2017 ANNUAL REPORT & FORM 10-K
Letter from the Chairman and CEO
JOHN M. MATOVINA
Our leadership in guaranteed income
remained strong. In September, we
adapted to our independent agents’
increasing emphasis on accumulation
by raising caps and participation rates
on our Choice series of accumulation-
focused fixed index annuities. This effort
was successful, as Choice accounted
for 33 percent of American Equity
Investment Life Insurance Company
sales in the fourth quarter of 2017.
In the second half of the year, we began
expanding our investment universe
beyond our historical concentration in
public corporate debt to support the
higher caps and participation rates.
These new focus areas, including
asset-backed securities and private
corporate debt, tend to be less liquid
but have demonstrated excellent credit
performance over time. The current
liquidity in our investment portfolio
supports our ability to allocate new
money to less liquid credit structures
while maintaining our commitment to
a sound investment philosophy.
A merican Equity enjoyed a solid
2017: we delivered strong
financial performance despite
a challenging sales environment,
continued to grow our policyholder
funds under management and deployed
our sound investment strategy to
minimize impairment losses. Some
key highlights include:
• 7.1 percent increase in policyholder
funds under management.
• Record non-GAAP operating
income1 of $285 million or $3.16
per diluted share.
• Non-GAAP operating return on
average equity1 of 14.0 percent.
• Investment impairment losses of
less than 0.2 percent of average
equity after the effects of deferred
acquisition costs and income taxes.
Reflecting industry headwinds and
increased competition, our fixed index
annuity sales dropped to $4.0 billion
last year from $5.7 billion in 2016.
1
9764_Cover.indd 2
American Equity Investment
Life Holding Company®
Board of Directors
JOHN M. MATOVINA
Chairman, Chief Executive Officer,
and President
JOYCE A. CHAPMAN
Retired Banking Executive and
Community Volunteer
ALEXANDER M. CLARK
Senior Managing Director
Griffin Financial Group
BRENDA J. CUSHING
Consultant and
Retired Executive
JAMES M. GERLACH
Retired Executive
ROBERT L. HOWE
Consultant and Retired Deputy Commissioner
Iowa Insurance Division
WILLIAM R. KUNKEL
General Counsel
Archdiocese of Chicago
ALAN D. MATULA
Chief Information Officer
Weber-Stephen Products LLC
DAVID S. MULCAHY
Chairman
Monarch Materials Group, Inc.
GERARD D. NEUGENT
Co-Chair and Chief Executive Officer
Knapp Properties, Inc.
DEBRA J. RICHARDSON
Retired Executive
A.J. STRICKLAND, III
Professor of Strategic Management
University of Alabama School of Business
Shareholder Information
To learn more about American Equity
Investment Life Holding Company®, you
can request news releases, annual reports,
financial supplements, and Forms 10-K
and 10-Q by contacting:
STEVEN D. SCHWARTZ, CFA
VICE PRESIDENT – INVESTOR RELATIONS
6000 Westown Parkway
West Des Moines, IA 50266
(515) 273-3763 • Fax (515) 221-0744
Email: sschwartz@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 news releases,
conference calls, stock price information,
quarterly reports, SEC filings, management
presentations and more.
ANNUAL SHAREHOLDERS MEETING
June 7, 2018, 1:30 p.m.
AEL Headquarters
CORPORATE HEADQUARTERS
American Equity Investment
Life Holding Company®
6000 Westown Parkway
West Des Moines, IA 50266
(515) 221-0002 • www.american-equity.com
STOCK TRANSFER 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
4/6/18 2:06 AM
In 2017, we further strengthened
our balance sheet. We repaid our
outstanding $100 million term loan
and refinanced our $400 million of
senior notes with a $500 million senior
note issuance due 2027. This lowered
our long-term debt costs to 5 percent
from 6.625 percent. Shareholders’
equity, excluding other accumulated
comprehensive income, exceeded
$2.1 billion. Adjusted capital and surplus
on a regulatory basis for American
Equity Investment Life Insurance
Company, our flagship insurance
subsidiary, was nearly $3.3 billion. The
insurance company’s risk-based capital
ratio was 378 percent—the highest level
of the last 10 years.
