litigation reserve, net of offsets
Operating income
Operating income per common share
$
$
Operating income per common share—assuming dilution
8,648
34,161
—
—
9,580
110,187
1.80
1.69
18,354
29,051
—
—
—
$
$
$
$
133,653
2.25
2.12
379
(1,339)
92,524
38,167
171
—
27,297
108,947
1.86
1.70
$
$
29,952
687
3,948
—
101,778
1.81
1.75
$
$
(31,038)
(5,702)
741
—
72,472
1.35
1.30
16
Consolidated Balance Sheet Data:
Total investments
Total assets
Policy benefit reserves
Notes payable
Subordinated debentures
Accumulated other comprehensive income (loss)
("AOCI")
Total stockholders' equity
Other Data:
Life subsidiaries' statutory capital and surplus and asset
valuation reserve
Life subsidiaries' statutory net gain from operations
before income taxes and realized capital gains (losses)
Life subsidiaries' statutory net income (loss)
As of and for the Year Ended December 31,
2012
2011
2010
2009
2008
(Dollars in thousands, except per share data)
$
27,537,210
$
24,383,451
$
19,816,931
$
15,374,110
$
12,719,605
35,133,478
31,773,988
309,869
245,869
686,807
1,720,237
30,874,719
28,118,716
297,608
268,593
457,229
1,408,679
26,426,763
23,655,807
330,835
268,435
81,820
938,047
21,312,004
19,336,221
316,468
268,347
17,081,740
15,809,539
247,750
268,209
(30,456)
754,623
(147,376)
496,844
1,741,637
1,655,205
1,456,679
1,239,651
1,011,682
182,057
79,644
344,538
167,925
322,133
172,865
253,146
116,895
129,046
(7,073)
9.46
12.27
Book value per share (b)
$
27.46
$
23.82
$
16.07
$
13.08
$
Book value per share, excluding AOCI (b)
16.49
16.09
14.67
13.61
____________________
(a) In addition to net income, we have consistently utilized operating income, operating income per common share and operating income per
common share—assuming dilution, non-GAAP financial measures commonly used in the life insurance industry, as economic measures
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.
(b) Book value per share and book value per share excluding AOCI is calculated as total stockholders' equity and total stockholders' equity
excluding AOCI divided by the total number of shares of common stock outstanding. AOCI fluctuates from year to year due to unrealized
changes in the fair value of available for sale investments. Shares outstanding include shares held by the NMO Deferred Compensation
Trust and exclude unallocated shares held by our employee stock ownership plan—see note 11 to our audited consolidated financial
statements.
17
Item 7. 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, and our consolidated results
of operations for the three years in the period ended December 31, 2012, and where appropriate, factors that may affect future financial
performance. This discussion should be read in conjunction with our audited consolidated financial statements, notes thereto and selected
consolidated financial data appearing elsewhere in this report.
Cautionary Statement Regarding Forward-Looking Information
All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the 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. We caution that these statements may and often do vary from actual results and the differences between
these statements and actual results can be material. Accordingly, we cannot assure you that actual results will not differ materially from those
expressed or implied by the forward-looking statements. Factors that could contribute to these differences 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, which could result in impairments and other than temporary impairments, and certain liabilities, and
the lapse rate and profitability of policies;
customer response to new products and marketing initiatives;
changes in the 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; and
the risk factors or uncertainties listed from time to time in our filings with the SEC.
For a detailed discussion of these and other factors that might affect our performance, see Item 1A of this report.
Executive Summary
Since our formation in 1995, we have emphasized industry leading customer service to both our distribution force and our policyholders. We
believe this to be a major part of our ability to attract production from our independent agent network as well as maintain a low rate of policy
surrenders. Excellent customer service teamed with our ability to design innovative insurance products that provide principal protection and
tax deferred growth have continued to result in significant sales of our annuity products. In 2012, as we have done the last four years, we achieved
sales in excess of $3.6 billion, which has resulted in cash and investments in excess of $28 billion at December 31, 2012, in only 17 years of
operations. We have applied a conservative investment strategy to the annuity deposits we continue to manage which has provided reliable
returns on our invested assets. Our profitability has also been driven by maintaining an efficient operation.
We are currently in the midst of an unprecedented period of low interest rates. In response to this persistent 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. Accordingly,
the benefit from the renewal rate reductions did not have a material impact on 2011 spread results. 2012 spread results reflect the benefit from
these reductions; however, the reductions in cost of money were 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. Rates on new sales were again reduced
by approximately 0.25% beginning with applications received after December 5, 2012.
Our investment spread in 2012 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 (see Our Business and Profitability). 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. In 2011, we had $3.1 billion in such securities called and purchased $3.7 billion for a $600 million net purchase of
callable government agency securities. However, in the current interest rate environment, we have been reluctant to reinvest the call redemption
proceeds in government agency securities and have 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. We ended the year with $2.2 billion in excess cash and
other short-term investments. While high levels of excess cash and other short-term investments may persist for several more quarters, the
average quarterly balances should decline in 2013 due to reinvestment of year end cash and other short-term investments into longer term
securities and reduced exposure to callable securities in 2013. See Results of Operations - Net investment income for additional information
regarding our excess liquidity.
In 2012, our financial position strengthened by the redemption of $22 million principal amount of convertible junior subordinated debentures.
This debt carried an interest rate of 8% and most of the outstanding debt was converted to shares of our common stock (see note 10 to our
consolidated financial statements).
18
Our Business and Profitability
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 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.
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.
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:
Average yield on invested assets
Aggregate cost of money
Aggregate investment spread
Impact of:
Investment yield - additional prepayment income
Cost of money benefit from over hedging
Year Ended December 31,
2011
5.80%
2.77%
3.03%
—%
0.06%
2010
6.06%
2.91%
3.15%
(0.04)%
0.10%
2012
5.28%
2.58%
2.70%
0.06%
0.01%
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 Policies—Deferred 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 Policies—Policy Liabilities for Fixed Index Annuities and Financial Condition—Derivative Instruments.
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.
19
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:
Product Type
2012
2011
2010
Year Ended December 31,
(Dollars in thousands)
Fixed index annuities:
Index strategies
Fixed strategy
Fixed rate annuities:
Single-year rate guaranteed
Multi-year rate guaranteed
Single premium immediate annuities
Total before coinsurance ceded
Coinsurance ceded
$
2,225,902
$
2,839,295
$
2,401,891
1,208,324
3,434,226
98,821
249,228
164,657
512,706
3,946,932
203,734
1,377,987
4,217,282
169,304
397,925
305,603
872,832
5,090,114
326,531
1,551,007
3,952,898
160,077
384,116
171,628
715,821
4,668,719
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 decreases 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.
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.
20
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) $
Increased (decreased) amortization of deferred policy acquisition costs
Increased (decreased) net income
3,738
(2,243)
(9,132)
9,088
270
1,683
(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 note 13 to our consolidated financial statements. In 2010, we recognized the cost to
settle a class action lawsuit which included a settlement benefit to 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 Item 6. Selected 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.
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, fair value
changes in derivatives and embedded derivatives, loss on extinguishment of convertible debt, and the expense to establish litigation reserves or
settle class action lawsuits. 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 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.
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 in Item 6. Selected Consolidated Financial Data 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 in Item 6. Selected Consolidated Financial
Data 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 in Item 6. Selected Consolidated Financial Data relate primarily
to changes in the interest rates used to discount the embedded derivative liabilities.
21
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) $
Increased (decreased) amortization of deferred policy acquisition costs
Increased (decreased) operating income
7,288
(6,285)
(12,106)
12,498
305
1,430
(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 previously.
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.
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:
Call options:
Gain on option expiration
Change in unrealized gain (loss)
2015 notes hedges
Interest rate swaps
Interest rate caps
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
$
$
80,782
$
155,359
$
147,828
(2,488)
(4,261)
(723)
(248,941)
(21,002)
(144)
—
208,881
(67,078)
29,595
(2,536)
—
221,138
$
(114,728) $
168,862
22
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:
S&P 500 Index
Point-to-point strategy
Monthly average strategy
Monthly point-to-point strategy
Fixed income (bond index) strategies
Year Ended December 31,
2012
2011
2010
0.0% - 12.8%
0.0% - 19.3%
0.0% - 18.0%
1.6% - 10.0%
0.0% - 25.0%
0.0% - 15.5%
0.0% - 16.5%
1.3% - 10.0%
1.9% - 68.6%
0.4% - 51.2%
0.0% - 23.7%
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 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 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 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 the Change in fair value of embedded derivatives. 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. 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:
Available for sale fixed maturity securities:
Gross realized gains
Gross realized losses
Equity securities:
Gross realized gains
Gross realized losses
Mortgage loans on real estate:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
$
10,906
$
12,614
$
(562)
10,344
(1,423)
11,191
562
—
562
966
—
966
27,755
(2,575)
25,180
14,384
(71)
14,313
Increase in allowance for credit losses
(16,832)
(30,770)
(15,225)
Other investments:
Gains on sale of real estate
Impairment losses
5,149
(5,677)
(528)
377
(405)
(28)
—
(542)
(542)
$
(6,454) $
(18,641) $
23,726
See note 4 to our audited consolidated financial statements for additional discussion of allowance for credit losses recognized on mortgage loans
on real estate.
Net OTTI losses recognized in operations decreased to $14.9 million in 2012 and increased to $34.0 million in 2011 from $23.9 million in
2010. The impairments recognized in 2012, 2011 and 2010 were primarily on residential mortgage backed securities and were principally due
to changes of assumptions regarding loss severity of a number of securities we hold which affected our ongoing analysis of expected cash flow
projections. See Financial Condition—Investments for additional discussion of write downs of securities for other than temporary impairments.
23
Interest sensitive and index product benefits increased 5% to $818.1 million in 2012 and 6% to $775.8 million in 2011 from $733.2 million
in 2010. The components of interest credited to account balances are summarized as follows:
Index credits on index policies
Interest credited (including changes in minimum guaranteed interest for
fixed index annuities)
Living income benefit rider
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
447,393
$
448,248
$
454,660
328,729
41,965
302,691
24,818
818,087
$
775,757
$
265,539
13,019
733,218
$
$
The changes in 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 were $447.2 million, $454.2 million and $438.4 million for the years
ended December 31, 2012, 2011 and 2010, respectively. The increases in interest credited for 2012 and 2011 were due to an increase in the
average 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 16% to $26.0 billion in 2012 and 24% to $22.4 billion in 2011 from
$18.1 billion in 2010. The increases in interest credited were due to an increase in the average amount of annuity liabilities outstanding that
receive a fixed rate of interest. The increases in benefits recognized for living income benefit rider were due to increases in the number of
policies with lifetime income benefit riders and correlates to the increase in fees discussed in Annuity product charges.
Amortization of deferred sales inducements increased 21% to $87.2 million in 2012 and 20% to $71.8 million in 2011 from $59.9 million in
2010. In general, amortization of deferred sales inducements has been increasing each year due to growth in our annuity business and the deferral
of sales inducements incurred with respect to sales of premium bonus annuity products. Bonus products represented 97%, 95% and 95% of our
total annuity deposits during 2012, 2011 and 2010, respectively. 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 the net realized gains (losses) on investments and net OTTI losses recognized in operations and, in 2012 and 2010,
amortization associated with litigation liabilities. 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 will 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 expected lives of the contracts which typically exceed ten years. Amortization of deferred sales
inducements is summarized as follows:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
Amortization of deferred sales inducements before gross profit adjustments
$
136,254
$
116,938
$
99,938
Gross profit adjustments:
Fair value accounting for derivatives and embedded derivatives
(45,010)
(35,498)
(39,213)
Net realized losses on investments, net OTTI losses recognized in operations
and litigation liability
(4,087)
(9,659)
Amortization of deferred sales inducements after gross profit adjustments
$
87,157
$
71,781
$
(852)
59,873
See Net income and Operating income (a non-GAAP financial measure) above for discussion of the impact of unlocking on amortization of
deferred sales inducements for the years ended December 31, 2012, 2011 and 2010. See Critical Accounting Policies - Deferred Policy Acquisition
Costs and Deferred Sales Inducements.
Change in fair value of embedded derivatives primarily relates to the 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 Policies - Policy Liabilities for Fixed
Index Annuities. The primary reasons for the increase in the change in fair value of the embedded derivatives during 2012 were increases in
the expected index credits that resulted from increases in the fair value of the call options acquired to fund these index credits and decreases in
the discount rates used in estimating our liability for policy growth. The primary reason for the decrease in the change in fair value of embedded
derivatives in 2011 was a decrease in the expected index credits on the next policy anniversary dates which is correlated with the change in fair
value of call options acquired to fund those index credits, offset by decreases in the discount rates used in estimating the liability for policy
growth. The primary reason for the increase in the change in fair value of fixed index annuity embedded derivatives in 2010 was decreases in
the discount rates used in estimating our liability for policy growth offset in part by decreases in the expected index credits which correlated
with the decrease in the change in fair value of derivatives for 2010. The 2012, 2011 and 2010 changes include decreases of $2.5 million and
$21.0 million and an increase of $29.6 million, respectively, in the fair value of the 2015 notes embedded conversion derivative. As discussed
previously, these amounts were offset by a comparable decrease or increase in the fair value of the 2015 notes hedges.
24
Interest expense on notes payable decreased 10% to $28.5 million in 2012 and increased 43% to $31.6 million in 2011 from $22.1 million in
2010. The decrease in 2012 was primarily due to the extinguishment of $46.3 million principal amount of the 2024 notes at par as holders
required us to repurchase the notes at the initial put date of December 15, 2011. The 2011 increase was primarily due to the September 2010
issuance of $200 million principal amount of 3.50% convertible senior notes. The 2011 increase in interest expense from the convertible notes
was partially offset by a decrease in interest expense on borrowings under our revolving line of credit with banks. The weighted average interest
rate was 1.10% and the average borrowings outstanding was $108.5 million for the year ended December 31, 2010. We had no borrowings on
the revolving line of credit during the years ended December 31, 2012 and 2011. See note 9 to our audited consolidated financial statements.
Interest expense on subordinated debentures decreased 4% to $13.5 million in 2012 and 6% to $14.0 million in 2011 from $14.9 million in
2010. These decreases were primarily due to decreases in the weighted average interest rates on the outstanding subordinated debentures which
were 4.75%, 5.11% and 5.47% for 2012, 2011 and 2010, respectively, and partially due to the redemption of $22 million principal amount of
our 8% Convertible Junior Subordinated Debentures in 2012 (see note 10 to our audited consolidated financial statements). The weighted average
interest rates have decreased because $169.6 million principal amount of the subordinated debentures have a floating rate of interest based upon
the three month London Interbank Offered Rate plus an applicable margin. See Financial Condition—Liabilities.
Amortization of deferred policy acquisition costs increased 15% to $164.9 million in 2012 and 5% to $143.5 million in 2011 from $136.4
million in 2010. In general, amortization of deferred policy acquisition costs has been increasing each year 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 with net realized gains (losses) on investments and net OTTI losses recognized in
operations and, in 2012 and 2010, the amortization associated with litigation liabilities.
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:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
Amortization of deferred policy acquisition costs before gross profit adjustments
$
224,773
$
203,296
$
189,134
Gross profit adjustments:
Fair value accounting for derivatives and embedded derivatives
(53,296)
(45,360)
(48,332)
Net realized losses on investments, net OTTI losses recognized in operations
and litigation liability
(6,558)
(14,458)
(4,414)
Amortization of deferred policy acquisition costs after gross profit adjustments
$
164,919
$
143,478
$
136,388
See Net income and Operating income (a non-GAAP financial measure) above for discussion of the impact of unlocking on amortization of
deferred policy acquisition costs for the years ended December 31, 2012, 2011 and 2010. See Critical Accounting Policies - Deferred Policy
Acquisition Costs and Deferred Sales Inducements.
Other operating costs and expenses increased 41% to $95.5 million in 2012 and decreased 41% to $67.5 million in 2011 from $114.6 million
in 2010. The increase in 2012 includes the $17.5 million estimated litigation liability that was accrued in the third quarter and was recognized
in other operating costs and expenses. Other operating expenses also increased $9.1 million during 2012 due to a change in accounting which
we adopted prospectively effective January 1, 2012 for the types of costs that may be capitalized as acquisition costs of new and renewal insurance
contracts (see note 1 to our consolidated financial statements). The decrease in operating expenses in 2011 was principally attributable to a
litigation settlement accrual of $48 million which was recorded in the fourth quarter of 2010 related to the settlement of a class action lawsuit.
Other operating costs and expenses net of litigation settlements and the change in accounting are primarily affected by increases in salaries and
benefits, marketing expenses and general operating expenses due to the growth of our business as well as the fluctuation in legal expense for
the cost of defense of on-going litigation. Other operating costs and expenses excluding the litigation settlement and change in accounting
discussed previously increased 2% to $68.9 million in 2012 and 1% to $67.5 million in 2011.
Legal expenses decreased $4.8 million in 2011 compared to 2010. An elevated level of legal expense was incurred in 2010 related to the defense
of a class action lawsuit which had moved into the trial phase during 2010 and ended with the settlement agreement referred to above. Salaries
and benefits increased $2.5 million in 2011 compared to 2010. The increase in salaries and benefits for 2011 was due to an increased number
of employees due to growth in our business.
Income tax expense decreased in 2012 primarily because of the decrease in income before income taxes. Income tax expense increased in 2011
primarily because of the increase in income before income taxes. The effective income tax rates were 32.8%, 35.1% and 34.2% for 2012, 2011
and 2010, respectively.
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 (loss) 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
25
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 year to year based primarily on the relative size of pretax income (loss) from the two sources. The effective income tax rate decreased in
2012 due to new sources of net investment income that are exempt from Federal income tax. Although these sources of tax exempt net investment
income will continue in the future, our sources of taxable income may grow at a faster rate and our effective income tax rate in the future may
approach the 35.6% effective rate of our life insurance income.
Financial Condition
Investments
Our investment strategy is to maintain a predominantly investment grade fixed income portfolio, provide adequate liquidity to meet our cash
obligations to policyholders and others and maximize current income and total investment return through active investment management.
Consistent with this strategy, our investments principally consist of fixed maturity securities and mortgage loans on real estate.
Insurance statutes regulate the type of investments that our life subsidiaries are permitted to make and limit the amount of funds that may be
used for any one type of investment. In light of these statutes and regulations and our business and investment strategy, we generally seek to
invest in United States government and government-sponsored agency securities, corporate securities and United States municipalities, states
and territories securities rated investment grade by established nationally recognized statistical rating organizations ("NRSRO's") or in securities
of comparable investment quality, if not rated and commercial mortgage loans on real estate.
The composition of our investment portfolio is summarized as follows:
December 31,
2012
2011
Carrying
Amount
Percent
Carrying
Amount
Percent
(Dollars in thousands)
Fixed maturity securities:
United States Government full faith and credit
$
5,154
—% $
4,678
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Total fixed maturity securities
Equity securities
Mortgage loans on real estate
Derivative instruments
Other investments
1,772,025
3,578,323
105,259
14,542,860
2,888,113
357,982
998,508
24,248,224
53,422
2,623,940
415,258
196,366
6.5%
13.0%
0.4%
52.8%
10.5%
1.3%
3.6%
88.1%
0.2%
9.5%
1.5%
0.7%
4,368,053
3,333,383
68,333
10,167,188
2,703,290
—
463,390
21,108,315
62,845
2,823,047
273,314
115,930
—%
17.9%
13.7%
0.3%
41.7%
11.1%
—%
1.9%
86.6%
0.2%
11.6%
1.1%
0.5%
$
27,537,210
100.0% $
24,383,451
100.0%
During 2012 and 2011, we received $4.6 billion and $3.2 billion, respectively, in net redemption proceeds related to calls of our callable United
States Government sponsored agency securities, of which $2.6 billion and $0.2 billion, respectively, were classified as held for investment. The
proceeds from these redemptions that have been reinvested have primarily been in United States Government sponsored agencies, corporate
securities, commercial mortgage backed securities and other asset backed securities classified as available for sale. For the remaining amount
to be reinvested we are considering further diversification into other asset classes, but we remain committed to maintaining a high quality
investment portfolio with low credit risk. At December 31, 2012, 28% of our fixed income securities have call features and 0.4% ($0.1 billion)
were subject to call redemption. Another 7% ($1.5 billion) will become subject to call redemption during 2013, of which $727 million are short-
term U.S. Government agency securities with a book yield of 0.85%.
Fixed Maturity Securities
Our fixed maturity security portfolio is managed to minimize risks such as interest rate changes and defaults or impairments while earning a
sufficient and stable return on our investments. Historically, we have had a high percentage of our fixed maturity securities in U.S. Government
sponsored agency securities (for the most part Federal Home Loan Mortgage Corporation and Federal National Mortgage Association). While
U.S. Government sponsored agency securities are of high credit quality, the call features have resulted in our excess cash position. These calls
resulted from the low interest rate and tight agency spread environment. Since 2007, when we had almost 80% of our fixed maturity portfolio
invested in callable agencies, we have reallocated a significant portion of our fixed maturities from the callable agency securities to other highly
rated, long-term securities. The largest portion of our fixed maturity securities are now in investment grade (NAIC designation 1 or 2) publicly
traded or privately placed corporate securities. We have also built a portfolio of residential mortgage backed securities ("RMBS") that provide
26
our investment portfolio a source of regular cash flow and higher yielding assets than our agency securities. Beginning in 2009, we have acquired
a portfolio of taxable bonds issued by municipalities, states and territories of the United States that provide us with attractive yields while being
consistent with our aversion to credit risk. In 2012, we have increased our position in other asset backed securities as well as establishing a
position in commercial mortgage backed securities.
A summary of our fixed maturity securities by NRSRO ratings is as follows:
Rating Agency Rating
Aaa/Aa/A
Baa
Total investment grade
Ba
B
Caa and lower
In or near default
Total below investment grade
December 31,
2012
2011
Carrying
Amount
Percent of
Fixed Maturity
Securities
Carrying
Amount
Percent of
Fixed Maturity
Securities
$
14,613,775
60.3% $
14,777,524
(Dollars in thousands)
8,190,220
22,803,995
365,102
79,789
862,650
136,688
1,444,229
33.8%
94.1%
1.5%
0.3%
3.5%
0.6%
5.9%
4,945,809
19,723,333
257,585
169,112
858,694
99,591
1,384,982
70.0%
23.4%
93.4%
1.2%
0.8%
4.1%
0.5%
6.6%
$
24,248,224
100.0% $
21,108,315
100.0%
The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day credit quality assessment and valuation of securities owned
by state regulated insurance companies. Insurance companies report ownership of securities to the SVO when such securities are eligible for
regulatory filings. The SVO conducts credit analysis on these securities for the purpose of assigning an NAIC designation and/or unit price.
Typically, if a security has been rated by an NRSRO, the SVO utilizes that rating and assigns an NAIC designation based upon the following
system:
NAIC Designation
NRSRO Equivalent Rating
1
2
3
4
5
6
Aaa/Aa/A
Baa
Ba
B
Caa and lower
In or near default
Since 2009, the NAIC has utilized a process to assess non-agency RMBS that does not rely on NRSRO ratings. The NAIC retained the services
of PIMCO Advisory to model each non-agency RMBS owned by U.S. insurers at year-end 2012 and 2011. PIMCO Advisory has provided 5
prices for each security for life insurance companies to utilize in determining the NAIC designation for each RMBS based on each insurer's
statutory book value price. This process is used to determine the level of RBC requirements for non-agency RMBS. In 2010, the NAIC retained
the services of BlackRock Solutions to model each non-agency CMBS to determined the level of RBC requirements for non-agency CMBS in
a manner similar to that utilized by PIMCO Advisory for RMBS.
A summary of our fixed maturity securities by NAIC designation is as follows:
December 31, 2012
December 31, 2011
NAIC
Designation
Amortized
Cost
Fair Value
Carrying
Amount
Percentage
of Total
Carrying
Amount
Amortized
Cost
Fair Value
Carrying
Amount
(Dollars in thousands)
(Dollars in thousands)
$ 13,737,381
$ 15,250,560
$ 15,250,560
62.9% $ 14,359,272
$ 15,486,571
$ 15,469,765
7,838,186
8,533,121
8,533,121
35.2%
4,894,739
5,272,759
5,272,759
398,294
53,879
—
5,375
387,222
56,151
—
6,603
401,789
56,151
—
6,603
1.7%
0.2%
—%
—%
335,642
26,674
4,932
3,226
315,406
23,989
5,756
4,050
331,996
23,989
5,756
4,050
1
2
3
4
5
6
Percentage
of Total
Carrying
Amount
73.3%
25.0%
1.6%
0.1%
—%
—%
$ 22,033,115
$ 24,233,657
$ 24,248,224
100.0% $ 19,624,485
$ 21,108,531
$ 21,108,315
100.0%
27
A summary of our RMBS by collateral type and split by NAIC designation, as well as a separate summary of securities for which we have
recognized OTTI and those which we have not yet recognized any OTTI is as follows as of December 31, 2012:
Collateral Type
OTTI has not been recognized
Government agency
Prime
Alt-A
OTTI has been recognized
Prime
Alt-A
Total by collateral type
Government agency
Prime
Alt-A
Total by NAIC designation
1
2
3
4
6
$
$
$
$
$
$
$
Principal
Amount
Amortized
Cost
Fair Value
(Dollars in thousands)
1,052,139
$
1,024,731
$
1,119,249
$
$
$
$
$
$
862,805
40,631
1,955,575
600,945
419,868
1,020,813
1,052,139
1,463,750
460,499
2,976,388
2,477,404
415,472
48,054
31,612
3,846
$
$
$
$
$
$
821,727
41,164
1,887,622
523,048
332,867
855,915
1,024,731
1,344,775
374,031
2,743,537
2,303,619
365,763
43,778
27,900
2,477
877,356
41,685
2,038,290
515,385
334,438
849,823
1,119,249
1,392,741
376,123
2,888,113
2,447,562
364,421
44,734
29,584
1,812
$
2,976,388
$
2,743,537
$
2,888,113
The amortized cost and fair value of fixed maturity securities at December 31, 2012, by contractual maturity are presented in Note 3 to our
audited consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7.
28
Unrealized Losses
The amortized cost and fair value of fixed maturity securities and equity securities that were in an unrealized loss position were as follows:
Number of
Securities
Amortized
Cost
Unrealized
Losses
Fair Value
(Dollars in thousands)
December 31, 2012
Fixed maturity securities, available for sale:
United States Government sponsored agencies
United States municipalities, states and territories
Corporate securities:
Finance, insurance and real estate
Manufacturing, construction and mining
Utilities and related sectors
Wholesale/retail trade
Services, media and other
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Fixed maturity securities, held for investment:
Corporate security:
Insurance
Equity securities, available for sale:
Services
December 31, 2011
Fixed maturity securities, available for sale:
United States municipalities, states and territories
Foreign government obligations
Corporate securities:
Finance, insurance and real estate
Manufacturing, construction and mining
Utilities and related sectors
Wholesale/retail trade
Services, media and other
Residential mortgage backed securities
Other asset backed securities
Fixed maturity securities, held for investment:
Corporate security:
Insurance
Equity securities, available for sale:
Finance, insurance and real estate
6
8
19
34
20
11
19
56
12
11
$
977,196
$
(3,468) $
24,518
(125)
276,235
453,679
269,667
113,032
267,506
508,576
163,565
174,342
(12,564)
(5,584)
(9,399)
(992)
(3,085)
(27,728)
(1,983)
(2,973)
973,728
24,393
263,671
448,095
260,268
112,040
264,421
480,848
161,582
171,369
196
$
3,228,316
$
(67,901) $
3,160,415
1
$
76,088
$
(14,567) $
61,521
1
$
10,125
$
(1,403) $
8,722
1
1
52
31
28
4
9
95
17
$
3,545
$
14,524
562,449
226,113
226,551
26,180
47,937
1,077,045
136,703
(10) $
(242)
3,535
14,282
(52,186)
(8,758)
(14,522)
(1,382)
(3,144)
(72,081)
(5,611)
510,263
217,355
212,029
24,798
44,793
1,004,964
131,092
238
$
2,321,047
$
(157,936) $
2,163,111
1
$
75,932
$
(16,590) $
59,342
7
$
28,123
$
(4,345)
23,778
Unrealized losses decreased $95.0 million from $178.9 million at December 31, 2011 to $83.9 million at December 31, 2012. We decreased
unrealized losses by recognizing $9.5 million of credit OTTI losses on corporate securities and residential mortgage backed securities for the
year ended December 31, 2012. The remaining unrealized loss decrease was primarily due to a narrowing of credit spreads in certain sectors
of the corporate bond market during the year ended December 31, 2012.
29
The following table sets forth the composition by credit quality (NAIC designation) of fixed maturity securities with gross unrealized losses:
NAIC Designation
December 31, 2012
1
2
3
4
5
6
December 31, 2011
1
2
3
4
5
6
Carrying Value of
Securities with
Gross Unrealized
Losses
Percent of
Total
Gross
Unrealized
Losses
Percent of
Total
(Dollars in thousands)
$
$
$
1,992,406
1,071,009
157,464
13,812
—
1,812
61.5% $
33.1%
4.9%
0.4%
—%
0.1%
(38,125)
(23,969)
(19,410)
(299)
—
(665)
46.2%
29.1%
23.5%
0.4%
—%
0.8%
3,236,503
100.0% $
(82,468)
100.0%
1,229,962
825,771
165,902
15,310
—
2,098
54.9% $
36.9%
7.4%
0.7%
—%
0.1%
(88,632)
(56,551)
(25,402)
(3,026)
—
(915)
50.8%
32.4%
14.6%
1.7%
—%
0.5%
$
2,239,043
100.0% $
(174,526)
100.0%
Our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting
of 198 and 246 securities, respectively) have been in a continuous unrealized loss position at December 31, 2012 and 2011, along with a description
of the factors causing the unrealized losses is presented in Note 3 to our audited consolidated financial statements in this Form 10-K, which is
incorporated by reference in this Item 7.