Recently, the Department of Labor
(DOL) fiduciary rule—which had been
a significant challenge in 2016 and
2017—was vacated by the U.S. Fifth
Circuit Court of Appeals. We are
delighted with this development. While
well intended, the fiduciary rule would
have cost individuals access to helpful
retirement savings and income products
and retirement advice. Because there
may be challenges to this court ruling,
the final outcome of the DOL fiduciary
rule remains uncertain. However, we are
optimistic that going forward the DOL
will coordinate its rulemaking efforts
with other regulatory agencies, including
the National Association of Insurance
Commissioners, which should lead to
a better process and result. Regardless
of the outcome of the fiduciary rule,
you can be sure we are—and will
continue to be—prepared to respond
and grow our business.
We expect the impact of tax reform to
differ on new sales and in-force
business. The acceleration of tax
payments resulting from changes in
the calculation of taxable income will
likely offset much of the benefit of a
lower statutory rate for new sales and
the residual benefit is expected to be
competed away. However, we expect to
retain the majority of the benefit from
the lower tax rate on earnings generated
by our in-force business.
We are positioned for continued
success and look to capitalize on strong
performance from 2017 and the sales
momentum we built in late 2017.
Our value proposition to distributors
and policyholders of competitive,
transparent products and unparalleled
service remains as attractive as ever.
Americans’ need for guaranteed lifetime
income continues to grow, and our
fixed index annuities with lifetime
income riders are one of the most
efficient ways to provide that
guaranteed lifetime income.
On behalf of the board of directors,
our management team and our
530 employees, thank you for your
ownership in American Equity.
1 For a reconciliation of net income to non-GAAP operating income, please see page 3. Net income return on average equity was 8.6%.
9764_Insert.indd 2
2
4/6/18 2:42 AM
3Financial Highlights20172016201520142013Total assetsTotal stockholders’ equityAccumulated other comprehensive income (AOCI)Total stockholders’ equity excluding AOCI(b)Total annuity depositsNet incomeNon-GAAP operating income(a)Non-GAAP Financial Measures(a): Reconciliation of net income to non-GAAP operating income:(a) In addition to net income, we have consistently utilized non-GAAP operating income and non-GAAP 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. Non-GAAP operating income equals net income adjusted to eliminate the impact of items that fluctuate from year to year in a manner unrelated to core operations and we believe measures excluding their impact are useful in analyzing operating trends. The most significant adjustments to arrive at non-GAAP operating income eliminate the impact of fair value accounting for our fixed index annuity business and are not economic in nature but rather impact the timing of reported results. In addition, 2017 includes a $35.9 million adjustment to arrive at non-GAAP operating income resulting from the Tax Cuts and Jobs Act of 2017, which was enacted on December 22, 2017, and required a revaluation of our net deferred tax assets from 35% to 21%. We believe the combined presentation and evaluation of non-GAAP operating income together with net income provides information that may enhance an investor’s understanding of our underlying results and profitability. The amounts included in the reconciliation of net income to non-GAAP operating income are presented net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.(b) Total stockholders’ equity and book value per share excluding AOCI, non-GAAP financial measures, are based on stockholders’ equity excluding the effect of AOCI. Since AOCI fluctuates from quarter to quarter due to unrealized changes in the fair value of available for sale investments, we believe these non-GAAP financial measures provide useful supplemental information. $83,243 $219,830 $126,023 $253,283 7,188 5,737 4,429 (18,170) 56,634 (44,055) 79,053 (153,267) (1,265) 1,296 104 (2,038) —— —— 12,503 32,515 (1,957) —— (1,418) 30 (21,499) 13,012 (30,048) 51,067 $122,344 $195,820 $190,646 $163,420 $83,243 $219,830 $126,023 $253,283 $7,128,199 $7,083,979 $4,184,585 $4,212,488 (339,966) (201,663) (721,401) (46,196) $1,951,629 $1,742,872 $1,418,475 $1,338,491 $122,344 $195,820 $190,646 $163,420 $0.97 $2.72 $1.58 $3.38 $1.43 $2.42 $2.39 $2.18 $26.04 $23.83 $27.93 $19.40 $22.17 $21.36 $18.52 $18.75$174,645$1.93––––(5,093)$3.16(5,124)$174,645(1,224)$4,177,210(724,599)$2,125,558121,846$31.91$23.79285,050$285,050––––PER SHARE DATAEarnings per common share— assuming dilutionNon-GAAP operating income(a) per common share—assuming dilutionBook value per share including AOCI Book value per share excluding AOCI(b)20172016201520142013(Dollars in thousands, except for per share data)$56,053,472 $49,029,392 $43,976,689 $39,605,843 $2,291,595 $1,944,535 $2,139,876 $1,384,687$62,030,736$2,850,157Net income Net realized investment (gains) losses, including OTTI Change in fair value of derivatives and embedded derivatives—index annuities Change in fair value of derivatives and embedded derivatives—debt Extinguishment of debt Litigation reserve Income taxesNon-GAAP operating income9764_Insert.indd 34/6/18 2:42 AM 41020304050BILLIONS OF DOLLARS60Total Annuity Deposits62.2%2.5%0.1%34.9%0.3%––%JUNE30, 2013JUNE30, 2015JUNE30, 2014JUNE30, 2016JUNE30, 2017DEC.31, 20132013201520142016201739.644.049.056.162.0DEC.31, 2015DEC.31, 2014DEC.31, 2016DEC.31, 2017DEC.31, 2012Total AssetsComparison of Cumulative Five-Year Total ReturnCredit Quality of Fixed Maturity Securities1BILLIONS OF DOLLARS23456789American Equity Investment Life Holding Co.S&P 500 IndexS&P 500 Financials Index201320152014201620174.24.27.17.14.2NAIC Designation 1NAIC Designation 3NAIC Designation 5NAIC Designation 2NAIC Designation 4NAIC Designation 6$02512522575175275$50$100$150$200$250$3009764_Insert.indd 44/6/18 2:42 AM David J. Noble was a leader and an innovator. For more than 60 years, Mr. Noble was a force in the insurance industry. His philosophy was simple yet profound: people, service and future. PEOPLE: He was passionate about people—employees, agents, policyholders. He mentored and developed a future generation of insurance industry leaders and cultivated a family culture despite significant organizational growth. He valued and was committed to policyholders and the agents and advisors who called on them. His respect for his country and those who served was immeasurable. SERVICE: He believed in service: to agents and to policyholders. American Equity’s service is its differentiator. We strive every day to offer the best service in the insurance industry and to honor Mr. Noble’s commitment to our partners. FUTURE: He was committed to providing Americans with an attractive, safe way to save for retirement and ensure guaranteed lifetime income. He saw fixed index annuities, which he liked to refer to as “sleep insurance,” as the best product to fit these needs. David Noble’s strength, knowledge and determination drove American Equity’s success. He was truly an American success story, and his success lives on in the strength of our company. We owe him much and will miss his leadership and counsel greatly. It’s not about the building, the charter or the policy form … it’s about the people.”The Legacy of David J. Noble 1931–2017 DAVID J. NOBLE59764_Insert.indd 54/6/18 2:42 AM UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
or
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
Common stock, par value $1
Name of each exchange on which registered
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
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes
No
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
No
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
No
that the registrant was required to submit and post such files). Yes
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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting
company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and
"emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a smaller
reporting company)
Smaller reporting
company
Emerging growth
company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes
No
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $2,299,993,170 based on
the closing price of $26.28 per share, the closing price of the common stock on the New York Stock Exchange on June 30, 2017.
Shares of common stock outstanding as of February 21, 2018: 89,880,222
Documents incorporated by reference: Portions of the registrant's definitive proxy statement for the annual meeting of shareholders to be
held June 7, 2018, which will be filed within 120 days after December 31, 2017, 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, 2017
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, 2017.