30
The amortized cost and fair value of fixed maturity securities and equity securities in an unrealized loss position and the number of months in
a continuous unrealized loss position (fixed maturity securities that carry an NRSRO rating of BBB/Baa or higher are considered investment
grade) were as follows:
Number of
Securities
Amortized
Cost
Fair Value
(Dollars in thousands)
Gross
Unrealized
Losses
December 31, 2012
Fixed maturity securities:
Investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total investment grade
Below investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total below investment grade
Equity securities:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total equity securities
December 31, 2011
Fixed maturity securities
Investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total investment grade
Below investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total below investment grade
Equity securities:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total equity securities
106
$
2,464,476
$
2,440,131
$
(24,345)
4
14
124
23
9
41
73
—
1
—
1
40,054
165,718
39,151
155,618
2,670,248
2,634,900
110,435
135,915
387,806
634,156
—
10,125
—
10,125
108,531
129,086
349,419
587,036
—
8,722
—
8,722
198
$
3,314,529
$
3,230,658
$
105
$
888,771
$
845,654
$
16
32
153
15
8
63
86
4
2
1
7
133,766
333,116
121,320
304,408
1,355,653
1,271,382
193,472
56,065
791,789
1,041,326
17,123
6,000
5,000
28,123
180,373
50,215
720,483
951,071
15,004
5,024
3,750
23,778
(903)
(10,100)
(35,348)
(1,904)
(6,829)
(38,387)
(47,120)
—
(1,403)
—
(1,403)
(83,871)
(43,117)
(12,446)
(28,708)
(84,271)
(13,099)
(5,850)
(71,306)
(90,255)
(2,119)
(976)
(1,250)
(4,345)
246
$
2,425,102
$
2,246,231
$
(178,871)
31
The amortized cost and fair value of fixed maturity securities (excluding United States Government and United States Government sponsored
agency securities) segregated by investment grade (NRSRO rating of BBB/Baa or higher) and below investment grade and equity securities that
had unrealized losses greater than 20% and the number of months in a continuous unrealized loss position were as follows:
Number of
Securities
Amortized
Cost
Fair
Value
(Dollars in thousands)
Gross
Unrealized
Losses
December 31, 2012
Investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total investment grade
Below investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total below investment grade
December 31, 2011
Investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total investment grade
Below investment grade:
Less than six months
Six months or more and less than twelve months
Twelve months or greater
Total below investment grade
— $
— $
— $
20,000
—
20,000
1,416
—
9,324
10,740
15,379
—
15,379
1,131
—
7,148
8,279
30,740
$
23,658
$
83,332
$
56,501
$
(26,831)
—
—
—
—
—
—
83,332
56,501
(26,831)
1
—
1
1
—
3
4
5
9
—
—
9
4
1
3
8
$
$
—
(4,621)
—
(4,621)
(285)
—
(2,176)
(2,461)
(7,082)
(9,430)
(2,214)
(17,505)
(29,149)
(55,980)
38,506
7,464
78,945
124,915
29,076
5,250
61,440
95,766
17
$
208,247
$
152,267
$
32
The amortized cost and fair value of fixed maturity securities, by contractual maturity, that were in an unrealized loss position are shown below.
Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. All of our mortgage and other asset backed securities provide for periodic payments throughout their lives, and are
shown below as a separate line.
December 31, 2012
Due in one year of less
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Due after twenty years
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
December 31, 2011
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Due after twenty years
Residential mortgage backed securities
Other asset backed securities
Available for sale
Held for investment
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
(Dollars in thousands)
$
— $
— $
— $
22,160
623,802
1,319,250
416,621
2,381,833
508,576
163,565
174,342
21,059
617,848
1,302,283
405,426
2,346,616
480,848
161,582
171,369
—
—
—
76,088
76,088
—
—
—
—
—
—
—
61,521
61,521
—
—
—
$
$
3,228,316
$
3,160,415
$
76,088
$
61,521
— $
— $
— $
18,066
374,616
359,672
354,945
1,107,299
1,077,045
136,703
16,725
356,620
319,977
333,733
1,027,055
1,004,964
131,092
—
—
—
75,932
75,932
—
—
—
—
—
—
59,342
59,342
—
—
$
2,321,047
$
2,163,111
$
75,932
$
59,342
International Exposure
We hold fixed maturity securities with international exposure. As of December 31, 2012, 14% of the carrying amount of our fixed maturity
securities was comprised of corporate debt securities of issuers based outside of the United States and debt securities of foreign governments.
All of these securities are denominated in U.S. dollars and all are investment grade (NAIC designation of either 1 or 2), except for 8 securities
with a total fair value of $67.8 million which are all NAIC 3. Our investment professionals analyze each holding for credit risk by economic
and other factors of each country and industry. The following table presents our international exposure in our fixed maturity portfolio by country
or region:
GIIPS (1)
Asia/Pacific
Non-GIIPS Europe
Latin America
Non-U.S. North America
Australia & New Zealand
Other
December 31, 2012
Carrying
Amount/Fair
Value
Percent
of Total
Carrying
Amount
Amortized Cost
(Dollars in thousands)
$
224,380
$
102,885
1,366,524
188,893
639,746
315,618
317,359
237,613
115,282
1,495,697
208,591
722,447
343,754
361,051
1.0%
0.5%
6.2%
0.9%
3.0%
1.4%
1.5%
$
3,155,405
$
3,484,435
14.5%
(1) Greece, Ireland, Italy, Portugal and Spain continue to cause credit risk as economic conditions in these countries continue to be volatile,
especially within the financial and banking sectors. All of our exposure in GIIPS are corporate securities with issuers domiciled in these countries.
None of our foreign government obligations were held in any of these countries.
33
Watch List
At each balance sheet date, we identify invested assets which have characteristics (i.e. significant unrealized losses compared to amortized cost
and industry trends) creating uncertainty as to our future assessment of an other than temporary impairment. As part of this assessment we
review not only a change in current price relative to its amortized cost but the issuer's current credit rating and the probability of full recovery
of principal based upon the issuer's financial strength. Specifically for corporate issues we evaluate the financial stability and quality of asset
coverage for the securities relative to the term to maturity for the issues we own. A security which has a 25% or greater change in market price
relative to its amortized cost and a possibility of a loss of principal will be included on a list which is referred to as our watch list. We exclude
from this list securities with unrealized losses which are related to market movements in interest rates and which have no factors indicating that
such unrealized losses may be other than temporary as we do not intend to sell these securities and it is more likely than not we will not have to
sell these securities before a recovery is realized. In addition, we exclude our RMBS as we monitor all of our RMBS on a quarterly basis for
changes in default rates, loss severities and expected cash flows for the purpose of assessing potential other than temporary impairments and
related credit losses to be recognized in operations. At December 31, 2012, the amortized cost and fair value of securities on the watch list are
as follows:
General Description
Number of
Securities
Amortized
Cost
Unrealized
Losses
Fair Value
(Dollars in thousands)
Months in
Continuous
Unrealized
Loss Position
Months
Unrealized
Losses
Greater
Than 20%
Investment grade
Corporate fixed maturity securities:
Finance
Industrial
Below investment grade
Corporate fixed maturity securities:
Industrial
3
3
1
7
$
49,480
$
(7,911) $
18,256
(1,086)
41,569
17,170
16-25
17-28
0-14
0-28
20,611
(2,908)
$
88,347
$
(11,905) $
17,703
76,442
19
—
Our analysis of these securities that we have determined are temporarily impaired and their credit performance at December 31, 2012 is as
follows:
Finance: The decline in value of these securities is due to the continued wide spreads as a result of the ongoing concerns relating to capital,
asset quality and earnings stability due to the financial events of the past three years and the ongoing events in the Eurozone, specifically the
sovereign debt crisis. While these issuers have had their financial position and profitability weakened by the credit and liquidity crisis, we have
determined that these securities were not other than temporarily impaired due to our evaluation of the operating performance and the credit
worthiness of each individual issuer.
Industrial: The decline in value of these securities relates to ongoing operational issues. These issues have caused the price for these securities
to decline; however, the companies have strong liquidity and ample time to strengthen their credit profile. We have determined that these
securities were not other than temporarily impaired due to the issuers' very strong market position; restructuring actions that are expected to
favorably impact future profitability; and a history of strong, reliable operating performance, improving economic conditions and rising security
prices.
We do not intend to sell these securities and it is more likely than not we will not have to sell these securities before recovery of their amortized
cost and, as such, there were no other than temporary impairments on these securities at December 31, 2012.
Other Than Temporary Impairments
We have a policy and process in place to identify securities in our investment portfolio for which we should recognize impairments. See Critical
Accounting Policies—Evaluation of Other Than Temporary Impairments. We recognized other than temporary impairments and additional
credit losses on a number of securities for which we have previously recognized OTTI. A summary of OTTI is presented in Note 3 to our audited
consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7.
Several factors led us to believe that full recovery of amortized cost will not be expected. A discussion of these factors and our policy and process
in place to identify securities that could potentially have impairment that is other than temporary is in Note 3 to our audited consolidated financial
statements in this Form 10-K, which is incorporated by reference in this Item 7.
Mortgage Loans on Real Estate
Our commercial mortgage loan portfolio consists of mortgage loans collateralized by the related properties and diversified as to property type,
location and loan size. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and other criteria to
attempt to reduce the risk of default. Our commercial mortgage loans on real estate are reported at cost, adjusted for amortization of premiums
and accrual of discounts net of valuation allowances. At December 31, 2012 and 2011, the largest principal amount outstanding for any single
34
mortgage loan was $15.0 million and $10.2 million, respectively, and the average loan size was $2.4 million for both 2012 and 2011. We have
the contractual ability to pursue full personal recourse on 11.5% of the loans and partial personal recourse on 31.9% of the loans. In addition,
the average loan to value ratio for the overall portfolio was 53.5% and 54.5% at December 31, 2012 and 2011, respectively, based upon the
underwriting and appraisal at the time the loan was made. This loan to value is indicative of our conservative underwriting policies and practices
for making commercial mortgage loans and may not be indicative of collateral values at the current reporting date. Our current practice is to
only obtain market value appraisals of the underlying collateral at the inception of the loan unless we identify indicators of impairment in our
ongoing analysis of the portfolio, in which case, we may obtain a current appraisal of the underlying collateral. The commercial mortgage loan
portfolio is summarized by geographic region and property type in Note 4 of our audited consolidated financial statements of this Form 10-K,
which is incorporated by reference in this Item 7.
In the normal course of business, we commit to fund commercial mortgage loans up to 90 days in advance. At December 31, 2012, we had
commitments to fund commercial mortgage loans totaling $37.9 million, with fixed interest rates ranging from 4.25% to 4.85%. In 2012, the
commercial mortgage loan industry has become very competitive. This competition has resulted in a number of borrowers refinancing with
other lenders. For the year ended December 31, 2012, we received $439.7 million in cash for loans being paid in full compared to $107.6 million
for the year ended December 31, 2011. Some of the loans being paid off have either reached their maturity or are nearing maturity; however,
many borrowers are paying the prepayment fee and refinancing at a lower rate.
See note 4 to our consolidated financial statements for a presentation of our specific and general loan loss allowances, impaired loans, foreclosure
activity and troubled debt restructure analysis.
We recorded impairment losses of $15.0 million on 23 mortgage loans with outstanding principal due totaling $67.2 million, impairment losses
of $24.5 million on 32 loans with outstanding principal due totaling $99.4 million and impairment losses of $12.2 million on 9 loans with
outstanding principal due totaling $31.0 million during the years ended December 31, 2012, 2011 and 2010, respectively.
In 2012, we initiated a process by which we evaluate the credit quality of each of our commercial mortgage loans. This process utilizes each
loan's debt service coverage ratio as a primary metric. A summary of our portfolio by debt service coverage ratio follows:
Debt Service Coverage Ratio:
Greater than or equal to 1.5
Greater than or equal to 1.2 and less than 1.5
Greater than or equal to 1.0 and less than 1.2
Less than 1.0
December 31, 2012
Principal
Outstanding
(Dollars in
thousands)
$
1,517,840
604,512
262,165
274,366
$
2,658,883
Percent of
Total Principal
Outstanding
57.1%
22.7%
9.9%
10.3%
100.0%
At December 31, 2012, we have eight mortgage loans that are in the process of being satisfied by taking ownership of the real estate serving as
collateral on the loan. These eight loans have a total outstanding principal balance of $26.2 million for which we have recorded specific loan
loss allowances totaling $8.5 million ($5.7 million in 2012 and $2.8 million in 2011). We also have ten commercial mortgage loans at December 31,
2012 with a total outstanding principal balance of $26.7 million that have been given "workout" terms which generally allow for interest only
payments. We recorded specific loan loss allowances on two of the "workout" loans (aggregate principal balance of $3.1 million) of $1.7 million
($0.9 million in 2012 and $0.8 million in 2011). At December 31, 2012, we have agreed to discounted payoffs on three commercial mortgage
loans with outstanding principal of $8.5 million for which we have recorded specific loan loss allowances totaling $1.0 million in 2012. At
December 31, 2012, we have no commercial mortgage loans that were delinquent (60 days or more at the reporting date) in their principal and
interest payments. The total outstanding principal balance of these 21 loans is $61.4 million, which represents less than 5% of our total mortgage
loan portfolio.
Mortgage loans summarized in the following table represent all loans that we are either not currently collecting or those we feel it is probable
we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the borrower
to alleviate short-term cash flow issues, loans delinquent for 60 days or more at the reporting date, loans we have determined to be collateral
dependent and loans that we have recorded specific impairments on that we feel may continue to have performance issues).
December 31,
2012
2011
(Dollars in thousands)
Impaired mortgage loans with allowances
Impaired mortgage loans with no allowance for losses
Allowance for probable loan losses
Net carrying value of impaired mortgage loans
$
$
53,110
$
27,765
(23,134)
57,741
$
67,698
63,023
(23,664)
107,057
35
Derivative Instruments
Our derivative instruments primarily consist of call options purchased to provide the income needed to fund the annual index credits on our
fixed index annuity products. The fair value of the call options is based upon the amount of cash that would be required to settle the call options
obtained from the counterparties adjusted for the nonperformance risk of the counterparty. The nonperformance risk for each counterparty is
based upon its credit default swap rate. We have no performance obligations related to the call options.
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. A presentation of our derivative
instruments along with a discussion of the business strategy involved with our derivatives is included in Note 5 to our audited consolidated
financial statements in this Form 10-K, which is incorporated by reference in this Item 7.
Concurrently with the issuance of our 3.5% Convertible Senior Notes due in 2015 (the "2015 notes"), we entered into hedge transactions (the
"2015 notes hedges") with two counterparties whereby we have the option to receive the cash equivalent of the conversion spread on approximately
16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the
2015 notes. These options expire on September 15, 2015 and must be settled in cash. The aggregate cost of the 2015 notes hedges was
$37.0 million. The 2015 notes hedges are accounted for as derivative assets, and are included in Other assets in our Consolidated Balance Sheets.
The estimated fair value of the 2015 notes hedges was $43.1 million and $45.6 million as of December 31, 2012 and 2011, respectively.
The conversion option of the 2015 notes (the "2015 notes embedded conversion derivative") is an embedded derivative that requires bifurcation
from the 2015 notes and is accounted for as a derivative liability, which is included in Other liabilities on our Consolidated Balance Sheets. The
fair value of the 2015 notes embedded conversion derivative at the time of issuance of the 2015 notes was $37.0 million, and was recorded as
the original debt discount for purposes of accounting for the debt component of the 2015 notes. This discount will be recognized as interest
expense using the effective interest method over the term of the 2015 notes. The estimated fair value of the 2015 notes embedded conversion
derivative was $43.1 million and $45.6 million as of December 31, 2012 and 2011, respectively.
Liabilities
Our liability for policy benefit reserves increased to $31.8 billion at December 31, 2012 compared to $28.1 billion at December 31, 2011,
primarily due to additional annuity sales as discussed above. Substantially all of our annuity products have a surrender charge feature designed
to reduce the risk of early withdrawal or surrender of the policies and to compensate us for our costs if policies are withdrawn early. Notwithstanding
these policy features, the withdrawal rates of policyholder funds may be affected by changes in interest rates and other factors.
See Note 9 to our audited consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7 for discussion
of our notes payable and borrowings under repurchase agreements.
Our subsidiary trusts have issued fixed rate and floating rate trust preferred securities and the trusts have used the proceeds from these offerings
to purchase subordinated debentures from us. We also issued subordinated debentures to the trusts in exchange for all of the common securities
of each trust. The sole assets of the trusts are the subordinated debentures and any interest accrued thereon. The terms of the preferred securities
issued by each trust parallel the terms of the subordinated debentures. Our obligations under the subordinated debentures and related agreements
provide a full and unconditional guarantee of payments due under the trust preferred securities. Accounting standards for consolidation of
variable interest entities, specifically exempts qualifying special purpose entities from consolidation; therefore, we do not consolidate our
subsidiary trusts and record our subordinated debt obligations to the trusts and our equity investments in the trusts. See note 10 to our audited
consolidated financial statements for additional information concerning our subordinated debentures payable to, and the preferred securities
issued by, the subsidiary trusts.
Liquidity and Capital Resources
Liquidity for Insurance Operations
Our insurance subsidiaries' primary sources of cash flow are annuity deposits, investment income, and proceeds from the sale, maturity and calls
of investments. The primary uses of funds are investment purchases, payments to policyholders in connection with surrenders and withdrawals,
policy acquisition costs and other operating expenses.
Liquidity requirements are met primarily by funds provided from operations. Our life subsidiaries generally receive adequate cash flow from
annuity deposits and investment income to meet their obligations. Annuity and life insurance liabilities are generally long-term in nature.
However, a primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our
annuity policies, such as surrender charges, that help limit and discourage early withdrawals. At December 31, 2012, approximately 96% of our
annuity liabilities were subject to penalty upon surrender, with a weighted average remaining surrender charge period of 9.9 years and a weighted
average surrender charge rate of 15.4%.
Our insurance subsidiaries continue to have adequate cash flows from annuity deposits and investment income to meet their policyholder and
other obligations. Net cash flows from annuity deposits and funds returned to policyholders as surrenders, withdrawals and death claims were
$2.2 billion for the year ended December 31, 2012 compared to $3.2 billion for the year ended December 31, 2011 with the decrease primarily
attributable to a $1.1 billion decrease in net annuity deposits after coinsurance and a $126.1 million (after coinsurance) decrease in funds returned
to policyholders. We continue to invest the net proceeds from policyholder transactions and investment activities in high quality fixed maturity
securities and fixed rate commercial mortgage loans. As reported above under Financial Condition - Investments, during 2012 and 2011 we
experienced a significant amount of calls of United States Government sponsored agency securities. As a result we have had elevated levels of
36
short-term investments and cash and cash equivalents during 2012 and 2011. The proceeds from these redemptions that have been reinvested
have primarily been in United States Government sponsored agency securities, corporate securities. commercial mortgage backed securities and
other asset backed securities. For the remaining amount to be reinvested we are considering further diversification into other asset classes, but
remain committed to maintaining a high quality investment portfolio with low credit risk. At December 31, 2012, 28% of our fixed income
securities have call features and 0.4% ($0.1 billion) were subject to call redemption. Another 7% ($1.5 billion) will become subject to call
redemption during 2013, of which $727 million are short-term U.S. Government agency securities with a book yield of 0.85%.
Liquidity of Parent Company
We, as the parent company, are a legal entity separate and distinct from our subsidiaries, and have no business operations. We need liquidity
primarily to service our debt, including the convertible senior notes and subordinated debentures issued to subsidiary trusts, pay operating
expenses and pay dividends to stockholders. Our assets consist primarily of the capital stock and surplus notes of our subsidiaries. Accordingly,
our future cash flows depend upon the availability of dividends, surplus note interest payments and other statutorily permissible payments from
our subsidiaries, such as payments under our investment advisory agreements and tax allocation agreement with our subsidiaries. These sources
provide adequate cash flow to us to meet our current and reasonably foreseeable future obligations and we expect they will be adequate to fund
our parent company cash flow requirements in 2013.
The ability of our life insurance subsidiaries to pay dividends or distributions, including surplus note payments, will be limited by applicable
laws and regulations of the states in which our life insurance subsidiaries are domiciled, which subject our life insurance subsidiaries to significant
regulatory restrictions. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency
requirements and limit the amount of dividends these subsidiaries can pay.
Currently, American Equity Life may pay dividends or make other distributions without the prior approval of the Iowa Insurance Commissioner,
unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1) American Equity
Life's net gain from operations for the preceding calendar year, or (2) 10% of American Equity Life's statutory capital and surplus at the preceding
December 31. For 2013, up to $99.2 million can be distributed as dividends by American Equity Life without prior approval of the Iowa Insurance
Commissioner. In addition, dividends and surplus note payments may be made only out of statutory earned surplus, and all surplus note payments
are subject to prior approval by regulatory authorities in the life subsidiary's state of domicile. American Equity Life had $710.4 million of
statutory earned surplus at December 31, 2012.
The maximum distribution permitted by law or contract is not necessarily indicative of an insurer's actual ability to pay such distributions, which
may be constrained by business and regulatory considerations, such as the impact of such distributions on surplus, which could affect the insurer's
ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends or make other distributions.
Further, state insurance laws and regulations require that the statutory surplus of our life subsidiaries following any dividend or distribution must
be reasonable in relation to their outstanding liabilities and adequate for their financial needs. Along with solvency regulations, the primary
driver in determining the amount of capital used for dividends is the level of capital needed to maintain desired financial strength ratings from
A.M. Best. Given recent economic events that have affected the insurance industry, both regulators and rating agencies could become more
conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could
negatively affect the cash available to us from insurance subsidiaries. As of December 31, 2012, we estimate American Equity Life has sufficient
statutory capital and surplus, combined with capital available to the holding company, to meet this rating objective. However, this capital may
not be sufficient if significant future losses are incurred or A.M. Best modifies its rating criteria and, given the current market conditions, access
to additional capital could be limited.
The transfer of funds by American Equity Life is also restricted by a covenant in our line of credit agreement which requires American Equity
Life to maintain a minimum risk-based capital ratio of 275% and a minimum level of statutory surplus equal to the sum of 1) 80% of statutory
surplus at December 31, 2010, 2) 50% of the statutory net income for each fiscal quarter ending after December 31, 2010, and 3) 50% of all
capital contributed to American Equity Life after September 30, 2010. American Equity Life's risk-based capital ratio was 332% at December 31,
2012. Under this agreement we are also required to maintain a maximum ratio of adjusted debt to total adjusted capital of 0.35 and a minimum
cash coverage ratio of 1.0.
Statutory accounting practices prescribed or permitted for our life subsidiaries differ in many respects from those governing the preparation of
financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts
reported in the GAAP basis financial statements for comparable items. Information as to statutory capital and surplus and statutory net income
for our life subsidiaries as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 is included in note 12
to our consolidated financial statements.
As discussed in note 9 to our consolidated financial statements, during 2011, we terminated the $150 million line of credit and entered into a
$160 million revolving line of credit agreement. The new revolving line of credit terminates on January 28, 2014, and borrowings are available
for general corporate purposes of the parent company and its subsidiaries.
During 2012, we issued a notice of mandatory redemption of all of our 8% Convertible Junior Subordinated Debentures (the "Debentures") and
American Equity Capital Trust I, the holder of all of the Debentures, issued notices of mandatory redemption of all of its 8% Convertible Trust
Preferred Securities and all of its 8% Trust Common Securities. As of December 31, 2012, $20.6 million principal amount (688,327 shares) of
8% Convertible Trust Preferred Securities were converted into 2,549,333 shares of our common stock and 38,001 shares of these trust preferred
securities had been settled in cash of approximately $1.1 million. The remaining 6,000 shares will be settled in cash of $0.2 million.
37
During the fourth quarter of 2011, we retired $46.3 million principal amount of the 2024 notes at par as holders required us to repurchase the
notes at the initial put date of December 15, 2011, utilizing cash generated from the issuance of the 2029 notes.
During the third quarter 2010, we issued $200.0 million principal amount of the 2015 notes. Concurrently with the issuance of the 2015 notes,
we entered into hedge transactions (the "2015 notes hedges") with two counterparties whereby we have the option to receive the cash equivalent
of approximately 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate
adjustments in the 2015 notes. In separate transactions, we also sold warrants (the "2015 warrants") to two counterparties for the purchase of
up to approximately 16.0 million shares of our common stock at a price of $16.00 per share. The 2015 notes, 2015 notes hedges and 2015
warrants produced net cash proceeds of $171.9 million. We used $150.0 million of these proceeds to pay off the amount drawn on our now
terminated revolving line of credit.
We have the ability to issue equity, debt or other types of securities through one or more methods of distribution under a currently effective shelf
registration statement on Form S-3. The terms of any offering would be established at the time of the offering, subject to market conditions.
In the normal course of business, we enter into financing transactions, lease agreements, or other commitments. These commitments may obligate
us to certain cash flows during future periods. The following table summarizes such obligations as of December 31, 2012.
Total
Less Than
1 year
Payments Due by Period
1–3 Years
4–5 Years
(Dollars in thousands)
After
5 Years
Annuity and single premium universal life products (1)
$
31,291,653
$
1,996,794
$
6,946,835
$
5,137,659
$
17,210,365
Notes payable, including interest payments (2)
Subordinated debentures, including interest payments (3)
Operating leases
Mortgage loan funding
Total
380,210
624,159
11,294
37,946
14,564
11,438
1,493
37,946
365,646
22,875
2,957
—
—
22,875
2,515
—
—
566,971
4,329
—
$
32,345,262
$
2,062,235
$
7,338,313
$
5,163,049
$
17,781,665
(1) Amounts shown in this table are projected payments through the year 2031 which we are contractually obligated to pay to our annuity
policyholders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions
regarding mortality and persistency, when applicable. These assumptions are based on our historical experience.
(2) Period that principal amounts are due is determined by the earliest of the call/put date or the maturity date of each note payable.
(3) Amount shown is net of equity investments in the capital trusts due to the contractual right of offset upon repayment of the notes.
Inflation
Inflation does not have a significant effect on our consolidated balance sheet. We have minimal investments in property, equipment or inventories.
To the extent that interest rates may change to reflect inflation or inflation expectations, there would be an effect on our balance sheet and
operations. Lower interest rates and tighter spreads experienced in recent periods have increased the value of our fixed maturity investments.
It is likely that rising interest rates and wider spreads would have the opposite effect. It is not possible to calculate the effect such changes in
interest rates, if any, have had on our operating results.
Critical Accounting Policies
The increasing complexity of the business environment and applicable authoritative accounting guidance require us to closely monitor our
accounting policies. We have identified five critical accounting policies that are complex and require significant judgment. The following summary
of our critical accounting policies is intended to enhance your ability to assess our financial condition and results of operations and the potential
volatility due to changes in estimates.
Valuation of Investments
Our fixed maturity securities (bonds and redeemable preferred stocks maturing more than one year after issuance) and equity securities (common
and perpetual preferred stocks) classified as available for sale are reported at fair value. Unrealized gains and losses, if any, on these securities
are included directly in stockholders' equity as a component of accumulated other comprehensive income (loss), net of income taxes and certain
adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements. Unrealized gains and
losses represent the difference between the amortized cost or cost basis and the fair value of these investments. We use significant judgment
within the process used to determine fair value of these investments.
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction
between market participants at the measurement date. We categorize our investments into three levels of fair value hierarchy based on the priority
of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical
assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair
value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value
38
hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to
the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment
and considers factors specific to the financial instrument.
We categorize investments recorded at fair value in the consolidated balance sheets as follows:
Level 1 —
Level 2 —
Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not
adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale
could reasonably impact the quoted price.
Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial
instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted
prices that are observable.
Level 3 — Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and
include situations where there is little, if any, market activity for the financial instrument. The inputs into the
determination of fair value require significant management judgment or estimation. Financial instruments that are
included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected
future cash flows with our own assumptions about what a market participant would use in determining fair value.
The following table presents the fair value of fixed maturity and equity securities, available for sale, by pricing source and hierarchy level as of
December 31, 2012 and 2011, respectively:
December 31, 2012
Priced via third party pricing services
Priced via independent broker quotations
Priced via matrices
Priced via other methods
% of Total
December 31, 2011
Priced via third party pricing services
Priced via independent broker quotations
Priced via matrices
Priced via other methods
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
(Dollars in thousands)
Total
$
$
$
75,592
$
24,101,390
$
— $
24,176,982
—
—
—
32,492
—
14,272
75,592
$
24,148,154
$
—
—
1,812
1,812
32,492
—
16,084
$
24,225,558
0.3%
99.7%
—%
100.0%
108,104
$
18,201,877
$
— $
18,309,981
—
—
—
194,143
—
20,732
$
108,104
$
18,416,752
$
—
—
2,098
2,098
194,143
—
22,830
$
18,526,954
% of Total
0.6%
99.4%
—%
100.0%
Management's assessment of all available data when determining fair value of our investments is necessary to appropriately apply fair value
accounting.
We utilize independent pricing services in estimating the fair values of investment securities. The independent pricing services incorporate a
variety of observable market data in their valuation techniques, including:
•
•
•
•
•
•
•
•
reported trading prices,
benchmark yields
broker-dealer quotes,
benchmark securities,
bids and offers,
credit ratings,
relative credit information, and
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions,
including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of
observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
39
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity.
When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar
characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing
service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed.
In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices
received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are
compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with
similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes
on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the
pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally,
as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar
to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did
not make any significant adjustments as of December 31, 2012 and 2011.
Evaluation of Other Than Temporary Impairments and Allowance for Loan Loss
The evaluation of investments for other than temporary impairments involves significant judgment and estimates by management. We review
and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes
analyzing our ability to recover the amortized cost or cost basis of each investment that has a fair value that is lower than its amortized cost or
cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary
impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process in place to identify securities that could potentially have an impairment that is other than temporary. This process
involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
•
the length of time and the extent to which the fair value has been less than amortized cost or cost;
• whether the issuer is current on all payments and all contractual payments have been made as agreed;
•
the remaining payment terms and the financial condition and near-term prospects of the issuer;
•
the lack of ability to refinance due to liquidity problems in the credit market;
•
the fair value of any underlying collateral;
•
the existence of any credit protection available;
•
our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities;
•
our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot
recover to cost in a reasonable period of time;
our intent and ability to retain equity securities for a period of time sufficient to allow for recovery;
consideration of rating agency actions; and
changes in estimated cash flows of residential mortgage and asset backed securities.
•
•
•
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and
circumstances surrounding each security. Where the decline in market value of debt securities is attributable to changes in market interest rates
or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we
do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more
likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities,
we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or
we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable
period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and
its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there
is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration
in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more
likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has
occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the
entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We
determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each
security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference
between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in
operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income.
The determination of the credit loss component of a residential mortgage backed security is based on a number of factors. The primary consideration
in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of
40
purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent
third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual
default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and
prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual
obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each
security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future,
we use our "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential
credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the
expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary
impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed
securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates,
prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that
we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher
or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios,
geographic diversity, as well as other appropriate considerations. The default curves generally assume lower loss levels for older vintage securities
versus more recent vintage securities, which reflects the decline in underwriting standards over the years.
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial
performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to,
credit rating changes, financial statement and ratio analysis, changes in management, large changes in credit spreads, breaches of financial
covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears
unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined.
Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived
from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation
based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the
amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes
due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an
impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an
ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in
fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies
and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts
presented in our consolidated financial statements.
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the
measurement of an estimated loss for each individual loan identified. A mortgage loan is impaired when it is probable that we will be unable
to collect all amounts due according to the contractual terms of the loan agreement. If we determine that the value of any specific mortgage
loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash
flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell. In
addition, we analyze the mortgage loan portfolio for the need of a general loan allowance for probable losses on all other loans. The amount of
the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience,
delinquencies, credit concentrations, underwriting standards and national and local economic conditions.
Our commercial mortgage loan portfolio has had a population of mortgage loans that we have been carrying with workout terms (e.g. interest
only periods, period of suspended payments, etc.) and a population of mortgage loans that have been in a delinquent status (i.e. more than 60
days past due). It is from this population that we have been recognizing some impairment loss due to nonpayment and eventual satisfaction of
the loan by taking ownership of the collateral real estate. In most cases the fair value of the collateral less estimated costs to sell such collateral
has been less than the outstanding principal amount of the mortgage loan.
Our general loan loss allowance for periods through September 30, 2011 was calculated on the cumulative outstanding principal on loans making
up the group of loans currently in workout terms and loans currently more than 60 days past due. We applied a factor to the total outstanding
principal of these loans that was calculated as the average specific impairment loss for the most recent 4 quarters divided by the sum of the
average of the total outstanding principal of delinquent loans for the most recent 4 quarters and the average of the total outstanding principal of
loans in workout for the most recent 4 quarters. In the fourth quarter of 2011, we modified the calculation for determining our general loan loss
allowance. The group of loans that we utilized to calculate an estimate of general loan loss allowance were those that had a debt service coverage
ratio (DSCR) of less than 1.0. The DSCR is calculated by dividing the net operating income of the mortgaged property by the contractual
principal and interest payment due for the corresponding period. We developed the loss rates to apply to this group of loans by dividing the
specific impairment loss for the most recent 4 quarters by the principal outstanding of the loans with a DSCR of less than 1.0.
During the year ended December 31, 2012, we completed a process of rating the mortgage loans in our portfolio based on factors such as historical
operating performance, loan to value ratio and economic outlook, among others. We calculated a loss factor to apply to each rating based on
historical losses we have recognized in our mortgage loan portfolio. We applied the loss factors to the total principal outstanding within each
41
rating category to determine an appropriate estimate of general loan loss allowance at December 31, 2012. The change in methodology utilized
to determine the general loan loss allowance did not result a material adjustment.
Policy Liabilities for Fixed Index Annuities
We offer a variety of fixed index annuities with crediting strategies linked to the S&P 500 Index and other equity and bond market indices. We
purchase call options on the applicable indices as an investment to provide the income needed to fund the annual index credits on the index
products. See Financial Condition—Derivative Instruments. Certain derivative instruments embedded in the fixed index annuity contracts are
recognized in the consolidated balance sheet at their fair values and changes in fair value are recognized immediately in our consolidated
statements of operations in accordance with accounting standards for derivative instruments and hedging activities.
Accounting for derivatives prescribes that the contractual obligations for future annual index credits are treated as a "series of embedded
derivatives" over the expected life of the applicable contracts. Policy liabilities for fixed index annuities are equal to the sum of the "host" (or
guaranteed) component and the embedded derivative component for each fixed index annuity policy. The host value is established at inception
of the contract and accreted over the policy's life at a constant rate of interest. We estimate the fair value of the embedded derivative component
at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts
and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance
risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and
future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credits on the next
policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected
costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum
guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values. The
amounts reported in the consolidated statements of operations as "Interest sensitive and index product benefits" represent amounts credited to
policy liabilities pursuant to accounting by insurance companies for certain long-duration contracts which include index credits through the most
recent policy anniversary. The amounts reported in the consolidated statements of operations as "Changes in fair value of embedded derivatives"
equal the change in the difference between policy benefit reserves for fixed index annuities computed under the derivative accounting standard
and the long-duration contracts accounting standard at each balance sheet date.
In general, the change in the fair value of the embedded derivatives will not correspond to the change in fair value of the purchased call options
because the purchased call options are one year options while the options valued in the embedded derivatives represent the rights of the contract
holder to receive index credits over the entire period the fixed index annuities are expected to be in force, which typically exceeds 10 years.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract
values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract
values at December 31, 2012 were to increase by100 basis points, our reserves for fixed index annuities would decrease by $226.0 million
recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of
$136.7 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an
increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate
used to discount the excess projected contract values would increase our reserves for fixed index annuities by $252.2 million recorded through
operations as a increase in the change in fair value of embedded derivatives and increase our combined balance for deferred policy acquisition
costs and deferred sales inducements by $152.9 million recorded through operations as a decrease in amortization of deferred policy acquisition
costs and deferred sales inducements.
Deferred Policy Acquisition Costs and Deferred Sales Inducements
Costs relating to the production of new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs
or deferred sales inducements. Only costs which are expected to be recovered from future policy revenues and gross profits may be deferred.
Deferred policy acquisition costs and deferred sales inducements are subject to loss recognition testing on a quarterly basis or when an event
occurs that may warrant loss recognition. Deferred policy acquisition costs consist principally of commissions and certain costs of policy issuance.
Deferred sales inducements consist of premium and interest bonuses credited to policyholder account balances. See Adopted Accounting
Pronouncements in Note 1 to our audited consolidated financial statements in this Form 10-K for discussion of an accounting standards update
that modifies the definition of the types of costs that can be capitalized as deferred policy acquisition costs.
For annuity products, these costs are being amortized generally in proportion to expected gross profits from interest margins and, to a lesser
extent, from product charges. Current and future period gross profits/margins for fixed index annuities also include the impact of amounts
recorded for the change in fair value of derivatives and the change in fair value of embedded derivatives. Current period amortization is adjusted
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. Our estimates of future gross profits/margins are based on actuarial
assumptions related to the underlying policies terms, lives of the policies, yield on investments supporting the liabilities and level of expenses
necessary to maintain the polices over their entire lives. Revisions are made based on historical results and our best estimates of future experience.
The impact of unlocking during 2012 was a $0.2 million decrease in amortization of deferred sales inducements and a $3.7 million increase in
amortization of deferred policy acquisition costs. The impact of unlocking in 2012 was primarily due to adjustments made to future period
assumptions for interest margins, surrenders, and lifetime income benefit rider utilization. The impact of unlocking during 2011 was a $5.0
million decrease in amortization of deferred sales inducements and a $9.1 million decrease in amortization of deferred policy acquisition costs.
The impact of unlocking in 2011 was primarily due to account balance true ups as of September 30, 2011 and adjustments to future period
42
assumptions for interest margins and surrenders. The impact of unlocking during 2010 was a $0.3 million increase in the amortization of deferred
sales inducements and a $1.4 million increase in amortization of deferred policy acquisition costs. The impact of unlocking during 2010 was
primarily due to adjustments made to future period assumptions for interest margins, surrenders, lifetime income benefit rider utilization and
reinsurance costs.
Estimated future gross profits vary based on a number of sources including investment spread margins, surrender charge income, policy
persistency, policy administrative expenses and realized gains and losses on investments including credit related other than temporary impairment
losses. Estimated future gross profits are most sensitive to changes in investment spread margins which are the most significant component of
gross profits. If estimated gross profits for all future years on business in force at December 31, 2012 were to increase by 10%, our combined
balance for deferred policy acquisition costs and deferred sales inducements at December 31, 2012 would increase by $88.6 million recorded
through operations as a decrease to amortization of deferred policy acquisition costs and deferred sales inducements. Correspondingly, a 10%
decrease in estimated gross profits for all future years would result in a $100.5 million decrease in the combined December 31, 2012 balances
recorded through operations as an increase to amortization of deferred policy acquisition costs and deferred sales inducements.
Deferred Income Taxes
We account for income taxes using the liability method. This method provides for the tax effects of transactions reported in the consolidated
financial statements for both taxes currently due and deferred. Deferred income taxes reflect the impact of temporary differences between the
amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. A temporary difference
is a transaction, or amount of a transaction, that is recognized currently for financial reporting purposes but will not be recognized for tax purposes
until a future tax period, or is recognized currently for tax purposes but will not be recognized for financial reporting purposes until a future
reporting period. Deferred income taxes are measured by applying enacted tax rates for the years in which the temporary differences are expected
to be recovered or settled to the amount of each temporary difference.
The realization of deferred income tax assets is primarily based upon management's estimates of future taxable income. Valuation allowances
are established when management estimates, based on available information, that it is more likely than not that deferred income tax assets will
not be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of
such allowances. When making such determination, consideration is given to, among other things, the following:
•
•
•
•
future taxable income of the necessary character exclusive of reversing temporary differences and carryforwards;
future reversals of existing taxable temporary differences;
taxable income in prior carryback years; and
tax planning strategies.
Actual realization of deferred income tax assets and liabilities may materially differ from these estimates as a result of changes in tax laws as
well as unanticipated future transactions impacting related income tax balances.
The realization of deferred income tax assets related to unrealized losses on our available for sale fixed maturity securities is also based upon
our intent to hold these securities for a period of time sufficient to allow for a recovery in fair value and not realize the unrealized loss.
New Accounting Pronouncements
See Note 1 to our audited consolidated financial statements in this Form 10-K beginning on page F-13, which is incorporated by reference in
this Item 7, for new accounting pronouncement disclosures.
43
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We seek to invest our available funds in a manner that will maximize shareholder value and fund future obligations to policyholders and debtors,
subject to appropriate risk considerations. We seek to meet this objective through investments that: (i) consist substantially of investment grade
fixed maturity securities, (ii) have projected returns which satisfy our spread targets and (iii) have characteristics which support the underlying
liabilities. Many of our products incorporate surrender charges, market interest rate adjustments or other features to encourage persistency.
We seek to maximize the total return on our available for sale investments through active investment management. Accordingly, we have
determined that our available for sale portfolio of fixed maturity securities is available to be sold in response to: (i) changes in market interest
rates, (ii) changes in relative values of individual securities and asset sectors, (iii) changes in prepayment risks, (iv) changes in credit quality
outlook for certain securities, (v) liquidity needs and (vi) other factors. An OTTI shall be considered to have occurred when we have an intention
to sell available for sale securities in an unrealized loss position. If we do not intend to sell a debt security, we consider all available evidence
to make an assessment of whether it is more likely than not that we will be required to sell the security before the recovery of its amortized cost
basis. If it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, an OTTI will be
considered to have occurred. We have a portfolio of held for investment securities which principally consists of long duration bonds issued by
U.S. government agencies. These securities are purchased to secure long-term yields which meet our spread targets and support the underlying
liabilities.
Interest rate risk is our primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the
profitability of our products, the fair value of our investments and the amount of interest we pay on our floating rate subordinated debentures.
Our floating rate trust preferred securities bear interest at the three month LIBOR plus 3.50% - 4.00%. Our outstanding balance of floating rate
trust preferred securities was $164.5 million at December 31, 2012, of which $85.5 million have been swapped to a fixed rate and $79.0 million
have been capped for a term of seven years beginning March or July 2014 (See Note 5 to our audited consolidated financial statements in this
Form 10-K). The profitability of most of our products depends on the spreads between interest yield on investments and rates credited on
insurance liabilities. We have the ability to adjust crediting rates (caps, participation rates or asset fee rates for fixed index annuities) on
substantially all of our annuity liabilities at least annually (subject to minimum guaranteed values). In addition, substantially all of our annuity
products have surrender and withdrawal penalty provisions designed to encourage persistency and to help ensure targeted spreads are earned.
However, competitive factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or maintain crediting
rates at levels necessary to avoid narrowing of spreads under certain market conditions.
A major component of our interest rate risk management program is structuring the investment portfolio with cash flow characteristics consistent
with the cash flow characteristics of our insurance liabilities. We use computer models to simulate cash flows expected from our existing business
under various interest rate scenarios. These simulations enable us to measure the potential gain or loss in fair value of our interest rate-sensitive
financial instruments, to evaluate the adequacy of expected cash flows from our assets to meet the expected cash requirements of our liabilities
and to determine if it is necessary to lengthen or shorten the average life and duration of our investment portfolio. The "duration" of a security
is the time weighted present value of the security's expected cash flows and is used to measure a security's sensitivity to changes in interest rates.
When the durations of assets and liabilities are similar, exposure to interest rate risk is minimized because a change in value of assets should be
largely offset by a change in the value of liabilities.
If interest rates were to increase 10% (30 basis points) from levels at December 31, 2012, we estimate that the fair value of our fixed maturity
securities would decrease by approximately $634.3 million. The impact on stockholders' equity of such decrease (net of income taxes and certain
adjustments for changes in amortization of deferred policy acquisition costs and deferred sales inducements) would be a decrease of $190.9 million
in accumulated other comprehensive income and a decrease to stockholders' equity. The computer models used to estimate the impact of a 10%
change in market interest rates incorporate numerous assumptions, require significant estimates and assume an immediate and parallel change
in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of
our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate
scenarios, and the differences may be material. Because we actively manage our investments and liabilities, our net exposure to interest rates
can vary over time. However, any such decreases in the fair value of our fixed maturity securities (unless related to credit concerns of the issuer
requiring recognition of an other than temporary impairment) would generally be realized only if we were required to sell such securities at
losses prior to their maturity to meet our liquidity needs, which we manage using the surrender and withdrawal provisions of our annuity contracts
and through other means. See Financial Condition—Liquidity for Insurance Operations for a further discussion of the liquidity risk.
At December 31, 2012, 28% of our fixed income securities have call features and 0.4% ($0.1 billion) were subject to call redemption. Another
7% ($1.5 billion, of which $727 million are short-term U.S. Government agency securities with a book yield of 0.85%) will become subject to
call redemption during 2013. During the years ended December 31, 2012 and 2011, we received $3.2 billion and $5.2 billion, respectively, in
net redemption proceeds related to the exercise of such call options. We have reinvestment risk related to these redemptions to the extent we
cannot reinvest the net proceeds in assets with credit quality and yield characteristics similar to the redeemed bonds. Such reinvestment risk
typically occurs in a declining rate environment. Should rates decline to levels which tighten the spread between our average portfolio yield
and average cost of interest credited on our annuity liabilities, we have the ability to reduce crediting rates (caps, participation rates or asset fees
for fixed index annuities) on most of our annuity liabilities to maintain the spread at our targeted level. At December 31, 2012, approximately
99% of our annuity liabilities are subject to annual adjustment of the applicable crediting rates at our discretion, limited by minimum guaranteed
crediting rates specified in the policies.
With respect to our fixed index annuities, we purchase call options on the applicable indices to fund the annual index credits on such annuities.
These options are primarily one-year instruments purchased to match the funding requirements of the underlying policies. Fair value changes
associated with those investments are substantially offset by an increase or decrease in the amounts added to policyholder account balances for
44
index products. For the years ended December 31, 2012, 2011 and 2010, the annual index credits to policyholders on their anniversaries were
$447.4 million, $448.2 million and $454.7 million, respectively. Proceeds received at expiration or gains recognized upon early termination of
these options related to such credits were $447.2 million, $454.2 million and $438.4 million for the years ended December 31, 2012, 2011 and
2010, respectively. The difference between proceeds received at expiration or gains recognized upon early termination of these options and
index credits is primarily due to credits attributable to minimum guaranteed interest self funded by us.
Within our hedging process we purchase options out of the money to the extent of anticipated minimum guaranteed interest on index policies.
On the anniversary dates of the index policies, we purchase new one-year call options to fund the next annual index credits. The risk associated
with these prospective purchases is the uncertainty of the cost, which will determine whether we are able to earn our spread on our index business.
We manage this risk through the terms of our fixed index annuities, which permit us to change caps, participation rates and asset fees, subject
to contractual features. By modifying caps, participation rates or asset fees, we can limit option costs to budgeted amounts, except in cases
where the contractual features would prevent further modifications. Based upon actuarial testing which we conduct as a part of the design of
our index products and on an ongoing basis, we believe the risk that contractual features would prevent us from controlling option costs is not
material.
Item 8. Consolidated Financial Statements and Supplementary Data
The consolidated financial statements are included as a part of this report on Form 10-K on pages F-1 through F-47.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
In accordance with the Securities Exchange Act Rules 13a-15 and 15d-15, our management, under the supervision of our Chief Executive Officer
and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures
as of the end of the period covered by this report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the design and operation of our disclosure controls and procedures were effective as of December 31, 2012 in recording,
processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports the Company files
or submits under the Exchange Act.
(b) Management's Report on Internal Control over Financial Reporting.
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined
in the Exchange Act Rule 13a-15(f). The Company's internal control system is designed to provide reasonable assurance to the Company's
management and the board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent
limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness
to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2012
based upon criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on the assessment, management has determined that we maintained effective internal control over financial reporting as of
December 31, 2012.
The Company's independent registered public accounting firm, KPMG LLP, issued an attestation report on the effectiveness of management's
internal control over financial reporting. This report appears on page F-2.
(c) Changes in Internal Control over Financial Reporting.
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2012, that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
There is no information required to be disclosed on Form 8-K for the quarter ended December 31, 2012 which has not been previously reported.
The information required by Part III is incorporated by reference from our definitive proxy statement for our annual meeting of shareholders to
be held June 6, 2013 to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2012.
PART III
45
Item 15. Exhibits and Financial Statement Schedules
PART IV
Financial Statements and Financial Statement Schedules. See Index to Consolidated Financial Statements and Schedules on page F-1 for a
list of financial statements and financial statement schedules included in this report.
All other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are omitted because they are not applicable,
not required, or because the information is included elsewhere in the consolidated financial statements or notes thereto.
Exhibits. See Exhibit Index immediately preceding the Exhibits for a list of Exhibits filed with this report.
46
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, this 7th day of March 2013.
SIGNATURES
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
By:
/s/ JOHN M. MATOVINA
John M. Matovina,
Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this registration statement has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates indicated:
Date
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
March 7, 2013
Signature
Title (Capacity)
/s/ JOHN M. MATOVINA
John M. Matovina
/s/ TED M. JOHNSON
Ted M. Johnson
/s/ SCOTT A. SAMUELSON
Scott A. Samuelson
/s/ D.J. NOBLE
D.J. Noble
/s/ JOYCE A. CHAPMAN
Joyce A. Chapman
/s/ ALEXANDER M. CLARK
Alexander M. Clark
/s/ JAMES M. GERLACH
James M. Gerlach
/s/ ROBERT L. HILTON
Robert L. Hilton
/s/ ROBERT L. HOWE
Robert L. Howe
/s/ DAVID S. MULCAHY
David S. Mulcahy
/s/ GERARD D. NEUGENT
Gerard D. Neugent
/s/ DEBRA J. RICHARDSON
Debra J. Richardson
/s/ A.J. STRICKLAND, III
A.J. Strickland, III
/s/ HARLEY A. WHITFIELD
Harley A. Whitfield
Chief Executive Officer, President and Director
(Principal Executive Officer)
Chief Financial Officer and Treasurer
(Principal Financial Officer)
Vice President—Controller
(Principal Accounting Officer)
Executive Chairman and Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
47
(This page has been left blank intentionally.)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
YEARS ENDED DECEMBER 31, 2012, 2011 and 2010
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Schedules:
Schedule I—Summary of Investments—Other Than Investments in Related Parties
Schedule II—Condensed Financial Information of Registrant
Schedule III—Supplementary Insurance Information
Schedule IV—Reinsurance
Schedule V—Valuation and Qualifying Accounts
F-2
F-3
F-4
F-5
F-6
F-7
F-9
F-48
F-49
F-54
F-55
F-56
F-1
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
American Equity Investment Life Holding Company:
We have audited the accompanying consolidated balance sheets of American Equity Investment Life Holding Company and subsidiaries (the
Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in
stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of
the consolidated financial statements, we also have audited the financial statement schedules listed in the Index on page F-1. We also have
audited the Company's internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for these consolidated financial statements and financial statement schedules, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and
financial statement schedules and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement
and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial
statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit
of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.
Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide
a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors
of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company
as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended
December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2012, the Company modified the types of costs incurred
that can be capitalized when issuing or renewing insurance contracts due to the prospective adoption of Financial Accounting Standards Board
Accounting Standards Update (ASU) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.
Des Moines, Iowa
March 6, 2013
/s/ KPMG LLP
F-2
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
Assets
Investments:
Fixed maturity securities:
Available for sale, at fair value (amortized cost: 2012 - $21,957,027 ; 2011 - $16,980,279)
$
24,172,136
$
18,464,109
December 31,
2012
2011
Held for investment, at amortized cost (fair value: 2012 - $61,521 ; 2011 - $2,644,422)
Equity securities, available for sale, at fair value (cost: 2012 - $44,598 ; 2011 - $58,438)
Mortgage loans on real estate
Derivative instruments
Other investments
Total investments
Cash and cash equivalents
Coinsurance deposits
Accrued investment income
Deferred policy acquisition costs
Deferred sales inducements
Deferred income taxes
Income taxes recoverable
Other assets
Total assets
Liabilities and Stockholders' Equity
Liabilities:
Policy benefit reserves
Other policy funds and contract claims
Notes payable
Subordinated debentures
Deferred income taxes
Income taxes payable
Other liabilities
Total liabilities
Stockholders' equity:
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
2012 and 2011 - no shares issued and outstanding
Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
2012 - 61,750,601 shares (excluding 5,127,379 treasury shares);
2011 - 57,836,540 shares (excluding 5,616,595 treasury shares)
Additional paid-in capital
Unallocated common stock held by ESOP; 2012 - 239,799 shares; 2011 - 336,093 shares
Accumulated other comprehensive income
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
See accompanying notes to consolidated financial statements.
F-3
76,088
53,422
2,623,940
415,258
196,366
2,644,206
62,845
2,823,047
273,314
115,930
27,537,210
24,383,451
1,268,545
2,910,701
261,833
1,709,799
1,292,341
—
—
153,049
404,952
2,818,642
228,937
1,683,857
1,242,787
21,981
8,441
81,671
35,133,478
$
30,874,719
31,773,988
$
28,118,716
455,752
309,869
245,869
49,303
4,756
573,704
33,413,241
400,594
297,608
268,593
—
—
380,529
29,466,040
$
$
—
—
61,751
496,715
(2,583)
686,807
477,547
57,837
468,281
(3,620)
457,229
428,952
1,720,237
1,408,679
$
35,133,478
$
30,874,719
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Revenues:
Traditional life insurance premiums
Annuity product charges
Net investment income
Change in fair value of derivatives
Net realized gains (losses) on investments, excluding other than temporary
impairment ("OTTI") losses
OTTI losses on investments:
Total OTTI losses
Portion of OTTI losses recognized from other comprehensive income
Net OTTI losses recognized in operations
Loss on extinguishment of debt
Total revenues
Benefits and expenses:
Insurance policy benefits and change in future policy benefits
Interest sensitive and index product benefits
Amortization of deferred sales inducements
Change in fair value of embedded derivatives
Interest expense on notes payable
Interest expense on subordinated debentures
Interest expense on amounts due under repurchase agreements
Amortization of deferred policy acquisition costs
Other operating costs and expenses
Total benefits and expenses
Income before income taxes
Income tax expense
Net income
Earnings per common share
Earnings per common share - assuming dilution
Weighted average common shares outstanding (in thousands):
Earnings per common share
Earnings per common share - assuming dilution
See accompanying notes to consolidated financial statements.
Year Ended December 31,
2012
2011
2010
$
12,877
$
12,151
$
89,006
1,286,923
221,138
76,189
1,218,780
(114,728)
11,982
69,075
1,036,106
168,862
(6,454)
(18,641)
23,726
(5,411)
(9,521)
(14,932)
—
(20,180)
(13,796)
(33,976)
—
(19,544)
(4,323)
(23,867)
(292)
1,588,558
1,139,775
1,285,592
8,075
818,087
87,157
286,899
28,479
13,458
—
164,919
95,495
1,502,569
85,989
28,191
57,798
0.94
0.89
61,259
65,676
$
$
$
7,870
775,757
71,781
(105,194)
31,633
13,977
30
143,478
67,529
1,006,861
132,914
46,666
86,248
1.45
1.37
59,482
63,619
$
$
$
8,251
733,218
59,873
130,950
22,125
14,906
—
136,388
114,615
1,220,326
65,266
22,333
42,933
0.73
0.68
58,507
64,580
$
$
$
F-4
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Net income
Other comprehensive income:
Change in net unrealized investment gains/losses (1)
Noncredit component of OTTI losses (1)
Other comprehensive income before income tax
Income tax effect related to other comprehensive income
Other comprehensive income
Comprehensive income
Year Ended December 31,
2012
2011
2010
$
57,798
$
86,248
42,933
348,627
4,571
353,198
(123,620)
229,578
571,301
6,251
577,552
(202,143)
375,409
$
287,376
$
461,657
$
170,919
1,813
172,732
(60,456)
112,276
155,209
(1) Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.
See accompanying notes to consolidated financial statements.
F-5
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Common
Stock
Additional
Paid-in
Capital
Unallocated
Common
Stock Held
by ESOP
Accumulated
Other
Comprehensive
Income (Loss)
56,203
422,225
(5,679)
Balance at December 31, 2009
Net income for the year
Other comprehensive income
Conversion of $60 of subordinated debentures
—
—
7
—
—
49
Acquisition of 104,661 shares of common stock
(105)
(1,119)
Allocation of 80,224 shares of common stock by ESOP,
including excess income tax benefits
Share-based compensation, including excess income tax
benefits
Issuance of 862,504 shares of common stock under
compensation plans, including excess income tax
benefits
Issuance of warrants
Dividends on common stock ($0.10 per share)
Balance at December 31, 2010
Net income for the year
Other comprehensive income
Acquisition of 48,235 shares of common stock
Allocation of 110,955 shares of common stock by
ESOP, including excess income tax benefits
Share-based compensation, including excess income tax
benefits
Issuance of 916,329 shares of common stock under
compensation plans, including excess income tax
benefits
Dividends on common stock ($0.12 per share)
Balance at December 31, 2011
Net income for the year
Other comprehensive income
—
—
—
—
—
—
—
—
—
863
—
—
(23)
864
12,239
5,483
15,600
—
—
—
—
—
56,968
454,454
(4,815)
—
—
(48)
—
—
917
—
—
—
(436)
—
—
—
60
1,195
10,320
3,883
—
—
—
—
57,837
468,281
(3,620)
—
—
—
—
Retained
Earnings
312,330
42,933
—
—
—
—
—
—
—
(5,643)
349,620
86,248
—
—
—
—
—
(6,916)
428,952
57,798
—
—
—
—
—
(9,203)
Total
Stockholders'
Equity
754,623
42,933
112,276
56
(1,224)
841
12,239
6,346
15,600
(5,643)
938,047
86,248
375,409
(484)
1,255
10,320
4,800
(6,916)
1,408,679
57,798
229,578
19,591
1,085
6,904
5,805
(9,203)
(30,456)
—
112,276
—
—
—
—
—
—
—
81,820
—
375,409
—
—
—
—
—
457,229
—
229,578
—
—
—
—
—
Conversion of $20,770 of subordinated debentures
2,564
17,027
Allocation of 96,294 shares of common stock by
ESOP, including excess income tax benefits
Share-based compensation, including excess income tax
benefits
Issuance of 1,349,914 shares of common stock under
compensation plans, including excess income tax
benefits
Dividends on common stock ($0.15 per share)
—
—
1,350
—
48
1,037
6,904
4,455
—
—
—
—
Balance at December 31, 2012
$
61,751
$
496,715
$
(2,583) $
686,807
$
477,547
$
1,720,237
See accompanying notes to consolidated financial statements.