Exhibits and Financial Statement Schedules
Index to Consolidated Financial Statements and Schedules
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
16
16
16
17
18
20
47
48
48
48
48
49
49
52
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 issue fixed annuity products through our wholly-owned life insurance subsidiaries, American Equity Investment Life
Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York and Eagle Life Insurance
Company ("Eagle Life"). We have one business segment which represents our core business comprised of the sale of fixed index and fixed rate
annuities. Our business strategy is focused on growing our policyholder funds and earning predictable returns by managing investment spreads
and investment risk. We are 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 any amendments may be found on our 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 and corporate governance committee charter and (v) 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 or create guaranteed lifetime
income. 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 and this group has grown to 49.2 million in 2016. 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 due to their principal protection, competitive
rates of credited interest, tax-deferred growth, guaranteed lifetime income and alternative payout options. Our competitive fixed index and fixed
rate annuity products have enabled us to enjoy favorable growth in recent years and since our formation.
According to Wink's Sales and Market Report published by Wink, Inc., total industry sales of fixed index annuities decreased 10.0% to $40.4
billion for the first three quarters of 2017 from $44.9 billion for the first three quarters of 2016. Total industry sales of fixed index annuities
have increased 71% over the five-year period from 2011 to 2016 (data provided in the following table according to Wink's Sales and Market
Report published by Wink, Inc.), which we believe is attributable to more Americans reaching retirement age and seeking products that will
provide principal protection and guaranteed lifetime income.
Total industry sales of fixed index annuities
$
58,235,265
$
53,069,850
$
46,896,350
$
38,646,864
$
33,975,442
2016
2015
2014
2013
2012
For the Year Ended December 31,
(Dollars in thousands)
Increase from prior year
Increase from prior year
Strategy
5,165,415
6,173,500
8,249,486
4,671,422
1,588,397
9.7%
13.2 %
21.3%
13.7%
4.9%
Key elements of executing our strategy include the following:
Expand and Enhance our Distribution Network. We currently distribute through several distribution channels, including independent
agents, broker/dealers, banks and registered investment advisors. American Equity Life has relationships with 32 national marketing
organizations, through which more than 23,000 independent agents are under contract. Eagle Life has relationships with 9 wholesale
distribution partners, though which there are 58 selling agreements and nearly 6,000 representatives. Fourteen of these selling
agreements are with broker/dealers affiliated with banks. Our objective is to improve the productivity and efficiency of our independent
agent distribution channel by focusing our marketing and recruiting efforts on those independent agents capable of selling $1 million
or more of annuity premium annually. We will also be alert for opportunities to establish relationships with successful national
marketing organizations and agents not presently associated with us. We continue to grow distribution through broker/dealers, banks
and registered investment advisors. According to Wink's Sales and Market Report published by Wink, Inc., sales of fixed index
annuities through broker/dealers and banks represented almost 35% of industry sales in the third quarter of 2017. Eagle Life is focused
solely on the broker/dealer, bank and registered investment advisor channel and is developing a network of broker/dealers, banks and
registered investment advisors that have the ability to distribute fixed index and fixed rate annuity products in large volume. We also
offer broker/dealer and bank friendly products for those broker/dealers and banks that choose to associate with us through American
Equity Life. We continue to strive to provide all of our distribution partners with the highest quality service possible.
1
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 competitive products. We were one of the first companies to offer a fixed index
annuity that allows a choice among interest crediting strategies including both equity and bond indices as well as a traditional fixed
rate strategy. We were one of the first companies to include a lifetime income benefit rider with our fixed index annuities and first to
have a lifetime income benefit rider with gender-based income payments. We believe that our continued focus on anticipating and
being responsive to the product needs of the ever-growing population of retirees will lead to increased customer loyalty, revenues and
profitability.
Use our Expertise to Achieve Targeted Spreads on Annuity Products. 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.