F-6
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Interest sensitive and index product benefits
Amortization of deferred sales inducements
Annuity product charges
Change in fair value of embedded derivatives
Increase in traditional life and accident and health insurance reserves
Policy acquisition costs deferred
Amortization of deferred policy acquisition costs
Provision for depreciation and other amortization
Amortization of discounts and premiums on investments
Loss on extinguishment of debt
Realized gains/losses on investments and net OTTI losses recognized in operations
Change in fair value of derivatives
Deferred income taxes
Share-based compensation
Change in accrued investment income
Change in income taxes recoverable/payable
Change in other assets
Change in other policy funds and contract claims
Change in collateral held for derivatives
Change in other liabilities
Other
Net cash provided by operating activities
Investing activities
Sales, maturities, or repayments of investments:
Fixed maturity securities—available for sale
Fixed maturity securities—held for investment
Equity securities—available for sale
Mortgage loans on real estate
Derivative instruments
Short-term investments
Other investments
Acquisitions of investments:
Fixed maturity securities—available for sale
Fixed maturity securities—held for investment
Equity securities—available for sale
Mortgage loans on real estate
Derivative instruments
Short-term investments
Other investments
Purchases of property, furniture and equipment
Net cash used in investing activities
Year Ended December 31,
2012
2011
2010
$
57,798
$
86,248
$
42,933
818,087
87,157
(89,006)
286,899
26,150
(403,411)
164,919
18,404
(69,828)
—
21,386
(221,138)
(52,336)
6,552
(32,896)
13,197
(7,090)
55,158
99,242
5,927
(857)
784,314
3,298,623
2,618,207
13,604
543,211
483,362
—
33,601
(8,266,692)
—
—
(386,507)
(379,592)
—
(86,569)
(738)
775,757
71,781
(76,189)
(105,194)
76,220
(478,834)
143,478
18,970
733,218
59,873
(69,075)
130,950
43,921
(402,607)
136,388
11,580
(154,483)
(240,532)
—
52,617
112,608
(80,869)
9,339
(61,292)
(2,307)
5,005
177,734
(215,775)
(77,082)
59
277,791
3,705,605
219,372
2,958
206,741
506,057
—
2,274
(5,347,839)
(1,940,163)
—
(481,680)
(395,938)
—
(77,955)
(5,265)
292
141
(141,719)
(118,048)
11,993
(53,987)
97,550
(26,516)
103,457
35,075
64,776
812
420,475
4,568,499
1,585,267
46,187
145,754
492,058
600,000
—
(8,544,788)
(745,207)
(10,125)
(317,250)
(331,263)
(599,746)
(456)
(5,318)
(2,129,490)
(3,605,833)
(3,116,388)
F-7
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
Financing activities
Receipts credited to annuity and single premium universal life policyholder account balances
$
3,782,275
$
4,784,511
$
4,497,091
Year Ended December 31,
2012
2011
2010
Coinsurance deposits
Return of annuity policyholder account balances
Financing fees incurred and deferred
Proceeds from notes payable
Repayments of notes payable
Purchase of 2015 notes hedges
Repayment of subordinated debentures
Acquisition of common stock
Excess tax benefits realized from share-based compensation plans
Proceeds from issuance of common stock
Proceeds from issuance of warrants
Change in checks in excess of cash balance
Dividends paid
Net cash provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest expense
Income taxes
Income tax refunds received
Non-cash operating activity:
Deferral of sales inducements
Non-cash investing activity:
Real estate acquired in satisfaction of mortgage loans
Mortgage loan on real estate sold
Non-cash financing activities:
Conversion of subordinated debentures
See accompanying notes to consolidated financial statements.
4,885
(122,415)
(267,638)
(1,575,340)
(1,494,554)
(1,465,434)
—
—
—
—
(1,141)
—
481
5,741
—
1,071
(9,203)
(1,566)
—
(46,251)
—
—
(484)
1,061
4,686
—
17,156
(6,916)
(6,800)
200,000
(156,641)
(37,000)
—
(1,224)
480
6,124
15,600
(13,238)
(5,643)
2,208,769
3,135,228
2,765,677
863,593
404,952
(192,814)
597,766
$
1,268,545
$
404,952
$
$
27,666
$
30,650
$
67,450
512
129,250
466
69,764
528,002
597,766
25,802
143,748
101,395
306,659
385,123
370,714
26,324
—
20,770
20,978
1,215
—
7,408
—
60
F-8
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Significant Accounting Policies
Nature of Operations
American Equity Investment Life Holding Company ("we", "us" or "our"), through its wholly-owned subsidiaries, American Equity Investment
Life Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York ("American Equity Life
of New York") and Eagle Life Insurance Company ("Eagle Life"), is licensed to sell insurance products in 50 states and the District of Columbia
at December 31, 2012. We operate solely in the insurance business.
We primarily market fixed index and fixed rate annuities and to a lesser extent, life insurance. Premiums and annuity deposits (net of coinsurance),
which are not included as revenues in the accompanying consolidated statements of operations, collected in 2012, 2011 and 2010, by product
type were as follows:
Product Type
2012
2011
2010
Year Ended December 31,
(Dollars in thousands)
Fixed index annuities:
Index strategies
Fixed strategy
Fixed rate annuities
Single premium immediate annuities (SPIA)
Life insurance
$
2,223,652
$
2,835,422
$
2,312,720
1,206,784
3,430,436
148,105
164,657
12,877
1,375,321
4,210,743
247,237
305,603
12,151
1,472,576
3,785,296
232,832
171,628
11,982
$
3,756,075
$
4,775,734
$
4,201,738
Three national marketing organizations through which we market our products each accounted for more than 10% of the annuity deposits and
insurance premium collections during 2012 representing 12%, 11% and 10% individually, of the annuity deposits and insurance premiums
collected. Two national marketing organization accounted for more than 10% of the annuity deposits and insurance premium collections during
2011 representing 14% and 12% individually, of the annuity deposits and insurance premiums collected. One national marketing organization
accounted for more than 10% of the annuity deposits and insurance premium collections during 2010 representing 17% of the annuity deposits
and insurance premiums collected.
Consolidation and Basis of Presentation
The consolidated financial statements include our accounts and our wholly-owned subsidiaries: American Equity Life, American Equity Life
of New York, Eagle Life, AERL, L.C., American Equity Capital, Inc., American Equity Investment Properties, L.C., American Equity Advisors,
Inc. and American Equity Investment Service Company. All significant intercompany accounts and transactions have been eliminated.
During 2012, we identified certain classification errors related to amounts reported in the financing activities section of our consolidated statements
of cash flows. We evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded they were not material
to any prior periods. However, we revised the 2011 and 2010 consolidated statements of cash flows to be consistent with the 2012 presentation.
The changes resulted in decreases of $305.6 million and $171.6 million to receipts credited to annuity and single premium universal life
policyholder account balances and return of annuity policyholder account balances for 2011 and 2010, respectively but had no net impact on
net cash provided by financing activities. These changes had no impact on our consolidated balance sheets, statements of operations or statements
of changes in stockholders' equity.
Estimates and Assumptions
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Significant estimates and assumptions are utilized in the calculation of deferred policy acquisition costs, deferred sales inducements, policy
benefit reserves, valuation of derivatives, including embedded derivatives on index annuity reserves, contingent convertible senior notes, valuation
of investments, other than temporary impairment of investments, allowances for loan losses on mortgage loans and valuation allowances on
deferred tax assets. A description of each critical estimate is incorporated within the discussion of the related accounting policies which follow.
It is reasonably possible that actual experience could differ from the estimates and assumptions utilized.
Investments
Fixed maturity securities (bonds and redeemable preferred stocks maturing more than one year after issuance) that may be sold prior to maturity
are classified as available for sale. Available for sale securities are reported at fair value and unrealized gains and losses, if any, on these securities
F-9
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
are included directly in a separate component of stockholders' equity, net of income taxes and certain adjustments for assumed changes in
amortization of deferred policy acquisition costs and deferred sales inducements. Fair values, as reported herein, of fixed maturity and equity
securities are based on quoted market prices in active markets when available, or for those fixed maturity securities not actively traded, yield
data and other factors relating to instruments or securities with similar characteristics are used. See note 2 for more information on assumptions
and valuation models used in the determination of fair value. Premiums and discounts are amortized/accrued using methods which result in a
constant yield over the securities' expected lives. Amortization/accrual of premiums and discounts on residential and commercial mortgage
backed securities incorporate prepayment assumptions to estimate the securities' expected lives. Interest income is recognized as earned.
Fixed maturity securities that we have the positive intent and ability to hold to maturity are classified as held for investment. Such securities
may, at times, be called prior to maturity. Held for investment securities are reported at cost adjusted for amortization of premiums and discounts.
Changes in the fair value of these securities, except for declines that are other than temporary, are not reflected in our consolidated financial
statements.
Equity securities, comprised of common and perpetual preferred stocks, are classified as available for sale and are reported at fair value. Unrealized
gains and losses are included directly in a separate component of stockholders' equity, net of income taxes and certain adjustments for assumed
changes in amortization of deferred policy acquisition costs and deferred sales inducements. Dividends are recognized when declared.
The carrying amounts of our impaired investments in fixed maturity and equity securities are adjusted for declines in value that are other than
temporary. Other than temporary impairment losses are reported as a component of revenues in the consolidated statements of operations, which
presents the amount of noncredit impairment losses for certain fixed maturity securities that is reported in accumulated other comprehensive
income (loss). See note 3 for further discussion of other than temporary impairment losses.
Deterioration in credit quality of the companies or assets backing our investment securities, deterioration in the condition of the financial services
industry, imbalances in liquidity recurring in the marketplace or declines in real estate values may further affect the fair value of these investment
securities and increase the potential that certain unrealized losses be recognized as other than temporary impairments in the future.
Mortgage loans on real estate are reported at cost, adjusted for amortization of premiums and accrual of discounts. Interest income is recorded
when earned; however, interest ceases to accrue for loans on which interest is more than 90 days past due based upon contractual terms and/or
when the collection of interest is not considered probable. We evaluate the mortgage loan portfolio for the establishment of a loan loss reserve
by specific identification of impaired loans and the measurement of an estimated loss, if any, for each impaired loan identified and an analysis
of the mortgage loan portfolio for the need of a general loan allowance for probable losses on all loans. If we determine that the value of any
specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of
expected future cash flows from the loan discounted at the loan's contractual interest rate, or the fair value of the underlying collateral, less costs
to sell. The amount of the general loan allowance, if any, is based upon our evaluation of the probability of collection, historical loss experience,
delinquencies, credit concentrations, underwriting standards and national and local economic conditions. The carrying value of impaired loans
is reduced by the establishment of an allowance for loan losses, changes to which are recognized as realized gains or losses on investments.
Interest income on impaired loans is recorded on a cash basis.
Other invested assets include company owned life insurance, real estate, limited partnerships accounted for using the equity method and policy
loans. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the end of the reporting
period, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. Policy loans are stated
at current unpaid principal balances.
Real estate owned is reported at cost less accumulated depreciation. Cost is determined at the time ownership is acquired in satisfaction of
mortgage loans and is the lower of the carrying value of the mortgage loan or fair value of the real estate less its estimated cost to sell. Buildings
and improvements are depreciated using the straight-line method over their estimated useful lives. Impairment losses on real estate owned are
recognized when there are indicators of impairment present and the expected future undiscounted cash flows are not sufficient to recover the
real estate's carrying value. Any impairment losses are reported as realized losses and are part of net income.
Derivative Instruments
Our derivative instruments include call options used to fund fixed index annuity credits, interest rate swap and caps to manage interest rate risk
associated with the floating rate component on certain of our subordinated debentures, call options to hedge the conversion spread on our
convertible senior notes (see note 9) and certain other derivative instruments embedded in other contracts. All of our derivative instruments are
recognized in the balance sheet at fair value and changes in fair value are recognized immediately in operations. See note 5 for more information
on derivative instruments.
Cash and Cash Equivalents
We consider all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
We also consider reverse repurchase agreements, which typically have an initial maturity of six weeks or less, to be cash equivalents. Amounts
advanced under these agreements represent short-term loans that carry a fixed rate of interest. Borrowers under these agreements are required
to post collateral that is investment grade debt securities with fair value in excess of the amount advanced.
F-10
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Book Overdrafts
Under our cash management system, checks issued but not yet presented to banks frequently result in overdraft balances for accounting purposes
and are classified as Other liabilities on our consolidated balance sheets. We report the changes in the amount of the overdraft balance as a
financing activity in our consolidated statement of cash flows as Change in checks in excess of cash balance.
Deferred Policy Acquisition Costs and Deferred Sales Inducements
Our accounting policy for deferred policy acquisition costs which follows, has been updated from our Form 10-K for the year ended December
31, 2011 to reflect the adoption of new accounting standards.
To the extent recoverable from future policy revenues and gross profits, certain costs that are incremental or directly related to the successful
production of new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs or deferred sales
inducements. Deferred policy acquisition costs and deferred sales inducements are subject to loss recognition testing on a quarterly basis or
when an event occurs that may warrant loss recognition. Deferred policy acquisition costs consist primarily of commissions and certain costs
of policy issuance. Deferred sales inducements consist of premium and interest bonuses credited to policyholder account balances.
For annuity products, these capitalized costs are being amortized generally in proportion to expected gross profits from investment spreads,
including the cost of hedging the fixed indexed annuity obligations, and, to a lesser extent, from product charges and mortality and expense
margins. That amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins
(including the impact of net realized gains on investments and net OTTI losses recognized in operations) to be realized from a group of products
are revised. Deferred policy acquisition costs and deferred sales inducements are also adjusted for the change in amortization that would have
occurred if available for sale fixed maturity securities and equity securities had been sold at their aggregate fair value at the end of the reporting
period and the proceeds reinvested at current yields. The impact of this adjustment is included in accumulated other comprehensive income
within consolidated stockholders' equity, net of applicable taxes. See note 6 for more information on deferred policy acquisition costs and
deferred sales inducements.
Policy Benefit Reserves
Policy benefit reserves for fixed index annuities with returns linked to the performance of a specified market index are equal to the sum of the
fair value of the embedded derivatives and the host (or guaranteed) component of the contracts. The host value is established at inception of
the contract and accreted over the policy's life at a constant rate of interest. Future policy benefit reserves for fixed index annuities earning a
fixed rate of interest and other deferred annuity products are computed under a retrospective deposit method and represent policy account balances
before applicable surrender charges. For the years ended December 31, 2012, 2011 and 2010, interest crediting rates for these products ranged
from 1.80% to 5.25%. These rates include interest bonuses capitalized as deferred sales inducements.
Policy benefit reserves are not reduced for amounts ceded under coinsurance agreements which are reported as coinsurance deposits on our
consolidated balance sheets. See note 7 for more information on reinsurance.
The liability for future policy benefits for traditional life insurance is based on net level premium reserves, including assumptions as to interest,
mortality, and other assumptions underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 3.0% to
5.5%. Policy benefit claims are charged to expense in the period that the claims are incurred.
Deferred Income Taxes
Deferred income tax assets or liabilities are computed based on the temporary differences between the financial statement and income tax bases
of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or
liability from period to period. Deferred income tax assets are subject to ongoing evaluation of whether such assets will more likely than not
be realized. The realization of deferred income tax assets primarily depends on generating future taxable income during the periods in which
temporary differences become deductible. Deferred income tax assets are reduced by a valuation allowance if, based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. In making such a determination, all
available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning
strategies and recent financial operations, is considered. The realization of deferred income tax assets related to unrealized losses on available
for sale fixed maturity securities is also based upon our intent and ability to hold those securities for a period of time sufficient to allow for a
recovery in fair value and not realize the unrealized loss.
Recognition of Premium Revenues and Costs
Revenues for annuity products include surrender and living income benefit rider charges assessed against policyholder account balances during
the period. Interest sensitive and index product benefits related to annuity products include interest credited or index credits to policyholder
account balances. In addition, the change in fair value of embedded derivatives within fixed index annuity contracts is included in benefits and
expenses.
Traditional life insurance premiums are recognized as revenues over the premium-paying period. Certain group policies include provisions for
annual experience refunds of premiums equal to net premiums received less a 16% administrative fee and less claims incurred. Such amounts
F-11
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(2012—$1.1 million; 2011—$1.8 million; and 2010—$1.1 million) are reported as a reduction of traditional life insurance premiums in the
consolidated statements of operations. Future policy benefits are recognized as expenses over the life of the policy by means of the provision
for future policy benefits.
All insurance-related revenues, including the change in the fair value of derivatives for call options related to the business ceded under coinsurance
agreements (see note 7), benefits, losses and expenses are reported net of reinsurance ceded.
Other Comprehensive Income
Other comprehensive income includes all changes in stockholders' equity during a period except those resulting from investments by and
distributions to stockholders. Other comprehensive income excludes net realized investment gains (losses) included in net income which merely
represent transfers from unrealized to realized gains and losses. These amounts totaled $(21.4) million, $(52.6) million and $(0.2) million in
2012, 2011 and 2010, respectively. Such amounts, which have been measured through the date of sale, are net of adjustments to deferred policy
acquisition costs, deferred sales inducements and income taxes totaling $(12.8) million in 2012, $(34.3) million in 2011 and $0.2 million in
2010.
Adopted Accounting Pronouncements
In October 2010, as a result of a consensus of the Financial Accounting Standards Board ("FASB") Emerging Issues Task Force (EITF), the
FASB issued an accounting standards update (ASU) that modifies the definition of the types of costs incurred that can be capitalized in the
acquisition of new and renewal insurance contracts. This guidance defines the costs that qualify for deferral as incremental direct costs that
result directly from and are essential to successful contract transactions and would not have been incurred by the insurance entity had the contract
transactions not occurred. In addition, it lists certain costs as deferrable as those that are directly related to underwriting, policy issuance and
processing, medical and inspection, and sales force contract selling as deferrable, as well as the portion of an employee's total compensation
related directly to time spent performing those activities for actual acquired contracts and other costs related directly to those activities that would
not have been incurred if the contract had not been acquired. This amendment to current GAAP became effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2011. Other operating costs and expenses for the year ended December 31, 2012
increased $9.1 million due to the prospective adoption of this ASU effective January 1, 2012, which decreased net income $5.8 million and
earnings per share $0.09 for the year ended December 31, 2012.
In May 2011, the FASB issued an ASU that addresses fair value measurement and disclosure as part of its convergence efforts with the International
Accounting Standards Board. The guidance is intended to create common fair value measurement and disclosure requirements in GAAP and
International Financial Reporting Standards. This ASU changes the wording used to describe many of the requirements in GAAP for measuring
fair value and for disclosing information about fair value measurements. Some changes clarify the FASB's intent about the application of existing
fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing
information about fair value measurements. The disclosure requirements add information about transfers between Level 1 and Level 2 of the
fair value hierarchy, information about the sensitivity of a fair value measurement categorized within Level 3 of the fair value hierarchy to
changes in unobservable inputs and any interrelationships between those unobservable inputs and the categorization by level of the fair value
hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value of such items is required
to be disclosed. This ASU became effective for interim and annual periods beginning after December 15, 2011. See note 2 for disclosures
regarding fair value measurements.
In June 2011, the FASB issued an ASU that expands the disclosure requirements related to other comprehensive income (loss). A reporting
entity is now required to present the total of comprehensive income (loss), the components of net income, and the components of other
comprehensive income (loss) either in a single continuous statement of comprehensive income (loss) or in two separate but consecutive statements.
Under both choices, the reporting entity is required to present each component of net income along with total net income, each component of
other comprehensive income (loss) along with a total for other comprehensive income (loss) and a total amount for comprehensive income (loss).
This ASU became effective for interim and annual periods beginning after December 15, 2011. We adopted this ASU on January 1, 2012.
New Accounting Pronouncements
There are no accounting standards updates finalized to become effective in the future that will significantly affect our consolidated financial
statements.
F-12
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Fair Values of Financial Instruments
The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:
Assets
Fixed maturity securities:
Available for sale
Held for investment
Equity securities, available for sale
Mortgage loans on real estate
Derivative instruments
Other investments
Cash and cash equivalents
Coinsurance deposits
Interest rate caps
2015 notes hedges
Liabilities
Policy benefit reserves
Single premium immediate annuity (SPIA) benefit reserves
Notes payable
Subordinated debentures
2015 notes embedded derivative
Interest rate swaps
December 31,
2012
2011
Carrying
Amount
Fair Value
Carrying
Amount
Fair Value
(Dollars in thousands)
$
24,172,136
$
24,172,136
$
18,464,109
$
18,464,109
76,088
53,422
61,521
53,422
2,623,940
2,848,235
415,258
163,193
1,268,545
2,910,701
3,247
43,105
415,258
163,517
1,268,545
2,678,232
3,247
43,105
2,644,206
62,845
2,823,047
273,314
79,109
404,952
2,644,422
62,845
3,030,308
273,314
76,648
404,952
2,818,642
2,549,025
—
45,593
—
45,593
31,452,496
26,264,831
27,842,770
23,407,540
455,167
309,869
245,869
43,105
4,261
469,768
422,175
218,283
43,105
4,261
397,248
297,608
268,593
45,593
—
412,998
376,370
233,809
45,593
—
Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market
participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each
measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.
We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value.
The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority
inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash
flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial
instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our
assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific
to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1—
Level 2—
Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust
the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably
impact the quoted price.
Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments
in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are
observable.
Level 3— Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include
situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair
value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities
for which no market activity or data exists and for which we used discounted expected future cash flows with our own
assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security. There
were no transfers between levels during 2012 and 2011.
F-13
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2012 and 2011 are presented below based on
the fair value hierarchy levels:
Total
Fair Value
Quoted
Prices in
Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
(Dollars in thousands)
Significant
Unobservable
Inputs
(Level 3)
December 31, 2012
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Equity securities, available for sale: finance, insurance and real estate
Derivative instruments
Cash and cash equivalents
Interest rate caps
2015 notes hedges
Liabilities
2015 notes embedded derivative
Interest rate swap
Fixed index annuities—embedded derivatives
December 31, 2011
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Other asset backed securities
Equity securities, available for sale: finance, insurance and real estate
Derivative instruments
Cash and cash equivalents
2015 notes hedges
Liabilities
2015 notes embedded derivative
Fixed index annuities—embedded derivatives
$
5,154
$
5,154
$
— $
1,772,025
3,578,323
105,259
14,433,641
2,886,301
357,982
998,130
16,494
415,258
—
3,247
43,105
1,772,025
3,578,323
105,259
14,466,772
2,888,113
357,982
998,508
53,422
415,258
—
—
—
33,131
—
—
378
36,928
—
1,268,545
1,268,545
—
—
3,247
43,105
25,955,713
43,105
4,261
3,337,556
$
$
1,344,136
$
24,609,765
— $
—
—
43,105
4,261
—
$
$
1,812
—
—
3,337,556
3,384,922
$
— $
47,366
$
3,337,556
4,678
$
4,678
$
— $
—
—
—
58,827
—
370
44,229
—
404,952
—
1,799,779
3,333,383
68,333
10,032,429
2,701,192
463,020
18,616
273,314
—
45,593
1,799,779
3,333,383
68,333
10,091,256
2,703,290
463,390
62,845
273,314
404,952
45,593
19,250,813
45,593
2,530,496
2,576,089
$
$
$
513,056
$
18,735,659
— $
—
— $
45,593
—
45,593
$
$
$
2,098
—
2,530,496
2,530,496
—
—
—
—
—
1,812
—
—
—
—
—
—
—
—
—
—
—
—
2,098
—
—
—
—
—
$
$
$
$
$
$
$
F-14
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these
consolidated financial statements.
Fixed maturity securities and equity securities
The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing
services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
•
•
•
•
•
•
•
•
reported trading prices,
benchmark yields,
broker-dealer quotes,
benchmark securities,
bids and offers,
credit ratings,
relative credit information, and
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions,
including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of
observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity.
When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar
characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing
service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed.
In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices
received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are
compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with
similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes
on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the
pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally,
as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar
to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did
not make any significant adjustments as of December 31, 2012 and 2011.
Mortgage loans on real estate
Mortgage loans on real estate are not measured at fair value on a recurring basis. The fair values of mortgage loans on real estate are calculated
using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans. The fair values
of impaired mortgage loans on real estate that we have considered to be collateral dependent are based on the fair value of the real estate collateral
(based on appraised values) less estimated costs to sell. The inputs utilized to determine fair value of all mortgage loans are unobservable market
data (competitive market interest rates and appraised property values); therefore, fair value of mortgage loans falls into Level 3 in the fair value
hierarchy.
Derivative instruments
The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative
instrument on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and are
adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates
and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty
is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index
annuity policy liabilities.
Other investments
None of the financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included
in other investments are policy loans, an equity method investment and company owned life insurance (COLI). We have not attempted to
determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded
these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the
benefit to be derived. The fair value of our equity method investment qualifies as a Level 3 fair value and was determined by calculating the
present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. The risk spread and liquidity discount
F-15
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
are rates determined by our investment professionals and are unobservable market inputs. The fair value of our COLI approximates the cash
surrender value of the policies and whose fair values fall within Level 2 of the fair value hierarchy.
Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due
to the nature of the assets assigned to this category.
Interest rate swap and caps
The fair values of our pay fixed/receive variable interest rate swaps and interest rate caps are obtained from third parties and are determined by
discounting expected future cash flows using projected LIBOR rates for the term of the swaps and caps.
2015 notes hedges
The fair value of these call options is determined by a third party who applies market observable data such as our common stock price, its
dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.
Policy benefit reserves, coinsurance deposits and SPIA benefit reserves
The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated
at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization
date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. For period-certain annuity
benefit contracts, the fair value is determined by discounting the benefits at the interest rates currently in effect for newly purchased immediate
annuity contracts. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality
or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require
disclosures of fair value. Policy benefit reserves, coinsurance deposits and SPIA benefit reserves are not measured at fair value on a recurring
basis. All of the fair values presented within these categories fall within Level 3 of the fair value hierarchy as most of the inputs are unobservable
market data.
Notes payable
The fair value of the convertible senior notes is based upon pricing matrices developed by a third party pricing service when quoted market
prices are not available and are categorized as Level 2 within the fair value hierarchy. Notes payable are not remeasured at fair value on a
recurring basis.
Subordinated debentures
Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including
our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining
for the debt being valued. These fair values are categorized as Level 2 within the fair value hierarchy. Subordinated debentures are not measured
at fair value on a recurring basis.
2015 notes embedded derivative
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion
premium are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market
data.
Fixed index annuities - embedded derivatives
We estimate the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each valuation date by
(i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the
excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those
liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy
decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy
anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected
costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum
guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
F-16
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at
fair value on a recurring basis using significant unobservable inputs for the years ended December 31, 2012 and 2011:
Year Ended December 31,
2012
2011
(Dollars in thousands)
Available for sale securities
Beginning balance
Principal returned
(Amortization)/accretion of premium/discount
Total gains (losses) (unrealized/realized):
Included in other comprehensive income
Net OTTI losses recognized in operations
$
2,098
$
(300)
67
250
(303)
Ending Balance
$
1,812
$
2,702
(393)
66
443
(720)
2,098
The Level 3 assets included in the table above are not material to our financial position, results of operations or cash flows, and it is management's
opinion that the sensitivity of the inputs used in determining the fair value of these assets is not material as well.
Fixed index annuities—embedded derivatives
Beginning balance
Premiums less benefits
Change in unrealized losses (gains), net
Ending balance
Year Ended December 31,
2012
2011
(Dollars in thousands)
$
$
2,530,496
$
1,971,383
765,942
41,118
919,375
(360,262)
3,337,556
$
2,530,496
Change in unrealized losses (gains), net for each period in our embedded derivatives are included in change in fair value of embedded derivatives
in the consolidated statements of operations.
Certain derivatives embedded in our fixed index annuity contracts are our most significant financial instrument measured at fair value that are
categorized as Level 3 in the fair value hierarchy. The contractual obligations for future annual index credits within our fixed index annuity
contracts are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. We estimate the fair value of these
embedded derivatives at each valuation date by the method described above under fixed index annuities - embedded derivatives. The projections
of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract
values.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract
values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract
values at December 31, 2012, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $226.0 million
and be recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease
of $136.7 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as
an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount
rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $252.2 million and be
recorded through operations as an increase in the change in fair value of embedded derivatives and increase our combined balance for deferred
policy acquisition costs and deferred sales inducements by $152.9 million and be recorded through operations as a decrease in amortization of
deferred policy acquisition costs and deferred sales inducements.
F-17
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Investments
At December 31, 2012 and 2011, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(Dollars in thousands)
Fair Value
December 31, 2012
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
$
4,590
$
564
$
— $
5,154
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Held for investment:
Corporate security
Equity securities, available for sale:
Finance, insurance and real estate
December 31, 2011
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Other asset backed securities
Held for investment:
United States Government sponsored agencies
Corporate security
Equity securities, available for sale:
Finance, insurance and real estate
1,763,789
3,116,678
86,099
12,930,173
2,743,537
354,870
957,291
21,957,027
76,088
$
$
11,704
461,770
19,160
1,568,223
172,304
5,095
44,190
(3,468)
(125)
—
(31,624)
(27,728)
(1,983)
(2,973)
1,772,025
3,578,323
105,259
14,466,772
2,888,113
357,982
998,508
2,283,010
$
(67,901) $
24,172,136
— $
(14,567) $
61,521
44,598
$
10,227
$
(1,403) $
53,422
4,084
$
594
$
— $
4,678
1,780,401
2,981,699
60,809
9,092,737
2,618,040
442,509
16,980,279
2,568,274
75,932
2,644,206
58,438
$
$
$
$
19,378
351,694
7,766
1,078,511
157,331
26,492
1,641,766
16,806
—
16,806
8,752
$
$
$
$
—
(10)
(242)
(79,992)
(72,081)
(5,611)
1,799,779
3,333,383
68,333
10,091,256
2,703,290
463,390
(157,936) $
18,464,109
— $
2,585,080
(16,590)
59,342
(16,590) $
2,644,422
(4,345) $
62,845
$
$
$
$
$
$
$
$
During 2012 and 2011, we received $4.6 billion and $3.2 billion, respectively, in net redemption proceeds related to calls of our callable United
States Government sponsored agency securities, of which $2.6 billion and $0.2 billion, respectively, were classified as held for investment. The
proceeds from these redemptions that have been reinvested have primarily been in United States Government sponsored agencies, corporate
securities, commercial mortgage backed securities and other asset backed securities classified as available for sale. For the remaining amount
to be reinvested we are considering further diversification into other asset classes, but we remain committed to maintaining a high quality
investment portfolio with low credit risk. At December 31, 2012, 28% of our fixed income securities have call features and 0.4% ($0.1 billion)
were subject to call redemption. Another 7% ($1.5 billion) will become subject to call redemption during 2013, of which $727 million are short-
term U.S. Government agency securities with a book yield of 0.85%.
F-18
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The amortized cost and fair value of fixed maturity securities at December 31, 2012, by contractual maturity are shown below. Actual maturities
will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties. All of our mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as
separate lines.
Available for sale
Held for investment
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
(Dollars in thousands)
Due in one year or less
$
39,743
$
41,276
$
— $
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Due after twenty years
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
679,050
4,655,968
5,608,423
6,918,145
17,901,329
2,743,537
354,870
957,291
765,237
5,049,957
6,134,359
7,936,704
19,927,533
2,888,113
357,982
998,508
—
—
—
76,088
76,088
—
—
—
—
—
—
—
61,521
61,521
—
—
—
$
21,957,027
$
24,172,136
$
76,088
$
61,521
Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity
were comprised of the following:
December 31,
2012
2011
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
2,223,933
$
1,488,237
Adjustments for assumed changes in amortization of deferred policy acquisition costs and
deferred sales inducements
Deferred income tax valuation allowance reversal
Deferred income tax benefit
(1,201,974)
22,534
(357,686)
Net unrealized gains reported as accumulated other comprehensive income
$
686,807
$
(819,476)
22,534
(234,066)
457,229
The National Association of Insurance Commissioners ("NAIC") assigns designations to fixed maturity securities. These designations range
from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given
by the Nationally Recognized Statistical Rating Organizations ("NRSRO's"). The NAIC designations are utilized by insurers in preparing their
annual statutory statements. NAIC Class 1 and 2 designations are considered "investment grade" while NAIC Class 3 through 6 designations
are considered "non-investment grade." Based on the NAIC designations, 98% of the fair value our fixed maturity portfolio is rated investment
grade at both December 31, 2012 and 2011.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
December 31,
2012
2011
NAIC
Designation
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
1
2
3
4
5
6
(Dollars in thousands)
$
13,737,381
$
15,250,560
$
14,359,272
$
15,486,571
7,838,186
8,533,121
4,894,739
5,272,759
398,294
53,879
—
5,375
387,222
56,151
—
6,603
335,642
26,674
4,932
3,226
315,406
23,989
5,756
4,050
$
22,033,115
$
24,233,657
$
19,624,485
$
21,108,531
F-19
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that
individual securities (consisting of 198 and 246 securities, respectively) have been in a continuous unrealized loss position, at December 31,
2012 and 2011:
Less than 12 months
12 months or more
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
(Dollars in thousands)
December 31, 2012
Fixed maturity securities:
Available for sale:
United States Government sponsored agencies
$
973,728
$
(3,468) $
United States municipalities, states and territories
24,393
(125)
— $
—
— $
973,728
$
(3,468)
—
24,393
(125)
Corporate securities:
Finance, insurance and real estate
Manufacturing, construction and mining
Utilities and related sectors
Wholesale/retail trade
Services, media and other
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Held for investment:
Corporate security:
Insurance
Equity security, available for sale:
Services
December 31, 2011
Fixed maturity securities:
Available for sale:
177,962
426,120
221,044
101,790
264,421
220,622
161,582
145,238
(4,126)
(4,303)
(5,187)
(784)
(3,085)
(8,679)
(1,983)
(2,242)
85,709
21,975
39,224
10,250
—
260,226
—
26,131
(8,438)
(1,281)
(4,212)
(208)
—
(19,049)
—
(731)
263,671
448,095
260,268
112,040
264,421
480,848
161,582
171,369
(12,564)
(5,584)
(9,399)
(992)
(3,085)
(27,728)
(1,983)
(2,973)
$ 2,716,900
$
(33,982) $
443,515
$
(33,919) $ 3,160,415
$
(67,901)
$
$
— $
— $
61,521
$
(14,567) $
61,521
$
(14,567)
— $
— $
8,722
$
(1,403) $
8,722
$
(1,403)
United States municipalities, states and territories
$
3,535
$
(10) $
— $
— $
3,535
$
Foreign government obligations
Corporate securities:
Finance, insurance and real estate
Manufacturing, construction and mining
Utilities and related sectors
Wholesale/retail trade
Services, media and other
Residential mortgage backed securities
Other asset backed securities
—
—
14,282
(242)
14,282
363,909
201,762
174,251
15,523
27,688
295,352
115,542
(36,575)
146,354
(15,611)
(7,131)
(7,576)
(188)
(249)
(19,920)
(2,863)
15,593
37,778
9,275
17,105
709,612
15,550
(1,627)
(6,946)
(1,194)
(2,895)
510,263
217,355
212,029
24,798
44,793
(52,161)
1,004,964
(2,748)
131,092
(10)
(242)
(52,186)
(8,758)
(14,522)
(1,382)
(3,144)
(72,081)
(5,611)
$ 1,197,562
$
(74,512) $
965,549
$
(83,424) $ 2,163,111
$
(157,936)
Held for investment:
Corporate security:
Insurance
Equity securities, available for sale:
Finance, insurance and real estate
$
$
— $
— $
59,342
$
(16,590) $
59,342
$
(16,590)
20,028
$
(3,095) $
3,750
$
(1,250) $
23,778
$
(4,345)
F-20
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following is a description of the factors causing the unrealized losses by investment category as of December 31, 2012:
United States Government sponsored agencies and United States municipalities, states and territories: These securities are relatively long in
duration; however, they are callable in less than 12 months making the value of such securities sensitive to changes in market interest rates. The
timing of when some of these securities were purchased in 2012 gave rise to unrealized losses at December 31, 2012.
Corporate securities: The unrealized losses in these securities are due partially to the timing of purchases in 2012 and a small number of securities
seeing their credit spreads remain wide due to issuer or industry specific news. In addition, some financial and industrial sector credit spreads
remain wide due to continued economic uncertainty and concerns of economic instability in the European Union.
Residential mortgage backed securities: At December 31, 2012, we had no exposure to sub-prime residential mortgage backed securities. All
of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own
are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A"
residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $374.0 million and a fair value of $376.1
million. Despite recent improvements in the capital markets, the fair values of RMBS continue at prices below amortized cost. RMBS prices
will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Commercial mortgage backed securities: The unrealized losses in these securities are due partially to the timing of purchases in 2012. A number
of purchases made in the middle of the fourth quarter were at yields lower than what could be executed at the end of the year due to the increase
in the treasury yield during December. Yield spreads for commercial mortgage backed securities have narrowed during the course of the year
but remain attractive.
Other asset backed securities: The unrealized losses in these securities are predominantly assigned to financial sector capital trust securities
which have longer maturity dates and have declined in price due to prolonged stress in the financial sector. Only one security in an unrealized
loss position is rated below investment grade.
Equity securities: We have one equity security in an unrealized loss position that is a perpetual preferred security of a service company. Despite
modest deterioration of its business profile our view for the investment over the intermediate term is constructive.
Approximately 75% and 83% of the unrealized losses on fixed maturity securities shown in the above table for December 31, 2012 and 2011,
respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity
securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains/losses on investments for the years ended December 31, 2012, 2011 and 2010 are as follows:
Fixed maturity securities held for investment carried at amortized cost
Investments carried at fair value:
Fixed maturity securities, available for sale
Equity securities, available for sale
Adjustment for effect on other balance sheet accounts:
Deferred policy acquisition costs and deferred sales inducements
Deferred income tax asset
Year Ended December 31,
2012
2011
2010
$
$
(Dollars in thousands)
$
$
14,783
731,279
4,417
735,696
$
$
40,668
1,275,061
(369)
1,274,692
(382,498)
(123,620)
(506,118)
(697,140)
(202,143)
(899,283)
(7,233)
417,318
(5,380)
411,938
(239,206)
(60,456)
(299,662)
Change in net unrealized gains/losses on investments carried at fair value
$
229,578
$
375,409
$
112,276
F-21
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Components of net investment income are as follows:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
Fixed maturity securities
$
1,112,296
$
1,048,376
$
Equity securities
Mortgage loans on real estate
Cash and cash equivalents
Other
Less investment expenses
Net investment income
3,090
176,354
2,243
6,348
1,300,331
(13,408)
3,315
172,731
554
4,020
1,228,996
(10,216)
875,894
5,299
159,193
621
1,636
1,042,643
(6,537)
$
1,286,923
$
1,218,780
$
1,036,106
Proceeds from sales of available for sale fixed maturity securities for the years ended December 31, 2012, 2011 and 2010 were $492.5 million,
$252.2 million and $340.6 million, respectively. Scheduled principal repayments, calls and tenders for available for sale fixed maturity securities
for the years ended December 31, 2012, 2011 and 2010 were $2.8 billion, $3.4 billion and $4.1 billion, respectively. Calls of held for investment
fixed maturity securities for the years ended December 31, 2012, 2011 and 2010 were $2.6 billion, $0.2 billion and $1.6 billion, respectively.
Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized
gains (losses) on investments, excluding other than temporary impairment losses are as follows:
Available for sale fixed maturity securities:
Gross realized gains
Gross realized losses
Equity securities:
Gross realized gains
Gross realized losses
Mortgage loans on real estate:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
$
10,906
$
12,614
$
(562)
10,344
(1,423)
11,191
562
—
562
966
—
966
27,755
(2,575)
25,180
14,384
(71)
14,313
Increase in allowance for credit losses
(16,832)
(30,770)
(15,225)
Other investments:
Gains on sale of real estate
Impairment losses on real estate
5,149
(5,677)
(528)
377
(405)
(28)
—
(542)
(542)
$
(6,454) $
(18,641) $
23,726
The following table summarizes the carrying value of our fixed maturity securities, mortgage loans on real estate and real estate owned that have
been non-income producing for 12 consecutive months:
Fixed maturity securities, available for sale
Mortgage loans on real estate
Real estate owned
December 31,
2012
2011
(Dollars in thousands)
$
$
4,691
2,783
1,270
5,852
4,064
5,257
8,744
$
15,173
F-22
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process
includes analyzing our ability to recover the amortized cost or cost basis of each investment that has a fair value that is lower than its amortized
cost or cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary
impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process in place to identify securities that could potentially have an impairment that is other than temporary. This process
involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
•
the length of time and the extent to which the fair value has been less than amortized cost or cost;
• whether the issuer is current on all payments and all contractual payments have been made as agreed;
•
the remaining payment terms and the financial condition and near-term prospects of the issuer;
•
the lack of ability to refinance due to liquidity problems in the credit market;
•
the fair value of any underlying collateral;
•
the existence of any credit protection available;
•
our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities;
•
our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot
recover to cost in a reasonable period of time;
our intent and ability to retain equity securities for a period of time sufficient to allow for recovery;
consideration of rating agency actions; and
changes in estimated cash flows of residential mortgage and asset backed securities.
•
•
•
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and
circumstances surrounding each security. Where the decline in market value of debt securities is attributable to changes in market interest rates
or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we
do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more
likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities,
we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or
we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable
period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and
its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there
is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration
in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more
likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has
occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the
entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We
determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each
security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference
between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in
operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income.
The determination of the credit loss component of a residential mortgage backed security is based on a number of factors. The primary consideration
in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of
purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent
third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual
default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and
prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual
obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each
security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future,
we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential
credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of
the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary
impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed
securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates,
prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities
F-23
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled
higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios,
geographic diversity, as well as other appropriate considerations. The default curves generally assume lower loss levels for older vintage securities
versus more recent vintage securities, which reflects the decline in underwriting standards over the years.
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments
we have recognized on residential mortgage backed securities at December 31, 2012 and 2011, which are all senior level tranches within the
structure of the securities:
Sector
Vintage
Min
Max
Min
Max
Min
Max
Discount Rate
Default Rate
Loss Severity
Year ended December 31, 2012
Prime
Alt-A
Year ended December 31, 2011
Prime
Alt-A
2005
2006
2007
2004
2005
2006
2007
2005
2006
2007
2008
2004
2005
2006
2007
6.5 %
5.8 %
6.1 %
5.8 %
5.6 %
6.0 %
6.2 %
5.8 %
6.4 %
5.8 %
6.6 %
5.8 %
5.7 %
6.0 %
6.2 %
7.7 %
7.6 %
7.3 %
5.8 %
8.7 %
6.0 %
7.0 %
7.9 %
7.6 %
7.9 %
6.6 %
5.8 %
7.7 %
7.3 %
7.4 %
8 %
9 %
11 %
11 %
12 %
32 %
31 %
6 %
8 %
8 %
13 %
11 %
11 %
23 %
29 %
19 %
19 %
38 %
11 %
38 %
46 %
55 %
19 %
15 %
30 %
13 %
11 %
32 %
47 %
59 %
40 %
40 %
40 %
60 %
5 %
55 %
55 %
40 %
45 %
40 %
45 %
50 %
5 %
50 %
50 %
50 %
55 %
60 %
60 %
55 %
60 %
65 %
55 %
60 %
60 %
45 %
50 %
55 %
60 %
70 %
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial
performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited
to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of
financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer
appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined.
Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived
from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation
based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the
amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes
due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an
impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an
ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline
in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies
and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts
presented in our consolidated financial statements.
F-24
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes other than temporary impairments by asset type:
Number of
Securities
Total OTTI
Losses
Portion of OTTI
Losses
Recognized from
Other
Comprehensive
Income
Net OTTI Losses
Recognized in
Operations
(Dollars in thousands)
1
1
39
41
$
$
(1,765)
$
(622)
(3,024)
(5,411)
$
— $
—
(9,521)
(9,521)
$
(1,765)
(622)
(12,545)
(14,932)
Year ended December 31, 2012
Fixed maturity securities, available for sale:
Corporate securities:
Finance
Retail
Residential mortgage backed securities
Year ended December 31, 2011
Fixed maturity securities, available for sale:
Residential mortgage backed securities
66
$
(19,420)
$
(13,796)
$
(33,216)
Equity securities, available for sale:
Finance
Year ended December 31, 2010
Fixed maturity securities, available for sale:
Corporate securities:
Finance
Retail
Residential mortgage backed securities
1
67
1
1
30
32
$
$
$
(760)
—
(20,180)
$
(13,796)
$
(760)
(33,976)
(822)
(1,576)
(17,146)
(19,544)
$
—
—
(4,323)
(4,323)
$
(822)
(1,576)
(21,469)
(23,867)
The cumulative portion of other than temporary impairments determined to be credit losses which have been recognized in operations for debt
securities are summarized as follows:
Cumulative credit loss at beginning of year
Credit losses on securities for which OTTI has not previously been recognized
Additional credit losses on securities for which OTTI has previously been recognized
Accumulated losses on securities that were disposed of during the period
Cumulative credit loss at end of year
Year Ended December 31,
2012
2011
(Dollars in thousands)
$
$
(119,095)
$
(12,365)
(2,567)
—
(96,893)
(4,141)
(29,075)
11,014
(134,027)
$
(119,095)
F-25
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes the cumulative noncredit portion of OTTI and the change in fair value since recognition of OTTI, both of which
were recognized in other comprehensive income, by major type of security for securities that are part of our investment portfolio at December 31,
2012 and 2011:
December 31, 2012
Fixed maturity securities, available for sale:
Corporate securities
Residential mortgage backed securities
Equity securities, available for sale:
Finance, insurance and real estate
December 31, 2011
Fixed maturity securities, available for sale:
Corporate securities
Residential mortgage backed securities
Equity securities, available for sale:
Finance, insurance and real estate
Amortized Cost
OTTI
Recognized
in Other
Comprehensive
Income
Change in
Fair Value Since
OTTI was
Recognized
(Dollars in thousands)
Fair Value
$
$
$
$
10,599
$
(2,151)
$
5,676
$
855,915
(177,604)
171,514
9,976
—
9,668
876,490
$
(179,755)
$
186,858
$
3,347
$
(2,151)
$
4,818
$
999,024
(187,126)
125,502
12,019
—
8,110
1,014,390
$
(189,277)
$
138,430
$
14,124
849,825
19,644
883,593
6,014
937,400
20,129
963,543
At December 31, 2012 and 2011, fixed maturity securities and short-term investments with an amortized cost of $27.2 billion and $23.9 billion,
respectively, were on deposit with state agencies to meet regulatory requirements. There are no restrictions on these assets.
At December 31, 2012 and 2011, we had no investment in any person or its affiliates (other than bonds issued by agencies of the United States
Government) that exceeded 10% of stockholders' equity.
4. Mortgage Loans on Real Estate
Our mortgage loan portfolio, summarized in the following table, totaled $2.6 billion and $2.8 billion at December 31, 2012 and 2011, respectively,
with commitments outstanding of $37.9 million at December 31, 2012.
Principal outstanding
Loan loss allowance
Deferred prepayment fees
Carrying value
December 31,
2012
2011
(Dollars in thousands)
$
$
2,658,883
$
2,856,011
(34,234)
(709)
(32,964)
—
2,623,940
$
2,823,047
F-26
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The portfolio consists of commercial mortgage loans collateralized by the related properties and diversified as to property type, location and
loan size. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and other criteria to attempt to reduce
the risk of default. The mortgage loan portfolio is summarized by geographic region and property type as follows:
Geographic distribution
East
Middle Atlantic
Mountain
New England
Pacific
South Atlantic
West North Central
West South Central
Property type distribution
Office
Medical Office
Retail
Industrial/Warehouse
Hotel
Apartment
Mixed use/other
December 31,
2012
2011
Principal
Percent
Principal
Percent
(Dollars in thousands)
$
$
$
732,762
155,094
387,599
26,385
320,982
458,802
370,168
207,091
27.5% $
5.8%
14.6%
1.0%
12.1%
17.3%
13.9%
7.8%
719,231
169,240
411,054
36,815
309,693
493,764
487,693
228,521
25.2%
5.9%
14.4%
1.3%
10.8%
17.3%
17.1%
8.0%
2,658,883
100.0% $
2,856,011
100.0%
666,467
136,764
677,951
692,637
94,045
219,335
171,684
25.1% $
5.1%
25.5%
26.1%
3.5%
8.2%
6.5%
777,343
175,580
635,916
710,426
139,193
187,548
230,005
27.2%
6.1%
22.3%
24.9%
4.9%
6.6%
8.0%
$
2,658,883
100.0% $
2,856,011
100.0%
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the
measurement of an estimated loss for each individual loan identified. A mortgage loan is impaired when it is probable that we will be unable
to collect all amounts due according to the contractual terms of the loan agreement. If we determine that the value of any specific mortgage
loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash
flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell. In
addition, we analyze the mortgage loan portfolio for the need of a general loan allowance for probable losses on all other loans. The amount of
the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience,
delinquencies, credit concentrations, underwriting standards and national and local economic conditions.
Our financing receivables currently consist of one portfolio segment which is our commercial mortgage loan portfolio. These are mortgage
loans with collateral consisting of commercial real estate and borrowers consisting mostly of limited liability partnerships or limited liability
corporations. Credit loss experience in our mortgage loan portfolio has been limited to the most recent fiscal years. We experienced our first
credit loss from our mortgage loan portfolio in 2009.
We have a population of mortgage loans that we have been carrying with workout terms (e.g. interest only periods, period of suspended payments,
etc.) and a population of mortgage loans that have been in a delinquent status (i.e. more than 60 days past due). It is from this population that
we have been recognizing some impairment loss due to nonpayment and eventual satisfaction of the loan by taking ownership of the collateral
real estate. In most cases the fair value of the collateral less estimated costs to sell such collateral has been less than the outstanding principal
amount of the mortgage loan.
Our general loan loss allowance for periods through September 30, 2011 was calculated on the cumulative outstanding principal on loans making
up the group of loans currently in workout terms and loans currently more than 60 days past due. We applied a factor to the total outstanding
principal of these loans that was calculated as the average specific impairment loss for the most recent 4 quarters divided by the sum of the
average of the total outstanding principal of delinquent loans for the most recent 4 quarters and the average of the total outstanding principal of
loans in workout for the most recent 4 quarters. In the fourth quarter of 2011, we modified the calculation for determining our general loan loss
allowance. The group of loans that we utilized to calculate an estimate of general loan loss allowance were those that had a debt service coverage
ratio (DSCR) of less than 1.0. The DSCR is calculated by dividing the net operating income of the mortgaged property by the contractual
principal and interest payment due for the corresponding period. We developed the loss rates to apply to this group of loans by dividing the
specific impairment loss for the most recent 4 quarters by the principal outstanding of the loans with a DSCR of less than 1.0.
F-27
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During the year ended December 31, 2012, we completed a process of rating the mortgage loans in our portfolio based on factors such as historical
operating performance, loan to value ratio and economic outlook, among others. We calculated a loss factor to apply to each rating based on
historical losses we have recognized in our mortgage loan portfolio. We applied the loss factors to the total principal outstanding within each
rating category to determine an appropriate estimate of general loan loss allowance at December 31, 2012. The change in methodology utilized
to determine the general loan loss allowance did not result in a material adjustment.
The following table presents a rollforward of our specific and general valuation allowances for mortgage loans on real estate:
Year Ended December 31,
2012
2011
2010
Specific
Allowance
General
Allowance
Specific
Allowance
General
Allowance
Specific
Allowance
General
Allowance
(Dollars in thousands)
Beginning allowance balance
$
(23,664)
$
(9,300)
$
(13,224) $
(3,000)
$
(5,266)
$
Charge-offs
Recoveries
15,562
—
—
—
14,030
—
—
—
4,267
—
Provision for credit losses
(15,032)
(1,800)
(24,470)
(6,300)
(12,225)
Ending allowance balance
$
(23,134)
$
(11,100)
$
(23,664) $
(9,300)
$
(13,224)
$
—
—
—
(3,000)
(3,000)
The specific allowance is a total of credit loss allowances on loans which are individually evaluated for impairment. The general allowance is
the group of loans discussed above which are collectively evaluated for impairment. The following table presents the total outstanding principal
of loans evaluated for impairment by basis of impairment method:
December 31,
2012
2011
2010
(Dollars in thousands)
Individually evaluated for impairment
Collectively evaluated for impairment
Total loans evaluated for impairment
$
$
53,110
2,605,723
2,658,833
$
$
67,698
2,788,313
2,856,011
31,027
2,583,838
2,614,865
The amount of loans collectively evaluated for impairment at December 31, 2011 and 2010 were modified from what was originally reported
to be consistent with the groupings used in 2012.
The amount of charge-offs include the amount of allowance that has been established for loans that were satisfied by taking ownership of the
collateral. When the property is taken it is recorded at its fair value as a component of other investments and the mortgage loan is recorded as
fully paid, with any allowance for credit loss that has been established charged off. Fair value of the real estate is determined by third party
appraisal. There could be other situations that develop where we have established a larger specific loan loss allowance than is needed based on
increases in the fair value of collateral supporting collateral dependent loans or improvements in the financial position of a borrower so that a
loan would become reliant on cash flows from debt service instead of dependent upon sale of the collateral. Charge-offs of the allowance would
be recognized in those situations as well. We define collateral dependent loans as those mortgage loans for which we still depend on the value
of the collateral real estate to satisfy the outstanding principal of the loan.
During the years ended December 31, 2012 and 2011, thirteen and eleven mortgage loans, respectively, were satisfied by taking ownership of
the real estate serving as collateral. The following table summarizes the activity in the real estate owned which was obtained in satisfaction of
mortgage loans on real estate:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
Real estate owned at beginning of period
$
36,821
$
19,122
$
Real estate acquired in satisfaction of mortgage loans
Additions
Sales
Impairments
Depreciation
26,324
398
(23,825)
(5,677)
(869)
20,978
387
(3,027)
—
(639)
12,268
7,408
352
—
(542)
(364)
Real estate owned at end of period
$
33,172
$
36,821
$
19,122
F-28
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We analyze credit risk of our mortgage loans by analyzing all available evidence on loans that are delinquent and loans that are in a workout
period.
Credit Exposure--By Payment Activity
Performing
In workout
Delinquent
Collateral dependent
December 31,
2012
2011
(Dollars in thousands)
$
2,597,440
2,743,068
26,723
—
34,720
67,425
6,595
38,923
$
2,658,883
$
2,856,011
Mortgage loans are considered delinquent when they become 60 days past due. When loans become 90 days past due, become collateral dependent
or enter a period with no debt service payments required we place them on non-accrual status and discontinue recognizing interest income. If
payments are received on a delinquent loan, interest income is recognized to the extent it would have been recognized if normal principal and
interest would have been received timely. If the payments are received to bring a delinquent loan back to current we will resume accruing interest
income on that loan. Outstanding principal of loans in a non-accrual status at December 31, 2012 and 2011 totaled $34.7 million and $45.5
million, respectively.
All of our commercial mortgage loans depend on the cash flow of the borrower to be at a sufficient level to service the principal and interest
payments as they come due. In general, cash inflows of the borrowers are generated by collecting monthly rent from tenants occupying space
within the borrowers' properties. Our borrowers face operating risks such as tenants going out of business, tenants struggling to make rent
payments as they become due and tenants canceling leases and moving to other locations. We have a number of loans where the real estate is
occupied by a single tenant. Our borrowers sometimes face both a reduction in cash flow on their mortgage property as well as a reduction in
the fair value of the real estate collateral. If borrowers are unable to replace lost rent revenue and increases in the fair value of their property do
not materialize we could potentially incur more losses than what we have allowed for in our specific and general loan loss allowances.
Aging of financing receivables is summarized in the following table, with loans in a "workout" period as of the reporting date considered current
if payments are current in accordance with agree upon terms:
30 - 59 Days
60 - 89 Days
90 Days and
Over
Total Past
Due
Current
Collateral
Dependent
Receivables
Total
Financing
Receivables
(Dollars in thousands)
Commercial Mortgage Loans
December 31, 2012
December 31, 2011
$
$
— $
3,378
$
— $
— $
— $
— $
2,624,113
6,595
$
9,973
$
2,807,115
$
$
34,720
38,923
$
$
2,658,833
2,856,011
F-29
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Financing receivables summarized in the following table represent all loans that we are either not currently collecting or those we feel it is
probable we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the
borrower to alleviate short-term cash flow issues, loans delinquent for more than 60 days at the reporting date, loans we have determined to be
collateral dependent and loans that we have recorded specific impairments on that we feel may continue to have performance issues).
December 31, 2012
Mortgage loans with an allowance
Mortgage loans with no related allowance
December 31, 2011
Mortgage loans with an allowance
Mortgage loans with no related allowance
December 31, 2010
Mortgage loans with an allowance
Mortgage loans with no related allowance
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest Income
Recognized
(Dollars in thousands)
$
$
$
$
$
$
29,976
27,765
57,741
44,034
63,023
107,057
17,803
81,994
99,797
$
$
$
$
$
$
53,110
27,765
80,875
67,698
63,023
130,721
31,027
81,994
113,021
$
$
$
$
$
$
(23,134) $
—
(23,134) $
(23,664) $
—
37,480
27,696
65,176
53,617
60,974
(23,664) $
114,591
(13,224) $
—
24,062
82,535
(13,224) $
106,597
$
$
$
$
$
$
1,946
1,664
3,610
3,284
3,509
6,793
656
4,921
5,577
The loans that are categorized as "in workout" consist of loans that we have agreed to lower or no mortgage payments for a period of time while
the borrowers address cash flow and/or operational issues. The key features of these workouts have been determined on a loan-by-loan basis.
Most of these loans are in a period of low cash flow due to tenants vacating their space or tenants requesting rent relief during difficult economic
periods. Generally, we have allowed the borrower a six month interest only period and in some cases a twelve month period of interest only.
Interest only workout loans are expected to return to their regular debt service payments after the interest only period. Interest only loans that
are not fully amortizing will have a larger balance at their balloon date than originally contracted. Fully amortizing loans that are in interest
only periods will have larger debt service payments for their remaining term due to lost principal payments during the interest only period. In
limited circumstances we have allowed borrowers to pay the principal portion of their loan payment into an escrow account that can be used for
capital and tenant improvements for a period of not more than 12 months. In these situations new loan amortization schedules are calculated
based on the principal not collected during this 12 month workout period and larger payments are collected for the remaining term of each loan.
In all cases, original interest rate and maturity date have not been modified and we have not forgiven any principal amounts.
A Troubled Debt Restructuring ("TDR") is a situation where we have granted a concession to a borrower for economic or legal reasons related
to the borrower's financial difficulties that we would not otherwise consider. A mortgage loan that has been granted new terms, including workout
terms as described previously, would be considered a TDR if it meets conditions that would indicate a borrower is experiencing financial difficulty
and the new terms constituting a concession on our part. We analyze all loans that we agree to workout terms and all loans that we have refinanced
to determine if they meet the definition of a TDR. We consider the following factors in determining whether or not a borrower is experiencing
financial difficulty:
•
•
•
•
•
•
borrower is in default,
borrower has declared bankruptcy,
there is growing concern about the borrower's ability to continue as a going concern,
borrower has insufficient cash flows to service debt,
borrower's inability to obtain funds from other sources, and
there is a breach of financial covenants by the borrower.
If the borrower is determined to be in financial difficulty, we consider the following conditions to determine if the borrower was granted a
concession:
assets used to satisfy debt are less than our recorded investment,
interest rate is modified,
•
•
• maturity date extension at an interest rate less than market rate,
•
•
•
capitalization of interest,
delaying principal and/or interest for a period of three months or more, and
partial forgiveness of the balance or charge-off.
F-30
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Mortgage loan workouts, refinances or restructures that are classified as TDR are individually evaluated and measured for impairment. A
summary of mortgage loans on commercial real estate with outstanding principal at December 31, 2012 and 2011 that we determined to be
TDR's are as follows:
Geographic Region
Year ended December 31, 2012:
East
Mountain
South Atlantic
East North Central
West North Central
Year ended December 31, 2011:
East
Mountain
South Atlantic
West North Central
Number of
Mortgage
Loans
Principal
Balance
Outstanding
Specific Loan
Loss Allowance
Net Carrying
Amount
(Dollars in thousands)
1
10
9
1
3
24
3
10
11
1
25
$
$
$
$
4,208
$
(1,425)
$
28,786
23,358
2,232
9,466
(1,702)
(5,047)
(467)
(2,328)
68,050
$
(10,969)
$
8,489
$
(2,115)
$
29,539
28,676
1,937
(1,637)
(6,339)
(269)
68,641
$
(10,360)
$
2,783
27,084
18,311
1,765
7,138
57,081
6,374
27,902
22,337
1,668
58,281
5. Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. None of our derivatives qualify
for hedge accounting, thus, any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations.
The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts, presented in the
consolidated balance sheets are as follows:
Assets
Derivative instruments
Call options
Other assets
2015 notes hedges
Interest rate caps
Liabilities
Policy benefit reserves—annuity products
Fixed index annuities—embedded derivatives
Other liabilities
2015 notes embedded derivative
Interest rate swaps
December 31,
2012
2011
(Dollars in thousands)
$
$
$
415,258
$
273,314
43,105
3,247
45,593
—
461,610
$
318,907
3,337,556
$
2,530,496
43,105
4,261
45,593
—
$
3,384,922
$
2,576,089
F-31
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The change in fair value of derivatives included in the consolidated statements of operations are as follows:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
Change in fair value of derivatives:
Call options
$
228,610
$
(93,582) $
141,803
2015 notes hedges (see note 9)
Interest rate swaps
Interest rate caps
Change in fair value of embedded derivatives:
2015 notes embedded derivative (see note 9)
Fixed index annuities—embedded derivatives
(2,488)
(4,261)
(723)
(21,002)
(144)
—
29,595
(2,536)
—
221,138
$
(114,728) $
168,862
(2,488) $
(21,002) $
289,387
(84,192)
286,899
$
(105,194) $
29,595
101,355
130,950
$
$
$
We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the
gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives
consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all
such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to
fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses
recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective
anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to
fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to
change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps,
participation rates, or asset fees, we can generally manage option costs except in cases where the contractual features would prevent further
modifications.
Our strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process which evaluates the
program's effectiveness. We do not purchase call options that would require payment or collateral to another institution and our call options do
not contain counterparty credit-risk-related contingent features. We are exposed to risk of loss in the event of nonperformance by the counterparties
and, accordingly, we purchase our option contracts from multiple counterparties and evaluate the creditworthiness of all counterparties prior to
purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's
credit rating of A- or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration
limits. We also have credit support agreements that allow us to request the counterparty to provide collateral to us when the fair value of our
exposure to the counterparty exceeds specified amounts.
The notional amount and fair value of our call options by counterparty and each counterparty's current credit rating are as follows:
Counterparty
Bank of America
Barclays
BNP Paribas
Citibank, N.A.
Credit Suisse
Deutsche Bank
HSBC
J.P. Morgan
Morgan Stanley
UBS
Wells Fargo (Wachovia)
Credit Rating
(S&P)
Credit Rating
(Moody's)
Notional
Amount
Fair Value
Notional
Amount
Fair Value
December 31,
2012
2011
A
A+
A+
A
A+
A+
AA-
A+
A
A
AA-
A3
A2
A2
A3
A1
A2
Aa3
Aa3
Baa1
A2
Aa3
$
568,786
$
16,533
$
2,340,213
$
(Dollars in thousands)
3,463,777
2,207,097
2,878,588
936,625
886,688
295,520
735,016
1,590,505
—
103,929
60,301
67,592
21,518
20,787
6,539
21,940
40,113
—
2,419,339
2,533,301
—
1,423,802
384,420
348,674
2,109,019
244,180
39,147
43,481
60,903
48,293
—
27,464
7,697
4,557
27,961
7,375
240
$
$
2,060,903
15,623,505
$
$
56,006
415,258
$
$
2,227,235
14,069,330
$
$
45,343
273,314
F-32
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of December 31, 2012 and 2011, we held $328.7 million and $165.4 million, respectively, of cash and cash equivalents and other securities
received from counterparties for derivative collateral, which is included in other liabilities on our consolidated balance sheets. This derivative
collateral limits the maximum amount of economic loss due to credit risk that we would incur if parties to the call options failed completely to
perform according to the terms of the contracts to $93.7 million and $109.3 million at December 31, 2012 and 2011, respectively.
The future annual index credits on our fixed index annuities are treated as a "series of embedded derivatives" over the expected life of the
applicable contract. We do not purchase call options to fund the index liabilities which may arise after the next policy anniversary date. We must
value both the call options and the related forward embedded options in the policies at fair value.
We entered into an interest rate swap and caps to manage interest rate risk associated with the floating rate component on certain of our subordinated
debentures. See note 10 for more information on our subordinated debentures. The terms of the interest rate swap provide that we pay a fixed
rate of interest and receive a floating rate of interest. The terms of the interest rate caps limit the three month London Interbank Offered Rate
to 2.50%. The interest rate swap and caps are not effective hedges under accounting guidance for derivative instruments and hedging activities.
Therefore, we record the interest rate swap and caps at fair value and any net cash payments received or paid are included in the change in fair
value of derivatives in the consolidated statements of operations.
Details regarding the interest rate swap are as follows:
Maturity Date
Notional
Amount
Receive Rate
Pay Rate
Counterparty
Fair Value
Fair Value
March 15, 2021
$
85,500
*LIBOR
2.415%
SunTrust
$
(4,261)
$
—
(Dollars in thousands)
December 31,
2012
2011
___________________________________
* - three month London Interbank Offered Rate
Details regarding the interest rate caps are as follows:
Maturity Date
July 7, 2021
July 8, 2021
July 29, 2021
Notional
Amount
Floating Rate
$
$
40,000
12,000
27,000
79,000
*LIBOR
*LIBOR
*LIBOR
Cap
Rate
2.50%
2.50%
2.50%
Counterparty
Fair Value
Fair Value
SunTrust
SunTrust
SunTrust
(Dollars in thousands)
$
$
1,634
490
1,123
3,247
$
$
—
—
—
—
December 31,
2012
2011
___________________________________
* - three month London Interbank Offered Rate
The interest rate swap has a forward starting date beginning in March 2014 and converts floating rates to fixed rates for seven years. The interest
rate caps have a forward starting date beginning in July 2014 and cap our interest rates for seven years. As of December 31, 2012 we provided
$1.2 million of cash and cash equivalents to the counterparty for derivative collateral related to the swap and caps, which is included in other
assets on our consolidated balance sheets.
F-33
6. Deferred Policy Acquisition Costs and Deferred Sales Inducements
Policy acquisition costs deferred and amortized are as follows:
Balance at beginning of year
Costs deferred during the year:
Commissions
Policy issue costs
Amortization
Effect of net unrealized gains/losses
December 31,
2012
2011
2010
(Dollars in thousands)
$
1,683,857
$
1,747,760
$
1,625,785
399,001
4,410
(164,919)
(212,550)
463,889
14,945
(143,478)
(399,259)
390,631
11,976
(136,388)
(144,244)
Balance at end of year
$
1,709,799
$
1,683,857
$
1,747,760
Sales inducements deferred and amortized are as follows:
Balance at beginning of year
Costs deferred during the year
Amortization
Effect of net unrealized gains/losses
Balance at end of year
December 31,
2012
2011
2010
(Dollars in thousands)
$
1,242,787
$
1,227,328
$
1,011,449
306,659
(87,157)
(169,948)
385,123
(71,781)
(297,883)
370,714
(59,873)
(94,962)
$
1,292,341
$
1,242,787
$
1,227,328
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 unlocking adjustment in 2012 increased amortization
of deferred policy acquisition costs by $3.7 million and decreased amortization of deferred sales inducements by $0.2 million. The unlocking
adjustment in 2011 decreased amortization of deferred policy acquisition costs by $9.1 million and decreased amortization for deferred sales
inducements by $5.0 million. The unlocking adjustment in 2010 increased amortization of deferred policy acquisition costs by $1.4 million and
increased amortization for deferred sales inducements by $0.3 million.
7. Reinsurance and Policy Provisions
Coinsurance
We have entered into two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of our index
and fixed rate annuities issued from August 1, 2001 through December 31, 2001, 40% of those contracts issued during 2002 and 2003 and 20%
of those contracts issued from January 1, 2004 to July 31, 2004. The business reinsured under these agreements may not be recaptured.
Coinsurance deposits (aggregate policy benefit reserves, transferred to EquiTrust under these agreements were $1.0 billion and $1.1 billion at
December 31, 2012 and 2011, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to EquiTrust should
EquiTrust fail to meet the obligations it has coinsured. None of the coinsurance deposits with EquiTrust are deemed by management to be
uncollectible. The balance due under these agreements to EquiTrust was $9.2 million and $11.5 million at December 31, 2012 and 2011,
respectively, and represents the fair value of call options held by us to fund index credits related to the ceded business net of cash due to or from
EquiTrust related to monthly settlements of policy activity and other expenses.
Effective July 1, 2009, we entered into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life
reinsurer domiciled in Bermuda. One agreement cedes 20% of certain of our fixed index annuities issued from January 1, 2009 through March 31,
2010. The business reinsured under this agreement is not eligible for recapture until the end of the month following seven years after the date
of issuance of the policy. The other agreement cedes 80% of our multi-year rate guaranteed annuities issued on or after July 1, 2009. The
business reinsured under this agreement may not be recaptured. Coinsurance deposits (aggregate policy benefit reserves transferred to Athene
under these agreements) were $1.9 billion and $1.7 billion at December 31, 2012 and 2011, respectively. We remain liable to policyholders with
respect to the policy liabilities ceded to Athene should Athene fail to meet the obligations it has coinsured. The annuity deposits that have been
ceded to Athene are being held in a trust on a funds withheld basis. American Equity Life is named as the sole beneficiary of the trust. 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 account 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 in a trust for the amount of any
shortfall. None of the coinsurance deposits with Athene are deemed by management to be uncollectible. The balance due under these agreements
to Athene was $14.0 million and $8.4 million at December 31, 2012 and 2011, respectively, and represents the fair value of call options held by
us to fund index credits related to the ceded business net of cash due from Athene related to monthly settlements of policy activity.
F-34
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Amounts ceded to EquiTrust and Athene under these agreements are as follows:
Consolidated Statements of Operations
Annuity product charges
Change in fair value of derivatives
Interest sensitive and index product benefits
Change in fair value of embedded derivatives
Other operating costs and expenses
Consolidated Statements of Cash Flows
Annuity deposits
Cash payments to policyholders
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
$
$
$
$
$
$
$
$
$
6,796
17,106
23,902
94,113
9,373
9,333
$
$
$
8,149
(2,771)
5,378
99,724
(12,428)
8,970
9,063
19,408
28,471
96,872
3,373
8,948
112,819
$
96,266
$
109,193
(203,552) $
(326,531) $
(478,962)
208,437
204,116
211,324
4,885
$
(122,415) $
(267,638)
Financing Arrangements
We have entered into three reinsurance transactions with Hannover Life Reassurance Company of America ("Hannover"), which are treated as
reinsurance under statutory accounting practices and as financing arrangements under GAAP. The statutory surplus benefits under these
agreements are eliminated under GAAP and the associated charges are recorded as risk charges and included in other operating costs and expenses
in the consolidated statements of operations. The transactions became effective October 1, 2005 (the "2005 Hannover Transaction"),
December 31, 2008 (the "2008 Hannover Transaction") and March 31, 2011 (the "2011 Hannover Transaction"). The 2008 Hannover Transaction
and the 2011 Hannover Transaction terminate after the the final year of surplus reduction (see following discussion of each agreement), and the
statutory surplus benefit is reduced over a five year period and is eliminated upon termination.
The 2011 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided
$49.2 million in net pretax statutory surplus benefit at inception in 2011. Pursuant to the terms of this agreement, pretax statutory surplus was
reduced by $11.8 million and $9.2 million in 2012 and 2011, respectively, and is expected to be reduced as follows: 2013—$11.3 million, 2014
—$10.8 million and 2015—$10.3 million. These amounts include risk charges equal to 1.25% of the pretax statutory surplus benefit as of the
end of each calendar quarter. Risk charges attributable to this agreement were $1.8 million and $1.7 million during 2012 and 2011, respectively.
The 2008 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided
$29.5 million in net pretax statutory surplus benefit in 2008. Pursuant to the terms of this agreement, pretax statutory surplus was reduced by
$6.8 million and $6.7 million in 2012 and 2011, respectively, and is expected to be reduced as follows: 2013—$6.9 million These amounts
include risk charges equal to 1.25% of the pretax statutory surplus benefit as of the end of each calendar quarter. Risk charges attributable to
this agreement were $0.5 million, $0.8 million and $1.1 million during 2012, 2011 and 2010, respectively.
The 2005 Hannover Transaction is a yearly renewable term reinsurance agreement for statutory purposes covering 47% of waived surrender
charges related to penalty free withdrawals and deaths on certain business. The agreement has been amended several times to include policy
forms that were not in existence at the time this agreement became effective. We may recapture the risks reinsured under this agreement as of
the end of any quarter. However, the agreement, as amended, makes it punitive to us if we do not recapture the business ceded prior to January
1, 2016. The reserve credit recorded on a statutory basis by American Equity Life was $180.3 million and $162.5 million at December 31, 2012
and 2011, respectively. We pay quarterly reinsurance premiums under this agreement with an experience refund calculated on a quarterly basis
resulting in a risk charge equal to approximately 5.8% of the weighted average statutory reserve credit. Risk charges attributable to the 2005
Hannover Transaction were $9.9 million, $8.6 million and $6.9 million during 2012, 2011 and 2010, respectively.
Indemnity Reinsurance
In the normal course of business, we seek to limit our exposure to loss on any single insured and to recover a portion of benefits paid under our
annuity, life and accident and health insurance products by ceding reinsurance to other insurance enterprises or reinsurers. Reinsurance contracts
do not relieve us of our obligations to our policyholders. To the extent that reinsuring companies are later unable to meet obligations under
reinsurance agreements, our life insurance subsidiaries would be liable for these obligations, and payment of these obligations could result in
losses to us. To limit the possibility of such losses, we evaluate the financial condition of our reinsurers, and monitor concentrations of credit
risk. No allowance for uncollectible amounts has been established against our asset for amounts receivable from other insurance companies
since none of the receivables are deemed by management to be uncollectible.
F-35
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. Income Taxes
We file consolidated federal income tax returns that include all of our wholly-owned subsidiaries except Eagle Life which must file a separate
federal income tax return for 2009–2013 under applicable federal income tax guidelines. Our income tax expense as presented in the consolidated
financial statements is summarized as follows:
Consolidated statements of operations:
Current income taxes
Deferred income taxes (benefits)
Total income tax expense included in consolidated statements of operations
Stockholders' equity:
Expense (benefit) relating to:
Change in net unrealized investment losses
Share-based compensation
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
$
80,527
$
127,535
$
140,381
(52,336)
28,191
(80,869)
46,666
(118,048)
22,333
123,620
(392)
202,143
(1,061)
60,456
(480)
82,309
Total income tax expense included in consolidated financial statements
$
151,419
$
247,748
$
Income tax expense in the consolidated statements of operations differed from the amount computed at the applicable statutory federal income
tax rate of 35% as follows:
Income before income taxes
Income tax expense on income before income taxes
Tax effect of:
Tax exempt net investment income
Other
Income tax expense
Effective tax rate
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
85,989
30,096
$
$
132,914
46,520
$
$
(1,876)
(29)
—
146
65,266
22,843
—
(510)
28,191
$
46,666
$
22,333
32.8%
35.1%
34.2%
$
$
$
F-36
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Deferred income tax assets or liabilities are established for temporary differences between the financial reporting amounts and tax bases of assets
and liabilities that will result in deductible or taxable amounts, respectively, in future years. The tax effects of temporary differences that give
rise to the deferred tax assets and liabilities at December 31, 2012 and 2011, are as follows:
Deferred income tax assets:
Policy benefit reserves
Other than temporary impairments
Derivative instruments
Other policyholder funds
Litigation settlement accrual
Deferred compensation
Net operating loss carryforwards
Other
Gross deferred tax assets
Deferred income tax liabilities:
December 31,
2012
2011
(Dollars in thousands)
$
1,698,831
$
1,472,653
8,177
—
10,860
7,351
14,659
16,783
7,192
9,072
21,429
9,946
—
15,576
14,818
6,351
1,763,853
1,549,845
Deferred policy acquisition costs and deferred sales inducements
(1,425,266)
(1,266,042)
Net unrealized gains on available for sale fixed maturity and equity securities
Convertible senior notes
Derivative instruments
Investment income items
Other
Gross deferred tax liabilities
Net deferred income tax (liability) asset
(357,686)
(6,665)
(18,280)
(2,588)
(2,671)
(234,066)
(10,917)
—
(4,315)
(12,524)
(1,813,156)
(1,527,864)
$
(49,303) $
21,981
The total deferred income tax asset includes other than temporary impairments on investments. The other than temporary impairments will not
be available for utilization for tax purposes until the securities are either sold at a loss or deemed completely worthless. The other than temporary
impairments totaled $23.4 million and $26.0 million as of December 31, 2012 and 2011, respectively.
Included in the deferred income taxes is the expected income tax benefit attributable to unrealized losses on available for sale fixed maturity
securities. There is no valuation allowance provided for the deferred income tax asset attributable to unrealized losses on available for sale fixed
maturity securities. Management expects that the passage of time will result in the reversal of these unrealized losses due to the fair value
increasing as these securities near maturity. Management has the intent and ability to hold these securities to maturity because we generate
adequate cash flow from new business to fund all foreseeable cash flow needs and do not believe it would ever be necessary to liquidate these
securities at a loss to meet cash flow needs. For deferred income taxes related to unrealized losses on equity securities, we had sufficient future
taxable income from capital gain sources to support the realizability of the deferred income tax asset.
Realization of our deferred income tax assets is more likely than not based on expectations as to our future taxable income and considering all
other available evidence, both positive and negative. Therefore, no valuation allowance against deferred income tax assets has been established
as of December 31, 2012 and 2011.
There were no material income tax contingencies requiring recognition in our consolidated financial statements as of December 31, 2012. We
are no longer subject to income tax examinations by tax authorities for years prior to 2008.
At December 31, 2012, we had non-life net operating loss carryforwards for federal income tax purposes totaling $23.4 million which expire
beginning in 2018 through 2032.
F-37
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Notes Payable and Amounts Due Under Repurchase Agreements
In September 2010, we issued $200.0 million principal amount of 3.5% Convertible Senior Notes Due 2015 (the "2015 notes"). The 2015 notes
have a stated interest rate of 3.5%, mature on September 15, 2015, and are intended to be settled in cash; however, in certain limited circumstances
we have the discretion to settle in shares of our common stock or a combination of cash and shares of our common stock. Contractual interest
payable on the 2015 notes began accruing in September 2010 and is payable semi-annually in arrears each March 15th and September 15th.
The initial transaction fees and expenses totaling $6.8 million were capitalized as deferred financing costs and will be amortized over the term
of the 2015 notes using the effective interest method.
Upon occurrence of any of the conditions described below, holders may convert their 2015 notes at the applicable conversion rate at any time
prior to June 15, 2015. On or after June 15, 2015 through the maturity date of September 15, 2015, holders may convert each of their 2015 notes
at the applicable conversion rate regardless of the following conditions:
•
•
•
during the 5 business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price
per $1,000 principal amount of notes was less than 98% of the product of the last reported sale price of our common stock and the
applicable conversion rate on such trading day;
during any calendar quarter commencing after December 31, 2010, the Notes may be converted if the last reported price of the common
stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last
trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the applicable conversion price on each
applicable trading day. The “last reported sale price” means the closing sale price per share (or if no closing sale price is reported, the
average of the bid and ask prices or, if more than one in either case, the average of the average bid and the average ask prices) on that
date as reported in composite transactions for the New York Stock Exchange; or
upon the occurrence of specified corporate transactions.
The initial conversion rate for the 2015 notes is 80 shares of our common stock per $1,000 principal amount of 2015 notes, equivalent to a
conversion price of approximately $12.50 per share of our common stock, with the amount due on conversion. Upon conversion, a holder will
receive the sum of the daily settlement amounts, calculated on a proportionate basis for each day, during a specified observation period following
the conversion date. The conversion rate for the 2015 notes was adjusted to 80.9486 shares in December 2012, equivalent to a conversion price
of approximately $12.35 per share.
If a fundamental change, as defined in the indenture, occurs prior to maturity and our stock price is at least $10.00 per share at that time, the
conversion rate will increase by an additional amount of up to 20 shares of our common stock per $1,000 principal amount of 2015 notes, which
amount would be paid to each holder that elects to convert its 2015 notes at that time.
The conversion option of the 2015 notes (the "2015 notes embedded conversion derivative") is an embedded derivative that requires bifurcation
from the 2015 notes and is accounted for as a derivative liability, which is included in Other liabilities in our Consolidated Balance Sheets. The
fair value of the 2015 notes embedded conversion derivative at the time of issuance of the 2015 notes was $37.0 million, and was recorded at
the original debt discount for purposes of accounting for the debt component of the 2015 notes. This discount will be recognized as interest
expense using the effective interest method over the term of the 2015 notes. The estimated fair value of the 2015 notes embedded conversion
derivative was $43.1 million and $45.6 million as of December 31, 2012 and 2011, respectively.
Concurrently with the issuance of the 2015 notes, we entered into hedge transactions (the "2015 notes hedges") with two counterparties whereby
we have the option to receive the cash equivalent of the conversion spread on approximately 16.0 million shares of our common stock based
upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. These options expire on September 15,
2015 and must be settled in cash. The aggregate cost of the 2015 notes hedges was $37.0 million. The 2015 notes hedges are accounted for as
derivative assets, and are included in Other assets in our Consolidated Balance Sheets. The estimated fair value of the 2015 notes hedges was
$43.1 million and $45.6 million as of December 31, 2012 and 2011, respectively.
The 2015 notes embedded conversion derivative and the 2015 notes hedges are adjusted to fair value each reporting period and unrealized gains
and losses are reflected in our Consolidated Statements of Operations.
In separate transactions, we also sold warrants (the "2015 warrants") to two counterparties for the purchase of up to approximately 16.0 million
shares of our common stock at a price of $16.00 per share. The warrants expire on various dates from December 2015 through March 2016 and
are intended to be settled in net shares. The total number of shares of common stock deliverable under the 2015 warrants is, however, currently
limited to 11.6 million shares. We received $15.6 million in cash proceeds from the sale of the 2015 warrants, which has been recorded as an
increase in additional paid-in capital. Changes in the fair value of these warrants will not be recognized in our Consolidated Financial Statements
as long as the instruments remain classified as equity.
In December 2004, we issued $260.0 million of convertible senior notes due December 15, 2024 (the "2024 notes"), of which $22.9 million was
assigned to the equity component (net of income tax of $16.1 million). In December 2009, we issued $115.8 million of contingent convertible
senior notes due December 15, 2029 (the "2029 notes"), of which $15.6 million was assigned to the equity component (net of income tax of
$11.0 million), $52.2 million principal amount were issued for cash and $63.6 million were issued in exchange of $63.6 million of the 2024
notes.
F-38
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The 2024 notes and 2029 notes bear interest at a fixed rate of 5.25% per annum. Interest is payable semi-annually in arrears on June 6 and
December 6 of each year. In addition to regular interest on the notes, beginning with the six-month interest period ending June 6, 2012 for the
December 2024 notes and June 6, 2015 for the 2029 notes, we will also pay contingent interest under certain conditions at a rate of 0.5% per
annum based on the average trading price of the notes during a specified period.
The 2024 and 2029 notes are convertible at the holders' option prior to the maturity date into cash and shares of our common stock under the
following conditions:
•
during any fiscal quarter, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive
trading days ending on the last trading day of the fiscal quarter preceding the quarter in which the conversion occurs is more than
120% of the conversion price of the notes in effect on that 30th trading day;
• we have called the notes for redemption and the redemption has not yet occurred; or
•
upon the occurrence of specified corporate transactions.
Holders may convert any outstanding notes into cash and shares of our common stock at a conversion price per share of $13.74 for the 2024
notes and $9.57 for the 2029 notes. This represents a conversion rate of approximately 72.8 shares and 104.5 shares of common stock per $1,000
in principal amount of notes (the "conversion rate") for the 2024 notes and the 2029 notes, respectively. Subject to certain exceptions described
in the indentures covering these notes, at the time the notes are tendered for conversion, the value (the "conversion value") of the cash and shares
of our common stock, if any, to be received by a holder converting $1,000 principal amount of the notes will be determined by multiplying the
conversion rate by the "ten day average closing stock price", which equals the average of the closing per share prices of our common stock on
the New York Stock Exchange on the ten consecutive trading days beginning on the second trading day following the day the notes are submitted
for conversion. We will deliver the conversion value to holders as follows: (1) an amount in cash (the "principal return") equal to the lesser of
(a) the aggregate conversion value of the notes to be converted and (b) the aggregate principal amount of the notes to be converted, and (2) if
the aggregate conversion value of the notes to be converted is greater than the principal return, an amount in shares (the "net shares") equal to
such aggregate conversion value less the principal return (the "net share amount") and (3) an amount in cash in lieu of fractional shares of
common stock. The number of net shares to be paid will be determined by dividing the net share amount by the ten day average closing stock
price.
We may redeem some or all of the 2024 notes at any time and some or all of the 2029 notes at any time on or after December 15, 2014. In
addition, the holders may require us to repurchase all or a portion of their 2024 notes on December 15, 2014 and 2019, and their 2029 notes on
December 15, 2014, 2019 and 2024, and upon a change in control, as defined in the indenture governing the notes, holders may require us to
repurchase all or a portion of their notes for a period of time after the change in control. The redemption price or repurchase price shall be
payable in cash and equal to 100% of the principal amount of the notes plus accrued and unpaid interest (contingent interest and liquidated
damages, if any) up to but not including the date of redemption or repurchase.
Our convertible notes are senior unsecured obligations and rank equally in right of payment with all existing and future senior indebtedness and
senior to any existing and future subordinated indebtedness. Our convertible notes effectively rank junior in right of payment to any existing
and future secured indebtedness to the extent of the value of the assets securing such secured indebtedness. Our convertible notes are structurally
subordinated to all liabilities of our subsidiaries.
We are required to include the dilutive effect of the 2024 and 2029 notes in our diluted earnings per share calculation. Because these notes
include a mandatory cash settlement feature for the principal amount, incremental dilutive shares will only exist when the fair value of our
common stock at the end of the reporting period exceeds the conversion price per share disclosed above. At December 31, 2012 and 2011, the
conversion premium of the 2029 notes was dilutive and the effect has been included in diluted earnings per share for the years ended December
31, 2012 and 2011. The 2015 notes and the 2015 notes hedges are excluded from the dilutive effect in our diluted earnings per share calculation
as they are currently to be settled only in cash. The 2015 warrants could have a dilutive effect on our earnings per share to the extent that the
price of our common stock exceeds the strike price of the 2015 warrants.
In 2010, we extinguished $6.7 million principal amount of the outstanding 2024 notes for $6.6 million in cash. The extinguished notes carried
unamortized debt issue costs and unamortized debt discounts totaling $0.3 million. No value was assigned to reacquire of the equity component
of the debt. A $0.3 million loss on extinguishment of debt was recorded for the amount that the cash payment exceeded the carrying of value
the notes extinguished. On December 15, 2011, we repurchased $46.3 million principal amount of 2024 notes pursuant to the holders put option
on that date.
F-39
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The liability and equity components of the 2024 notes and 2029 notes are accounted for separately in the consolidated balance sheets. The
liability component of the 2015 notes and the liability and equity components of the 2024 notes and 2029 notes are as follows:
December 31, 2012
December 31, 2011
September
2015 Notes
December
2029 Notes
December
2024 Notes
September
2015 Notes
December
2029 Notes
December
2024 Notes
(Dollars in thousands)
(Dollars in thousands)
Notes payable:
Principal amount of liability component
Unamortized discount
Net carrying amount of liability component
Additional paid-in capital:
Carrying amount of equity component
Amount by which the if-converted value exceeds
principal
$
$
$
200,000
(21,944)
178,056
$
$
$
115,839
(12,269)
103,570
15,586
— $
30,382
$
$
$
$
28,243
—
28,243
$
$
200,000
(28,906)
171,094
22,637
$
$
$
115,839
(17,568)
98,271
15,586
— $
— $
8,846
$
$
$
$
28,243
—
28,243
22,637
—
The discount is being amortized over the expected lives of the notes, which is December 15, 2014 for the 2029 notes and September 15, 2015
for the 2015 notes, and was December 15, 2011 for the 2024 notes. The effective interest rates during the discount amortization periods are
8.9%, 8.5% and 11.9% on the 2015 notes, the 2024 notes and 2029 notes, respectively. The interest cost recognized in operations for the
convertible notes, inclusive of the coupon and amortization of the discount and debt issue costs was $28.5 million, $31.6 million, and $20.9
million for the years ended December 31, 2012, 2011 and 2010, respectively.
We had a $150 million revolving line of credit agreement with eight banks. The revolving period of the facility was five years. The applicable
interest rate was floating at LIBOR plus 0.80% or the greater of prime rate or federal funds rate plus 0.50%, as elected by us. During 2011, we
terminated the $150 million revolving line of credit agreement and entered into a $160 million revolving line of credit agreement with seven
banks for which the revolving period is three years. The interest rate is floating at a rate based on our election that will be equal to the alternate
base rate (as defined in the credit agreement) plus the applicable margin or the adjusted LIBOR rate (as defined in the credit agreement) plus
the applicable margin. We also pay a commitment fee on the available unused portion of the credit facility. The applicable margin and commitment
fee rate are based on our credit rating and can change throughout the period of the credit facility. 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%.
Under this agreement, we are required to maintain a minimum risk-based capital ratio at American Equity Life of 275%; a maximum ratio of
adjusted debt to total adjusted capital 0.35; a minimum cash coverage ratio of 1.0; and a minimum level of statutory surplus at American Equity
Life equal to the sum of 1) 80% of statutory surplus at December 31, 2010, 2) 50% of the statutory net income for each fiscal quarter ending
after December 31, 2010, and 3) 50% of all capital contributed to American Equity Life after September 30, 2010. No amounts were outstanding
at December 31, 2012 and 2011. As of December 31, 2012, $109.5 million is unrestricted and could be distributed to shareholders.
As part of our investment strategy, we enter into securities repurchase agreements (short-term collateralized borrowings). We had no borrowings
under repurchase agreements during 2012 and 2010. The maximum amount borrowed during 2011 was $180 million . When we do borrow
cash on these repurchase agreements, we pledge collateral in the form of debt securities with fair values approximately equal to the amount due
and we use the cash to purchase debt securities ahead of the time we collect the cash from selling annuity policies to avoid a lag between the
investment of funds and the obligation to credit interest to policyholders. We earn investment income on the securities purchased with these
borrowings at a rate in excess of the cost of these borrowings. Such borrowings averaged $12.9 million for the year ended December 31, 2011.
The weighted average interest rate on amounts due under repurchase agreements was 0.23% for the year ended December 31, 2011.
F-40
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. Subordinated Debentures
Our wholly-owned subsidiary trusts (which are not consolidated) have issued fixed rate and floating rate trust preferred securities and have used
the proceeds from these offerings to purchase subordinated debentures from us. We also issued subordinated debentures to the trusts in exchange
for all of the common securities of each trust. The sole assets of the trusts are the subordinated debentures and any interest accrued thereon.
The interest payment dates on the subordinated debentures correspond to the distribution dates on the trust preferred securities issued by the
trusts. The trust preferred securities mature simultaneously with the subordinated debentures. Our obligations under the subordinated debentures
and related agreements provide a full and unconditional guarantee of payments due under the trust preferred securities. All subordinated debentures
are callable by us at any time, except for the Trust II subordinated debt obligations.
Following is a summary of subordinated debt obligations to the trusts at December 31, 2012 and 2011:
December 31,
2012
2011
Interest Rate
Due Date
(Dollars in thousands)
American Equity Capital Trust I
$
— $
American Equity Capital Trust II
American Equity Capital Trust III
American Equity Capital Trust IV
American Equity Capital Trust VII
American Equity Capital Trust VIII
American Equity Capital Trust IX
American Equity Capital Trust X
American Equity Capital Trust XI
American Equity Capital Trust XII
76,259
27,840
12,372
10,830
20,620
15,470
20,620
20,620
41,238
22,893
76,090
8%
5%
27,840
*LIBOR + 3.90%
June 1, 2047
April 29, 2034
12,372
*LIBOR + 4.00%
January 8, 2034
10,830
*LIBOR + 3.75%
December 14, 2034
20,620
*LIBOR + 3.75%
December 15, 2034
15,470
*LIBOR + 3.65%
June 15, 2035
20,620
*LIBOR + 3.65%
September 15, 2035
20,620
*LIBOR + 3.65%
December 15, 2035
41,238
*LIBOR + 3.50%
April 7, 2036
*—three month London Interbank Offered Rate
$
245,869
$
268,593
During 2012, we issued a notice of mandatory redemption of all of our 8% Convertible Junior Subordinated Debentures (the "Debentures") and
American Equity Capital Trust I, the holder of all of the Debentures, issued notices of mandatory redemption of all of its 8% Convertible Trust
Preferred Securities and all of its 8% Trust Common Securities. As a result of this mandatory redemption, $20.6 million principal amount
(688,327 shares) of 8% Convertible Trust Preferred Securities were converted into 2,549,333 shares of our common stock and 38,001 shares of
these trust preferred securities were settled in cash of approximately $1.1 million. The remaining 6,000 shares will be settled in cash of $0.2
million. During 2012, prior to the mandatory redemption, 4,000 shares of these trust preferred securities were converted into 14,814 shares
shares of our common stock. During 2010, 2,010 shares of these trust preferred securities converted into 7,444 shares of our common stock.
There were no conversions during 2011.
The principal amount of the subordinated debentures issued by us to American Equity Capital Trust II ("Trust II") is $100.0 million. These
debentures were assigned a fair value of $74.7 million at the date of issue (based upon an effective yield-to-maturity of 6.8%). The difference
between the fair value at the date of issue and the principal amount is being accreted over the life of the debentures. The trust preferred securities
issued by Trust II were issued to Iowa Farm Bureau Federation, which owns more than 50% of the voting capital stock of FBL Financial
Group, Inc. ("FBL"). The consideration received by Trust II in connection with the issuance of its trust preferred securities consisted of fixed
income securities of equal value which were issued by FBL.
11. Retirement and Share-based Compensation Plans
We have adopted a contributory defined contribution plan which is qualified under Section 401(k) of the Internal Revenue Code. The plan
covers substantially all of our full-time employees subject to minimum eligibility requirements. Employees can contribute a percentage of their
annual salary (up to a maximum contribution of $17,000 in 2012 and $16,500 in 2011 and 2010) to the plan. We contribute an additional amount,
subject to limitations, based on the voluntary contribution of the employee. Further, the plan provides for additional employer contributions
based on the discretion of the Board of Directors. Plan contributions charged to expense were $0.4 million, $0.3 million and $0.3 million for
the years ended December 31, 2012, 2011 and 2010, respectively.
During 2010, we established the American Equity Investment Life Holding Company Short-Term Performance Incentive Plan. Under this plan,
certain members of our senior management may receive incentive awards comprised of a cash component and a restricted stock component.
Shares of restricted stock received will be granted pursuant to the 2009 Employee Incentive Plan and will vest on the date three years following
the date the Committee approves the payment of the incentive award provided that the participant remains employed by us. Compensation
expense is recognized over the three year vesting period. Shares vest immediately for participants 65 years of age with 10 years of service with
us and compensation expense under this plan for these participants is recognized upon approval of the incentive award by the compensation
F-41
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
committee. During 2012 and 2011, we issued 51,810 and 24,497 shares of common stock (37,369 and 16,819 shares were restricted stock),
respectively, and recognized share-based compensation expense of $0.5 million and $0.1 million, respectively.
We have deferred compensation arrangements with certain officers, directors, and consultants, whereby these individuals agreed to take our
common stock at a future date in lieu of cash payments at the time of service. The common stock is to be issued in conjunction with a "trigger
event," as that term is defined in the individual agreements. At December 31, 2012 and 2011, these individuals have earned, and we have reserved
for future issuance, 354,923 and 503,142 shares of common stock, respectively, pursuant to these arrangements. We have incurred share-based
compensation expense of $0.2 million, $0.3 million and $0.4 million for the years ended December 31, 2012, 2011 and 2010, respectively, under
these arrangements.
We have deferred compensation agreements with certain officers whereby these individuals may defer certain bonus compensation which is
deposited into the American Equity Officer Rabbi Trust (Officer Rabbi Trust). The amounts deferred are invested in assets at the direction of
the employee. The assets of the Officer Rabbi Trust are included in our assets and a corresponding deferred compensation liability is recorded.
The deferred compensation liability is recorded at the fair market value of the assets in the Officer Rabbi Trust with the change in fair value
included as a component of compensation expense. The deferred compensation liability related to these agreements was $1.4 million and
$1.6 million December 31, 2012 and 2011, respectively. During 2011 and 2010, the Officer Rabbi Trust purchased 1,250 shares of our common
stock at a cost of $0.01 million and 104,661 shares of our common stock at a cost of $1.2 million, respectively. The Officer Rabbi Trust did not
purchase any shares during 2012. The Officer Rabbi Trust held 104,551 shares and 139,751 shares of our common stock at December 31, 2012
and 2011, respectively, which are treated as treasury shares.
During 1997, we established the American Equity Investment NMO Deferred Compensation Plan ("NMO Deferred Compensation Plan") whereby
agents can earn common stock in addition to their normal commissions. The NMO Deferred Compensation Plan was effective until December 31,
2006 at which time it was suspended. Awards were calculated using formulas determined annually by our Board of Directors and are generally
based upon new annuity deposits. These shares are being distributed at the end of the vesting and deferral period of 9 years. We recognize
commission expense and an increase to additional paid-in capital as share-based compensation when the awards vest. For the year ended
December 31, 2010, agents vested in 1,052 shares of common stock and we recorded commission expense (capitalized as deferred policy
acquisition costs) of $0.01 million under this plan. All outstanding shares issued under this plan were fully vested at December 31, 2010. At
December 31, 2012 and 2011, the total number of undistributed vested shares under the NMO Deferred Compensation Plan was 1,142,332 and
1,631,548, respectively. These shares are included in the computation of earnings per share and earnings per share—assuming dilution.
We have a Rabbi Trust, the NMO Deferred Compensation Trust (the "NMO Trust"), which has purchased shares of our common stock to fund
the amount of vested shares under the NMO Deferred Compensation Plan. The common stock held in the NMO Trust is treated as treasury
stock. The NMO Trust purchased 81,745 shares of our common stock during 2011 at a cost of $0.9 million. The NMO Trust did not purchase
any shares during 2012 and 2010. The NMO Trust distributed 489,216, 306,032 and 166,965 shares during 2012, 2011 and 2010, respectively.
The number of shares held by the NMO Trust at December 31, 2012 and 2011, was 1,142,332 and 1,631,548, respectively.
Our 1996 Stock Option Plan, 2000 Employee Stock Option Plan, 2000 Directors Stock Option Plan and 2011 Director Stock Option Plan (adopted
in 2011) authorized grants of options to officers, directors and employees for an aggregate of up to 3,475,000 shares of our common stock. All
options granted under these plans have 10 year terms and a 6 month vesting period after which they become fully exercisable immediately. At
December 31, 2012, we had no shares of common stock available for future grant under the 2011 Director Stock Option Plan. In 2009, we
adopted the 2009 Employee Incentive Plan which authorizes the grant of options, stock appreciation rights, restricted stock awards and restricted
stock units convertible into or based upon our common stock up to 2,500,000 shares. All options granted under this plan have 10 year terms
and a 3 year vesting period after which they become fully exercisable immediately. At December 31, 2012, we had 1,709,243 shares of common
stock available for future grant under the 2009 Employee Incentive Plan.
The fair value for each stock option granted to officers, directors and employees during the years ended December 31, 2012, 2011 and 2010 was
estimated at the date of grant using a Black-Scholes option valuation model with the following assumptions:
Year Ended December 31,
2012
2011
2010
Directors and
Retirement
Eligible
Employees
Non-
Retirement
Eligible
Employees
Directors and
Retirement
Eligible
Employees
Non-
Retirement
Eligible
Employees
Directors and
Retirement
Eligible
Employees
Non-
Retirement
Eligible
Employees
Average risk-free interest rate
Dividend yield
Average expected life (years)
Volatility
0.76%
1.1%
5
62.5%
1.36%
1.3%
8
50.9%
1.66%
0.8%
5
66.1%
2.00%
1.0%
8
52.0%
2.17%
0.8%
5
75.7%
2.99%
0.8%
8
75.7%
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. We use the historical realized volatility of our
stock for the expected volatility assumption within the valuation model. For options granted since 2007, the weighted average expected term
for the majority of our options were calculated using average historical behavior.
F-42
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
During 2007, 2010 and 2012 we established Independent Insurance Agent Stock Option plans. Under these plans, agents of American Equity
Life may receive grants of options to acquire shares of our common stock based upon their individual sales. The plans authorize grants of options
to agents for an aggregate of up to 8,000,000 shares of our common stock. We recognize commission expense and an increase to additional
paid-in capital as share-based compensation equal to the fair value of the options as they are earned.
The fair value for each stock option granted to agents during the years ended December 31, 2012, 2011 and 2010 was estimated using a Black-
Scholes option valuation model until the grant date, at which time the options are included as permanent equity, with the following assumptions:
Average risk-free interest rate
Dividend yield
Average expected life (years)
Volatility
Year Ended December 31,
2012
2011
2010
0.51%
1.2%
3.75
41.1%
0.58%
1.2%
3.75
67.2%
1.44%
0.8%
3.75
68.0%
American Equity Life's agents earned 1,125,100 options during 2012, which were granted in January 2013, and we recorded commission expense
(capitalized as deferred policy acquisition costs) of $3.9 million in 2012. American Equity Life's agents earned 1,422,050 options during 2011,
which were granted in January 2012, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $6.8 million in
2011. American Equity Life's agents earned 1,361,900 options during 2010, which were granted in January 2011, and we recorded commission
expense (capitalized as deferred policy acquisition costs) of $8.2 million in 2010. All options granted have 7 year terms and a 6 month vesting
period after which they become exercisable immediately.
Changes in the number of stock options outstanding during the years ended December 31, 2012, 2011 and 2010 are as follows:
Number of
Shares
Weighted-Average
Exercise Price
per Share
Total
Exercise
Price
(Dollars in thousands, except per share data)
Outstanding at January 1, 2010
3,142,189
$
Granted
Canceled
Exercised
Outstanding at December 31, 2010
Granted
Canceled
Exercised
Outstanding at December 31, 2011
Granted
Canceled
Exercised
Outstanding at December 31, 2012
1,794,200
(120,000)
(695,539)
4,120,850
1,486,850
(177,500)
(585,350)
4,844,850
1,558,900
(28,050)
(643,250)
5,732,450
8.79
8.76
8.64
8.80
8.78
12.99
9.66
8.00
10.13
7.60
8.74
8.77
9.61
$
$
27,620
15,726
(1,037)
(6,122)
36,187
19,309
(1,714)
(4,685)
49,097
11,854
(245)
(5,642)
55,064
The following table summarizes information about stock options outstanding at December 31, 2012:
Range of
Exercise Prices
$5.07 - $9.16
$9.49 - $11.46
$11.88 - $14.34
$5.07 - $14.34
Stock Options Outstanding
Stock Options Vested
Number of
Awards
Remaining
Life (yrs)
Weighted-Average
Exercise Price
Per Share
Number of
Awards
Remaining
Life (yrs)
Weighted-Average
Exercise Price
Per Share
1,500,000
2,714,350
1,518,100
5,732,450
$
3.59
5.56
5.37
5.00
7.70
10.35
12.97
10.35
1,500,000
2,218,350
1,413,100
5,131,450
$
3.59
5.34
5.12
4.77
7.70
10.47
13.03
10.36
The aggregate intrinsic value for stock options outstanding and vested awards was $11.8 million and $10.6 million, respectively, at December 31,
2012. For the years ended December 31, 2012, 2011 and 2010, the total intrinsic value of options exercised by officers, directors and employees
was $0.9 million , $0.3 million and $0.6 million respectively. There were no option exercises during the year ended December 31, 2009. Intrinsic
value for stock options is calculated as the difference between the exercise price of the underlying awards and the price of our common stock
as of the reporting date. Cash received from stock options exercised for the years ended December 31, 2012 and 2011 was $5.7 million and
F-43
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
$4.7 million, respectively. The tax benefit realized for the tax deduction from the exercise of stock options by officers, directors, employees and
agents for both years ended December 31, 2012 and 2011, was $0.1 million.
We 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 us. Employees become eligible once they have completed a minimum
of six months of service. Employees become 100% vested after 2 years of service. Our contribution to the ESOP is determined by the Board
of Directors.
In August 2007, we issued a loan to the ESOP in the amount of $7.0 million to purchase 650,000 shares of our common stock from David J.
Noble, our Executive Chairman. The loan is to be repaid over a period of 20 years with annual interest payments due on December 31 of each
year. Required principal payments according to the terms of the loan of $1.8 million are due on December 31, 2012, 2017, and 2022 with the
final principal payment due on August 31, 2027; however, at December 31, 2012, the outstanding balance on this loan is $1.6 million as we have
been prepaying the balance due. 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 the ESOP, a contra-equity account in stockholders' equity. When
shares are committed for release, the shares become outstanding for earnings per share computations. For each plan year in which a payment or
prepayment of principal or interest is made, we will release from the pledge the number of shares determined under the principal and interest
method. Dividends on allocated ESOP shares are recorded as a reduction in retained earnings and are credited to employee accounts. Dividends
on unallocated shares held by the ESOP will be used to repay indebtedness. As of December 31, 2012 and 2011, there were 54,971 shares and
59,751 shares committed for release and compensation expense of $1.1 million, $1.3 million and $0.8 million was recognized in 2012, 2011 and
2010, respectively. The fair value of 239,799 unreleased shares and 336,093 unreleased shares was $2.9 million and $3.5 million at December 31,
2012 and 2011, respectively.
12. Statutory Financial Information and Dividend Restrictions
Statutory accounting practices prescribed or permitted by regulatory authorities for our life insurance subsidiaries differ from GAAP. Net income
for our primary life insurance subsidiary as determined in accordance with statutory accounting practices was as follows:
American Equity Life
82,039
169,365
177,311
Statutory capital and surplus for our primary life insurance subsidiary was as follows:
Year Ended December 31,
2012
2011
2010
(Dollars in thousands)
December 31,
2012
2011
(Dollars in thousands)
American Equity Life
$
1,658,929
$
1,597,018
American Equity Life is domiciled in the state of Iowa and is regulated by the Iowa Insurance Division. Life insurance companies are subject
to the National Association of Insurance Commissioners ("NAIC") risk-based capital (RBC) 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. Calculations using the NAIC formula indicated that American Equity Life's ratio of total adjusted capital to the highest level
of required capital at which regulatory action might be initiated (Company Action Level) is as follows:
Total adjusted capital
Company Action Level RBC
December 31,
2012
2011
(Dollars in thousands)
$
1,741,638
$
1,655,205
524,928
479,023
Ratio of adjusted capital to Company Action Level RBC
332%
346%
Prior approval of regulatory authorities is required for the payment of dividends to American Equity Investment Life Holding Company ("Parent
Company") by American Equity Life which exceed an annual limitation. American Equity Life may pay dividends without prior approval,
unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1) net gain from operations
before net realized capital losses for the preceding calendar year or, (2) 10% of the American Equity Life's capital and surplus at the preceding
year-end. The amount of dividends permitted to be paid by American Equity Life to its Parent Company without prior approval of regulatory
authorities (no dividends were paid by any of our insurance subsidiaries for any of the years presented in these financial statements) is $99.2
million as of December 31, 2012.
F-44
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Parent Company relies on its subsidiaries for cash flow, which has primarily been in the form of investment management fees and/or
dividends. Retained earnings in our consolidated financial statements primarily represent undistributed earnings of American Equity Life. As
such, our ability to pay dividends is limited by the regulatory restriction placed upon insurance companies as described above. In addition,
American Equity Life retains funds to allow for sufficient capital for growth.
13. Commitments and Contingencies
We lease our home office space and certain equipment under various operating leases. Rent expense for the years ended December 31, 2012,
2011 and 2010 totaled $2.0 million, $1.9 million and $1.9 million, respectively. At December 31, 2012, the aggregate future minimum lease
payments are $11.3 million. The following represents payments due by period for operating lease obligations as of December 31, 2012 (dollars
in thousands):
Year Ending December 31:
2013
2014
2015
2016
2017
2018 and thereafter
$
1,493
1,487
1,469
1,377
1,138
4,329
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, 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.
In accordance with applicable accounting guidelines, we establish an accrued liability for litigation and regulatory matters when those matters
present loss contingencies that are both probable and estimable. As a litigation or regulatory matter is developing we, in conjunction with outside
counsel, evaluate on an ongoing basis whether the matter presents a loss contingency that meets conditions indicating the need for accrual and/
or disclosure, and if not the matter will continue to be monitored for further developments. If and when the loss contingency related to litigation
or regulatory matters is deemed to be both probable and estimable, we will establish an accrued liability with respect to that matter and will
continue to monitor the matter for further developments that may affect the amount of the accrued liability. We recorded an estimated litigation
liability of $17.5 million during the third quarter of 2012 based on developments in the mediation of the matter discussed below.
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. We are currently a defendant in a purported class action, McCormack, et al. v.
American Equity Investment Life Insurance Company, et al., in the United States District Court for the Central District of California, Western
Division and Anagnostis v. American Equity, et al., coordinated in the Central District, entitled, In Re: American Equity Annuity Practices and
Sales Litigation, in the United States District Court for the Central District of California, Western Division (complaint filed September 7, 2005)
(the "Los Angeles Case"), involving allegations of improper sales practices and similar claims as described below.
The Los Angeles Case is a consolidated action involving several lawsuits filed by individuals, and the individuals are seeking class action status
for a national class of purchasers of annuities issued by us; however, no class has yet been certified. The named plaintiffs in this consolidated
case are Bernard McCormack, Gust Anagnostis by and through Gary S. Anagnostis and Robert C. Anagnostis, Regina Bush by and through
Sharon Schipiour, Lenice Mathews by and through Mary Ann Maclean and George Miller. The allegations generally attack the suitability of
sales of deferred annuity products to persons over the age of 65. The plaintiffs seek rescission and injunctive relief including restitution and
disgorgement of profits on behalf of all class members under California Business & Professions Code section 17200 et seq. and Racketeer
Influenced and Corrupt Organizations Act; 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 under California Civil Code section 1750 and California Welfare
& Institutions Codes section 15600 et seq. As previously reported, we participated in mediation sessions with plaintiffs' counsel in 2011 and
2012 where potential settlement terms continued to be discussed. Based upon the current status of those discussions, the $17.5 million litigation
liability referred to above represents our best estimate of probable loss with respect to this litigation. However, a formal settlement has not been
reached, the potential settlement has not been reviewed by the court and other factors could potentially result in a change in this estimate as
further developments take place. In light of the inherent uncertainties involved in the pending purported class action lawsuit, there can be no
assurance that such litigation, or any other pending or future litigation, will not have a material adverse effect on our business, financial condition,
or results of operations.
F-45
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. Earnings Per Share
The following table sets forth the computation of earnings per common share and earnings per common share—assuming dilution:
Numerator:
Net income—numerator for earnings per common share
Interest on convertible subordinated debentures (net of income tax benefit)
Numerator for earnings per common share—assuming dilution
Denominator:
Weighted average common shares outstanding (1)
Effect of dilutive securities:
Convertible subordinated debentures
Convertible senior notes
Stock options and deferred compensation agreements
Denominator for earnings per common share—assuming dilution
Earnings per common share
Earnings per common share—assuming dilution
Year Ended December 31,
2012
2011
2010
(Dollars in thousands, except per share data)
$
$
$
$
57,798
517
58,315
$
$
86,248
1,034
87,282
$
$
42,933
1,035
43,968
61,258,825
59,482,349
58,506,804
1,348,447
2,515,067
553,312
2,727,084
848,164
561,898
2,729,514
2,904,571
438,834
65,675,651
63,619,495
64,579,723
0.94
0.89
$
$
1.45
1.37
$
$
0.73
0.68
(1) Weighted average common shares outstanding include shares vested under the NMO Deferred Compensation Plan and exclude unallocated
shares held by the ESOP.
Options to purchase shares of our common stock that were outstanding during the respective periods indicated but were not included in the
computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares
are as follows:
Period
Year ended December 31, 2012
Year ended December 31, 2011
Year ended December 31, 2010
Number of
Shares
Range of
Exercise Prices
Minimum Maximum
1,522,100
2,290,200
$11.35
$10.65
1,945,500
$8.75
$14.34
$14.34
$14.34
In November 2011, our board of directors approved a share repurchase program authorizing us to repurchase up to 10,000,000 shares of our
common stock. As of December 31, 2012, no shares had been repurchased under this program.
F-46
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. Quarterly Financial Information (Unaudited)
Unaudited quarterly results of operations are summarized below.
2012
Premiums and product charges
Net investment income
Change in fair value of derivatives
Net realized gains (losses) on investments, excluding OTTI losses
Net OTTI losses recognized in operations
Total revenues
Net income (loss)
Earnings (loss) per common share
Earnings (loss) per common share—assuming dilution
2011
Premiums and product charges
Net investment income
Change in fair value of derivatives
Net realized gains (losses) on investments, excluding OTTI losses
Net OTTI losses recognized in operations
Total revenues
Net income (loss)
Earnings (loss) per common share
Earnings (loss) per common share—assuming dilution
Quarter ended
March 31,
June 30,
September 30,
December 31,
(Dollars in thousands, except per share data)
$
22,615
$
25,156
$
27,175
$
326,910
259,161
(6,076)
(2,881)
599,729
10,471
0.18
0.16
320,259
(150,847)
(611)
(978)
192,979
18,759
0.31
0.30
318,594
161,090
(1,238)
(1,686)
503,935
(7,829)
(0.13)
(0.13)
$
19,878
$
23,181
$
23,531
$
292,128
148,653
(1,193)
(6,571)
452,895
31,343
0.53
0.48
296,878
(22,029)
(854)
(2,229)
294,947
18,274
0.31
0.28
305,502
(333,621)
(17,292)
(8,891)
(30,771)
(13,068)
(0.22)
(0.22)
26,937
321,160
(48,266)
1,471
(9,387)
291,915
36,397
0.58
0.55
21,750
324,272
92,269
698
(16,285)
422,704
49,699
0.83
0.79
Earnings per common share for each quarter is computed independently of earnings per common share for the year. As a result, the sum of the
quarterly earnings per common share amounts may not equal the earnings per common share for the year.
In the quarter ended March 31, 2011, we adjusted for an overstatement of our single premium immediate annuity reserves that resulted in a
cumulative overstatement of net income for the first quarter of 2011 of $2.7 million.
The differences between the change in fair value of derivatives for each quarter primarily correspond to the performance of the indices upon
which our call options are based. The comparability of net income (loss) is impacted by the application of fair value accounting to our fixed
index annuity business as follows:
Quarter ended
March 31,
June 30,
September 30,
December 31,
(Dollars in thousands)
2012
2011
$
16,279
$
5,058
$
18,106
$
(2,945)
9,747
45,868
(8,270)
(21,313)
F-47
Schedule I—Summary of Investments—Other
Than Investments in Related Parties
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
December 31, 2012
Column A
Column B
Column C
Column D
Type of Investment
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
United States Government sponsored agencies
United States municipalities, states and territories
Foreign government obligations
Corporate securities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Held for investment:
Corporate security
Total fixed maturity securities
Equity securities, available for sale:
Non-redeemable preferred stocks
Common stocks
Total equity securities
Mortgage loans on real estate
Derivative instruments
Other investments
Total investments
Amortized
Cost(1)
Fair
Value
(Dollars in thousands)
Amount at
which shown
in the balance
sheet
$
4,590
$
5,154
$
5,154
1,763,789
3,116,678
86,099
12,930,173
2,743,537
354,870
957,291
1,772,025
3,578,323
105,259
14,466,772
2,888,113
357,982
998,508
1,772,025
3,578,323
105,259
14,466,772
2,888,113
357,982
998,508
21,957,027
24,172,136
24,172,136
76,088
61,521
76,088
22,033,115
$
24,233,657
24,248,224
29,955
14,643
44,598
2,623,940
196,106
196,366
30,120
23,302
53,422
2,848,235
415,258
30,120
23,302
53,422
2,623,940
415,258
196,366
$
25,094,125
$
27,537,210
(1) On the basis of cost adjusted for repayments and amortization of premiums and accrual of discounts for fixed maturity securities and short-
term investments, original cost for derivative instruments and unpaid principal balance less allowance for credit losses for mortgage loans.
See accompanying Report of Independent Registered Public Accounting Firm.
F-48
Schedule II—Condensed Financial Information of Registrant
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Balance Sheets
(Dollars in thousands)
Assets
Cash and cash equivalents
Equity securities of subsidiary trusts
Receivable from subsidiaries
Deferred income taxes
Federal income tax recoverable, including amount from subsidiaries
Other assets, including 2015 notes hedges
Investment in and advances to subsidiaries
Total assets
Liabilities and Stockholders' Equity
Liabilities:
Notes payable
Subordinated debentures payable to subsidiary trusts
Deferred income taxes
Other liabilities, including 2015 notes embedded derivative
Total liabilities
Stockholders' equity:
Common stock
Additional paid-in capital
Unallocated common stock held by ESOP
Accumulated other comprehensive income
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
December 31,
2012
2011
$
11,220
$
7,398
535
2,378
11,613
55,010
88,154
12,609
8,196
747
—
8,868
61,233
91,653
2,235,403
1,933,845
$
2,323,557
$
2,025,498
$
309,869
$
245,869
—
47,582
603,320
61,751
496,715
(2,583)
686,807
477,547
297,608
268,653
460
50,098
616,819
57,837
468,281
(3,620)
457,229
428,952
1,720,237
1,408,679
$
2,323,557
$
2,025,498
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-49
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Operations
(Dollars in thousands)
Revenues:
Net investment income
Dividends from subsidiary trusts
Investment advisory fees
Surplus note interest from subsidiary
Realized gain on investments
Change in fair value of derivatives
Loss on extinguishment of debt
Total revenues
Expenses:
Change in fair value of embedded derivatives
Interest expense on notes payable
Interest expense on subordinated debentures issued to subsidiary trusts
Other operating costs and expenses
Total expenses
Loss before income taxes and equity in undistributed income of subsidiaries
Income tax benefit
Loss before equity in undistributed income of subsidiaries
Equity in undistributed income of subsidiaries
Net income
Year Ended December 31,
2012
2011
2010
$
$
565
403
$
298
427
36,178
4,080
—
(7,472)
—
33,754
(2,488)
28,479
13,458
8,228
47,677
(13,923)
(5,944)
(7,979)
65,777
29,765
4,080
18
(21,146)
—
13,442
(21,002)
31,633
13,977
7,307
31,915
(18,473)
(7,407)
(11,066)
97,314
$
57,798
$
86,248
$
295
455
23,713
4,080
13
27,059
(292)
55,323
29,595
22,125
14,906
6,013
72,639
(17,316)
(7,417)
(9,899)
52,832
42,933
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-50
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Cash Flows
(Dollars in thousands)
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Change in fair value of 2015 notes embedded conversion derivative
Provision for depreciation and amortization
Accrual of discount on equity security
Equity in undistributed income of subsidiaries
Amortization of premium on fixed maturity security
Accrual of discount on contingent convertible notes
Change in fair value of derivatives
Realized (gain) loss on investments
Loss (gain) on extinguishment of debt
Accrual of discount on debenture issued to subsidiary trust
Share-based compensation
ESOP compensation
Deferred income tax benefit
Changes in operating assets and liabilities:
Receivable from subsidiaries
Federal income tax recoverable
Other assets
Other liabilities
Net cash provided by (used in) operating activities
Investing activities
Capital contributions to subsidiaries
Purchase of fixed maturity security
Sales, maturities or repayments of fixed maturity securities—available for sale
Purchases of property, plant and equipment
Net cash provided by (used in) investing activities
Year Ended December 31,
2012
2011
2010
$
57,798
$
86,248
$
42,933
(2,488)
2,382
(5)
(65,777)
—
12,261
7,472
—
—
110
1,348
45
(2,838)
1,205
(2,745)
(549)
(4,469)
3,750
—
—
—
—
—
(21,002)
2,395
(5)
(97,314)
1,005
13,024
21,002
(18)
—
158
866
45
(4,355)
1,596
142
1,702
(1,562)
3,927
(2,450)
(53,610)
52,623
—
(3,437)
29,595
1,270
(4)
(52,832)
185
7,761
(29,595)
(13)
292
148
1,087
82
(5,153)
(10)
(2,296)
(1,925)
3,708
(4,767)
(2,400)
(50,260)
50,088
(33)
(2,605)
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-51
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Cash Flows (Continued)
(Dollars in thousands)
Year Ended December 31,
2012
2011
2010
Financing activities
Financing fees incurred and deferred
Proceeds from notes payable
Repayments of notes payable
Purchase of 2015 notes hedges
Repayment of subordinated debentures
Excess tax benefits realized from share-based compensation plans
Proceeds from issuance of common stock
Proceeds from issuance of warrants
Dividends paid
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest on notes payable
Interest on subordinated debentures
Non-cash financing activity:
Conversion of subordinated debentures
$
— $
(1,566) $
—
—
—
(1,141)
6
5,370
—
(9,374)
(5,139)
(1,389)
12,609
—
(46,251)
—
—
28
4,686
—
(7,102)
(50,205)
(49,715)
62,324
11,220
$
12,609
$
(6,800)
200,000
(156,641)
(37,000)
—
31
6,123
15,600
(5,829)
15,484
8,112
54,212
62,324
$
$
14,564
$
16,917
$
13,102
13,703
11,085
14,717
20,770
—
60
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-52
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Note to Condensed Financial Statements
December 31, 2012
1. Basis of Presentation
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes
thereto of American Equity Investment Life Holding Company (Parent Company).
In the Parent Company financial statements, its investment in and advances to subsidiaries are stated at cost plus equity in undistributed
income (losses) of subsidiaries since the date of acquisition and net unrealized gains/losses on the subsidiaries' fixed maturity securities
classified as "available for sale" and equity securities.
See notes 9 and 10 to the consolidated financial statements for a description of the Parent Company's notes payable and subordinated
debentures payable to subsidiary trusts.
F-53
Schedule III—Supplementary Insurance Information
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Column A
As of December 31, 2012:
Life insurance
As of December 31, 2011:
Life insurance
As of December 31, 2010:
Life insurance
Column B
Column C
Column D
Column E
Deferred policy
acquisition
costs
Future policy
benefits,
losses, claims
and loss
expenses
Unearned
premiums
Other policy
claims and
benefits
payable
(Dollars in thousands)
$
$
$
1,709,799
1,683,857
1,747,760
$
$
$
31,773,988
28,118,716
23,655,807
$
$
$
— $
455,752
— $
400,594
— $
222,860
Column A
Column F
Column G
Premium
revenue
Net
investment
income
Column H
Benefits,
claims,
losses and
settlement
expenses
Column I
Column J
Amortization
of deferred
policy
acquisition
costs
Other
operating
expenses
(Dollars in thousands)
As of December 31, 2012:
Life insurance
As of December 31, 2011:
Life insurance
As of December 31, 2010:
Life insurance
$
$
$
101,883
88,340
81,057
$
$
$
1,286,923
1,218,780
1,036,106
$
$
$
1,200,218
750,214
932,292
$
$
$
164,919
143,478
136,388
$
$
$
137,432
113,169
151,646
See accompanying Report of Independent Registered Public Accounting Firm.
F-54
Schedule IV—Reinsurance
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Column A
Column B
Column C
Gross amount
Ceded to
other
companies
Column D
Assumed
from
other
companies
Column E
Net amount
Column F
Percent of
amount
assumed
to net
(Dollars in thousands)
Year ended December 31, 2012:
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life and accident and health insurance
premiums
Year ended December 31, 2011:
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life and accident and health insurance
premiums
Year ended December 31, 2010:
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life and accident and health insurance
premiums
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,350,473
93,472
12,525
105,997
2,469,428
84,338
11,777
96,115
2,505,280
78,138
11,811
$
$
$
$
$
$
$
$
4,742
6,796
364
7,160
4,692
8,149
348
8,497
3,147
9,063
711
89,949
$
9,774
$
61,488
$
2,407,219
2.55%
— $
86,676
—
5.56%
0.72%
—
5.94%
0.82%
2,529,933
2.58%
— $
76,189
12,877
99,553
12,151
88,340
716
716
65,197
$
$
722
722
69,734
$
$
2,571,867
2.71%
— $
69,075
882
882
$
11,982
81,057
—
7.36%
1.09%
See accompanying Report of Independent Registered Public Accounting Firm.
F-55
Schedule V—Valuation and Qualifying Accounts
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Balance
January 1,
Charged to
Costs and
Expenses
Translation
Adjustment
(Dollars in thousands
Write-offs/
Payments/
Other
Balance
December 31,
Year Ended December 31, 2012
Valuation allowance on mortgage loans
$
(32,964)
$
(16,832)
$
— $
15,562
$
(34,234)
Year Ended December 31, 2011
Valuation allowance on mortgage loans
$
(16,224)
$
(30,770)
$
— $
14,030
$
(32,964)
Year Ended December 31, 2010
Valuation allowance on mortgage loans
$
(5,266)
$
(15,225)
$
— $
4,267
$
(16,224)
See accompanying Report of Independent Registered Public Accounting Firm.
F-56
Item 15. Exhibits and Financial Statement Schedules.
(a) Exhibits:
Exhibit No.
3.1
3.2
3.3
3.4
3.5
4.8
4.9
4.10
4.10-A
4.11
4.12
4.13
4.14
4.15
4.16
4.17
4.18
4.19
4.20
4.23
4.24
4.25
4.26
4.27
4.28
Description
Articles of Incorporation, including Articles of Amendment (Incorporated by reference to Exhibit 3.1 to Form 10-Q for the period ended
June 30, 2000 filed on August 14, 2000)
Articles of Amendment to Articles of Incorporation (Incorporated by reference to the Registration Statement on Form S-1, File No.
333-108794, including all pre-effective amendments thereto)
Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3.3 to the Registration Statement on Form S-3
filed on January 15, 2008)
Third Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to Form 8-K filed on September 2, 2008)
Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3.5 to Form 10-Q for the period ended June 30,
2011 filed on August 5, 2011)
Indenture dated October 29, 1999 between American Equity Investment Life Holding Company and Wilmington Trust Company (as
successor in interest to West Des Moines State Bank), as trustee (Incorporated by reference to the Registration Statement on Form S-1, File
No. 333-108794, including all pre-effective amendments thereto)
Trust Preferred Securities Guarantee Agreement dated October 29, 1999 between American Equity Investment Life Holding Company and
Wilmington Trust Company (as successor in interest to West Des Moines State Bank), as trustee (Incorporated by reference to the
Registration Statement on Form S-1, File No. 333-108794, including all pre-effective amendments thereto)
Trust Common Securities Guarantee Agreement dated October 29, 1999 between American Equity Investment Life Holding Company and
West Des Moines State Bank, as trustee (Incorporated by reference to the Registration Statement on Form S-1, File No. 333-108794,
including all pre-effective amendments thereto)
Instruments of Resignation, Appointment and Acceptance, effective September 12, 2006, among American Equity Investment Life
Holding Company, Wilmington Trust Company, West Des Moines State Bank and Delaware Trust Company, National Association
(formerly known as First Union Trust Company, National Association) (Incorporated by reference to Exhibit 4.10A to Form 10-K for the
year ended December 31, 2008 filed on March 16, 2009)
Indenture dated December 16, 2003, between American Equity Investment Life Holding Company and Wilmington Trust Company, as
trustee (Incorporated by reference to Exhibit 4.11 to Form 10-K for the year ended December 31, 2003 filed on March 4, 2004)
Guarantee Agreement dated December 16, 2003, between American Equity Investment Life Holding Company and Wilmington Trust
Company, as trustee (Incorporated by reference to Exhibit 4.12 to Form 10-K for the year ended December 31, 2003 filed on March 4,
2004)
Indenture dated April 29, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.23 to Form 10-Q for the period ended June 30, 2005 filed on August 4,
2005)
Guarantee Agreement dated April 29, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.24 to Form 10-Q for the period ended June 30, 2005 filed on
August 4, 2005)
Indenture dated September 14, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.13 to Form 10-Q for the period ended September 30, 2004 filed on
November 9, 2004)
Guarantee Agreement dated September 14, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase
Bank, National Association, as trustee (Incorporated by reference to Exhibit 4.14 to Form 10-Q for the period ended September 30, 2004
filed on November 9, 2004)
Indenture dated December 22, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.17 to Form 10-K for the year ended December 31, 2004 filed on March 14,
2005)
Guarantee Agreement dated December 22, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase
Bank, National Association, as trustee (Incorporated by reference to Exhibit 4.18 to Form 10-K for the year ended December 31, 2004
filed on March 14, 2005)
Indenture dated December 6, 2004 between American Equity Investment Life Holding Company and US Bank National Association, as
trustee (Incorporated by reference to Exhibit 4.19 to Form 10-K for the year ended December 31, 2004 filed on March 14, 2005)
Registration Rights Agreement dated December 6, 2004 by and among American Equity Investment Life Holding Company, Deutsche
Bank Securities Inc., Raymond James & Associates, Inc., and Advest, Inc. (Incorporated by reference to Exhibit 4.20 to Form 10-K for the
year ended December 31, 2004 filed on March 14, 2005)
Indenture dated June 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.23 to Form 10-Q for the period ended June 30, 2005 filed on August 4,
2005)
Guarantee Agreement dated June 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.24 to Form 10-Q for the period ended June 30, 2005 filed on
August 4, 2005)
Indenture dated August 4, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.25 to Form 10-Q for the period ended September 30, 2005 filed on
November 4, 2005)
Guarantee Agreement dated August 4, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.26 to Form 10-Q for the period ended September 30, 2005 filed on
November 4, 2005)
Indenture dated December 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National
Association, as trustee (Incorporated by reference to Exhibit 4.27 to Form 10-K for the year ended December 31, 2005 filed on March 14,
2006)
Guarantee Agreement dated December 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.28 to Form 10-K for the year ended December 31, 2005 filed on
March 14, 2006)
F-57
Exhibit No.
Description
4.31
4.32
4.33
4.34
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
Amended and Restated Indenture dated July 7, 2006 between American Equity Investment Life Holding Company and Wells Fargo Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.31 to Form 10-Q for the period ended September 30, 2006 filed on
November 3, 2006)
Amended and Restated Guarantee Agreement dated July 7, 2006 between American Equity Investment Life Holding Company and Wells
Fargo Delaware Trust Company, as trustee (Incorporated by reference to Exhibit 4.32 to Form 10-Q for the period ended September 30,
2006 filed on November 3, 2006)
Indenture dated December 22, 2009 between American Equity Investment Life Holding Company and U.S. Bank National Association, as
trustee (Incorporated by reference to Exhibit 4.1 to Form 8-K filed on December 23, 2009)
Indenture dated September 22, 2010 between American Equity Investment Life Holding Company and U.S. Bank National Association, as
trustee (Incorporated by reference to Exhibit 4.1 to Form 8-K filed on September 28, 2010)
Deferred Compensation Agreements between American Equity Investment Life Holding Company and
(a) James M. Gerlach dated June 6, 1996 (Incorporated by reference to the Registration Statement on Form 10 filed on May 6, 1999)
(b) Terry A. Reimer dated November 11, 1996 (Incorporated by reference to the Registration Statement on Form 10 filed on May 6, 1999)
(c) David S. Mulcahy dated December 31, 1997 (Incorporated by reference to the Registration Statement on Form 10 filed on May 6,
1999)
2000 Employee Stock Option Plan (Incorporated by reference to Exhibit 10.7 to Form 10-Q for the period ended June 30, 2000 filed on
August 14, 2000)
2000 Director Stock Option Plan (Incorporated by reference to Exhibit 10.8 to Form 10-Q for the period ended June 30, 2000 filed on
August 14, 2000)
Retirement Benefit Agreement, dated as of June 4, 2009, between American Equity Investment Life Holding Company and David J. Noble
(Incorporated by reference to Exhibit 10.1 to Form 8-K filed on June 9, 2009)
American Equity Investment Life Holding Company 2009 Employee Incentive Plan (Incorporated by reference to Exhibit 10.2 to Form 8-
K filed on June 9, 2009)
Coinsurance Agreement dated December 19, 2001, including First Amendment dated February 26, 2002 between American Equity
Investment Life Insurance Company and EquiTrust Life Insurance Company (Incorporated by reference to Exhibit 10.10 to Form 10-K for
the year ended December 31, 2001 filed on April 1, 2002)
Coinsurance Agreement dated December 29, 2003 between American Equity Investment Life Insurance Company and EquiTrust Life
Insurance Company (Incorporated by reference to Exhibit 10.10-A to Form 10-K for the year ended December 31, 2003 filed on April 1,
2002)
First Amendment to Coinsurance Agreement dated July 30, 2004 between American Equity Investment Life Insurance Company and
EquiTrust Life Insurance Company (Incorporated by reference to Exhibit 10.10-B to Form 10-Q for the period ended June 30, 2004 filed
on August 4, 2004)
Form of Change in Control Agreement between American Equity Investment Life Holding Company and each of John M. Matovina and
Debra J. Richardson (Incorporated by reference to the Registration Statement on Form S-1, File No. 333-108794, including all pre-
effective amendments thereto)
10.11-A
Form of Amendment to Change in Control Agreement between American Equity Investment Life Holding Company and each of John M.
Matovina and Debra J. Richardson
10.14
10.15
10.16
10.18
10.19
10.20
10.21
10.22
10.26
10.27
2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment
Life Insurance Company and Hannover Life Reassurance Company of America (Incorporated by reference to Exhibit 10.22 to Form 10-Q
for the period ended March 31, 2006 filed on May 8, 2006)
Amendment I, effective January 1, 2006, to 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1,
2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America (Incorporated
by reference to Exhibit 10.23 to Form 10-Q for the period ended March 31, 2006 filed on May 8, 2006)
Amendment II, effective January 1, 2006, to 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1,
2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America (Incorporated
by reference to Exhibit 10.24 to Form 10-Q for the period ended March 31, 2006 filed on May 8, 2006)
American Equity Investment Life Holding Company Independent Insurance Agent Stock Option Plan (Incorporated by reference to
Exhibit 10.26 to Form 10-Q for the period ended September 30, 2007 filed on November 2, 2007)
Coinsurance and Yearly Renewable Term Reinsurance Agreement dated December 31, 2008 between American Equity Investment Life
Insurance Company and Hannover Life Reassurance Company of America (Incorporated by reference to Exhibit 10.20 to Form 10-K for
the year ended December 31, 2008 filed on March 16, 2009)
Amendment III, effective April 1, 2009, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1,
2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America (Incorporated
by reference to Exhibit 10.28 to Form 10-Q for the period ended June 30, 2009 filed on August 10, 2009)
Coinsurance Agreement effective July 1, 2009, between American Equity Investment Life Insurance Company and Athene Life Re Ltd
(Treaty #070109) (Incorporated by reference to Exhibit 10.29 to Form 10-Q for the period ended September 30, 2009 filed on November
9, 2009)
Coinsurance Agreement effective July 1, 2009, between American Equity Investment Life Insurance Company and Athene Life Re Ltd
(Treaty #08042009) (Incorporated by reference to Exhibit 10.29 to Form 10-Q for the period ended September 30, 2009 filed on
November 9, 2009)
Purchase Agreement, dated December 17, 2009, between American Equity Investment Life Holding Company and FBR Capital
Markets & Co. (Incorporated by reference to Exhibit 10.1 to Form 8-K filed on December 23, 2009)
Amendment IV, effective October 1, 2009, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective
October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Co. of America
(Incorporated by reference to Exhibit 10.30 to Form 10-K for the year ended December 31, 2009 filed on March 9, 2010)
F-58
Exhibit No.
Description
10.28
10.30
10.33
10.34
10.35
10.36
10.37
10.38
10.39
10.40
10.41
10.42
Amended Retirement Benefit Agreement, dated as of March 29, 2010, between American Equity Investment Life Holding Company and
David J. Noble (Incorporated by reference to Exhibit 10.1 to Form 8-K filed on April 2, 2010)
American Equity Investment Life Holding Company Short-Term Performance Incentive Plan (Incorporated by reference to Exhibit 10.2 to
Form 10-Q for the period ended September 30, 2010 filed on November 9, 2010)
2010 Independent Insurance Agent Stock Option Plan (Incorporated by reference to Exhibit 99.1 to the Registration Statement on Form
S-3 filed on December 15, 2010)
Credit Agreement dated January 28, 2011 among American Equity Investment Life Holding Company, JPMorgan Chase Bank, National
Association, Suntrust Bank and Deutsche Bank Securities, Inc. (Incorporated by reference to Exhibit 10.34 to Form 10-K for the year
ended December 31, 2010 filed on March 10, 2011)
Amendment V, effective November 18, 2010, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective
October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Co. of America
(Incorporated by reference to Exhibit 10.35 to Form 10-K for the year ended December 31, 2010 filed on March 10, 2011)
Transition and Severance Agreement between James M. Gerlach and American Equity Investment Life Insurance Company, dated
February 20, 2012 (Incorporated by reference to Exhibit 10.36 to Form 10-K for the year ended December 31, 2011 filed on March 1,
2012)
American Equity Investment Life Holding Company 2011 Director Stock Option Plan (Incorporated by reference to Appendix A to
Schedule 14A Definitive Proxy Statement for the 2011 annual meeting of stockholders filed on April 25, 2011)
Second Amendment to Coinsurance Agreement effective August 1, 2001 between American Equity Investment Life Insurance Company
and EquiTrust Life Insurance Company (Incorporated by reference to Exhibit 10.36 to Form 10-Q for the period ended September 30,
2011 filed on November 7, 2011)
Second Amendment to Coinsurance Agreement effective January 1, 2004 between American Equity Investment Life Insurance Company
and EquiTrust Life Insurance Company (Incorporated by reference to Exhibit 10.37 to Form 10-Q for the period ended September 30,
2011 filed on November 7, 2011)
2012 Independent Insurance Agent Stock Option Plan (Incorporated by reference to Exhibit 10.1 to the Registration Statement on Form
S-3 filed on August 23, 2012)
Form of Change in Control Agreement between American Equity Investment Life Holding Company and each of Ted M. Johnson, Ronald
J. Grensteiner and William R. Kunkel (Incorporated by reference to Exhibit 10.1 to Form 8-K filed on December 13, 2012)
Form of Change in Control Agreement between American Equity Investment Life Holding Company and Jeffrey D. Lorenzen
Exhibit No.
Description
12.1
21.2
23.1
31.1
31.2
32.1
32.2
Ratio of Earnings to Fixed Charges
Subsidiaries of American Equity Investment Life Holding Company
Consent of Independent Registered Public Accounting Firm
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
F-59
Exhibit 12.1
Ratio of Earnings to Fixed Charges
2012
2011
2010
2009
2008
Year Ended December 31,
(Dollars in thousands)
Consolidated income before income taxes
$
132,914
$
132,914
$
65,266 $
86,164 $
77,053
Interest sensitive and index product benefits and
amortization of deferred sales inducements
Interest expense on notes payable
Interest expense on subordinated debentures
Interest expense on amounts due under repurchase
agreements and other interest expense
Interest portion of rental expense
Consolidated earnings
Interest sensitive and index product benefits and
amortization of deferred sales inducements
Interest expense on notes payable
Interest expense on subordinated debentures
Interest expense on amounts due under repurchase
agreements and other interest expense
Interest portion of rental expense
Combined fixed charges
Ratio of consolidated earnings to fixed charges
Ratio of consolidated earnings to fixed charges, both
excluding interest sensitive and index product
benefits and amortization of deferred sales
inducements
905,244
28,479
13,458
—
697
847,538
31,633
13,977
30
665
793,091
387,882
22,125
14,906
—
648
14,853
15,819
534
570
235,836
19,773
19,445
8,207
459
1,080,792
$
1,026,757 $
896,036 $
505,822 $
360,773
905,244
$
847,538 $
793,091 $
387,882 $
235,836
28,479
13,458
—
697
31,633
13,977
30
665
22,125
14,906
—
648
14,853
15,819
534
570
19,773
19,445
8,207
459
$
$
$
947,878
$
893,843 $
830,770 $
419,658 $
283,720
1.1
4.1
1.1
1.1
1.2
1.3
3.9
2.7
3.7
2.6
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Subsidiaries of American Equity Investment Life Holding Company
Insurance Subsidiaries:
American Equity Investment Life Insurance Company
American Equity Investment Life Insurance Company of New York
Eagle Life Insurance Company
Noninsurance Subsidiaries:
American Equity Investment Service Company
American Equity Properties, L.C.
American Equity Capital, Inc.
American Equity Capital Trust I
American Equity Capital Trust II
American Equity Capital Trust III
American Equity Capital Trust IV
American Equity Capital Trust V
American Equity Capital Trust VI
American Equity Capital Trust VII
American Equity Capital Trust VIII
American Equity Capital Trust IX
American Equity Capital Trust X
American Equity Capital Trust XI
American Equity Capital Trust XII
AERL, L.C.
American Equity Advisors, Inc.
Exhibit 21.2
State of
Incorporation
Iowa
New York
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Iowa
Consent of Independent Registered Public Accounting Firm
Exhibit 23.1
The Board of Directors
American Equity Investment Life Holding Company:
We consent to the incorporation by reference in the registration statements (No. 333-184162, No 333-183504, No. 333-171161, No. 333-149854,
No. 333-148681, and No. 333-123862) on Form S-3 and the registration statements (No. 333-175355, No. 333-167755, and No. 333-127001)
on Form S-8 of American Equity Investment Life Holding Company and subsidiaries (the Company) of our report dated March 6, 2013, with
respect to the consolidated balance sheets of the Company as of December 31, 2012 and 2011, and the related consolidated statements of
operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended
December 31, 2012, and all related financial statement schedules, and the effectiveness of internal control over financial reporting as of
December 31, 2012, which report appears in the December 31, 2012 annual report on Form 10-K of American Equity Investment Life Holding
Company.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2012, the Company modified the types of costs incurred
that can be capitalized when issuing or renewing insurance contracts due to the prospective adoption of Financial Accounting Standards Board
Accounting Standards Update (ASU) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
Des Moines, Iowa
March 6, 2013
/s/ KPMG LLP
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 31.1
I, John M. Matovina, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of American Equity Investment Life Holding Company;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period
in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control
over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or
persons performing the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role
in the registrant's internal control over financial reporting.
Date: March 7, 2013
By:
/s/ JOHN M. MATOVINA
John M. Matovina, Chief Executive Officer and President
(Principal Executive Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 31.2
I, Ted M. Johnson, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of American Equity Investment Life Holding Company;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period
in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5.
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control
over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or
persons performing the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role
in the registrant's internal control over financial reporting.
Date: March 7, 2013
By:
/s/ TED M. JOHNSON
Ted M. Johnson, Chief Financial Officer and Treasurer
(Principal Financial Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the Annual Report of American Equity Investment Life Holding Company (the "Company") on
Form 10-K for the fiscal year ended December 31, 2012 as filed with the Securities and Exchange Commission on or about the
date hereof (the "Report"), I, John M. Matovina, Chief Executive Officer and President of the Company, certify, pursuant to 18
U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
1.
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
and
Date: March 7, 2013
By:
/s/ JOHN M. MATOVINA
John M. Matovina, Chief Executive Officer and President
(Principal Executive Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report of American Equity Investment Life Holding Company (the "Company") on
Form 10-K for the fiscal year ended December 31, 2012 as filed with the Securities and Exchange Commission on or about the
date hereof (the "Report"), I, Ted M. Johnson, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18
U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
1.
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
and
Date: March 7, 2013
By:
/s/ TED M. JOHNSON
Ted M. Johnson, Chief Financial Officer and Treasurer
(Principal Financial Officer)
SHAREHOLDER INFORMATION
To learn more about American Equity Investment Life
Holding Company, you can request news releases,
annual reports in printed format, financial supplements,
and forms 10-K and 10-Q at no cost by contacting:
Julie L. LaFollette
Director of Investor Relations
6000 Westown Parkway
West Des Moines, IA 50266
515-273-3602 | Fax 515-221-9989
jlafollette@american-equity.com
Debra J. Richardson
Executive Vice President and Corporate Secretary
6000 Westown Parkway
West Des Moines, IA 50266
515-273-3602 | Fax 515-221-9989
drichardson@american-equity.com
Stock Listing
American Equity is listed on the New York Stock
Exchange under the ticker symbol AEL.
Website
American Equity’s website, www.american-equity.com,
is continuously updated and includes Company-
issued news releases, conference calls, stock price and
dividend information, quarterly reports, SEC filings,
management presentations and more.
Annual Shareholders Meeting
Thursday, June 6, 2013
3:30 pm CDT
AEL Headquarters
Corporate Headquarters
American Equity Investment Life Holding Company
6000 Westown Parkway
West Des Moines, IA 50266
515-221-0002 | Toll-free 888-221-1234
www.american-equity.com
Stock Transfer Agent and Registrar
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, RI 02940-3078
877-282-1169
www.computershare.com
Independent Registered
Public Accounting Firm
KPMG LLP
2500 Ruan Center
Des Moines, IA 50309
515-288-7465
Other Certifications
American Equity submitted its CEO Certification to the
New York Stock Exchange in 2012. Additionally,
American Equity filed as an exhibit to its 2012 annual
report on Form 10-K, CEO/CFO Certifications with the
Securities and Exchange Commission as required under
Section 302 of the Sarbanes-Oxley Act.
outstanding service
has been the cornerstone
of American Equity’s success from
the company’s inception.
unwaivering commitment
. . . with rock solid service as our cornerstone.
2012 American Equity Investment Life Holding Company
Annual Report & Form 10-K
American Equity Investment Life Holding Company
West Des Moines, Iowa 50266
515-221-0002 | 888-221-1234
www.american-equity.com
AEL-AR-12