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. The expanded use of technological resources will continue to allow us to improve our processes, scalability and response
times.
Take Advantage of the Growing Popularity of Index Products. We believe that the growing popularity of fixed index annuity products
that allow equity market participation without the risk of loss of the premium deposit presents an attractive opportunity to grow our
business. The popularity of fixed index annuity products has increased in recent years with the availability of lifetime income benefit
riders that provide an attractive alternative for converting accumulated retirement savings into lifetime income. 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 our inception and continue to strive for an unprecedented level of timely and accurate service to both our agents and
policyholders. Examples of our high quality service include a live person answering phone calls and issuing policies within 24 hours
of receiving the application if the paperwork is in good order. We believe high quality service is one of our strongest competitive
advantages.
Be Proactive in the Changing Regulatory Environment. We have been a strong and vocal defender of our products and our industry
through continued regulatory challenges and have long been an advocate for appropriate regulation. We intend to remain flexible and
responsive to the ever changing regulatory environment and will continue to engage with our key regulators to ensure policyholder
protections are in place and adequate while permitting continued access to our much needed retirement products.
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 deposit 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:
Product Type
Year Ended December 31,
2017
2016
2015
Deposits
Collected
Deposits
as a % of
Total
Deposits
Collected
Deposits
as a % of
Total
Deposits
Collected
Deposits
as a % of
Total
(Dollars in thousands)
Fixed index annuities
$
3,966,839
Annual reset fixed rate annuities
Multi-year fixed rate annuities
Single premium immediate annuities
74,829
110,596
24,946
95 %
2 %
3 %
— %
5,724,758
64,317
1,303,273
35,851
80% $
6,791,689
1%
18%
1%
45,182
214,356
32,752
$
4,177,210
100 % $
7,128,199
100% $
7,083,979
96%
1%
3%
—%
100%
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. Bonus products represented 87%, 88% and 89% of our net annuity account
values at December 31, 2017, 2016 and 2015, respectively. The initial annuity deposit on these policies is increased at issuance by a specified
premium bonus ranging from 3% to 10%. Generally, the surrender charge and bonus vesting provisions of our policies are structured such that
we have comparable protection from early termination between bonus and non-bonus products.
2
The annuity contract value is equal to the sum of premiums paid, premium bonuses and interest credited ("index credits" for funds allocated to
an index based strategy), 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 12% and participation rates range from 10% to 100%. In addition, some products
have a spread or "asset fee" generally ranging from 0.75% to 4%, 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
surrender values are equal to no less than 87.5% of the premium collected plus interest credited at an annual rate ranging from 1% to 3%.
The initial caps and participation rates are largely a function of the cost of the call options we purchase to fund the annual index credits, 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 caps and participation rates, we take into account the cost of the call options we purchase to fund the annual index
credits, yield on our investment portfolio, annuity surrender and withdrawal assumptions and crediting rate history for particular groups of
annuity policies with similar characteristics.
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 seven years before it may be changed at our discretion. The
minimum guaranteed rate on our annual reset fixed rate deferred annuities ranges from 1% to 4% and the initial guaranteed rate on our multi-
year rate guaranteed policies ranges from 1.7% to 3.3%.
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 and withdrawal assumptions and crediting rate history for particular groups of annuity policies with similar
characteristics. As of December 31, 2017, crediting rates on our outstanding fixed rate deferred annuities generally ranged from 1.0% to 4.0%.
The average crediting rates on our outstanding annual reset and multi-year rate guaranteed fixed rate deferred annuities at December 31, 2017
were 1.87% and 2.72%, respectively.
We also sell single premium immediate annuities ("SPIAs"). Our SPIAs 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.
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
6 to 17 years for fixed index annuities and 5 to 15 years for fixed rate annuities from the date the policy is issued. This surrender charge initially
ranges from 7% to 20% for fixed index annuities and 8% to 20% for fixed rate annuities of the contract value and generally decreases by
approximately one-half to two percentage points per year during the surrender charge period. For certain policies, the premium bonus is considered
in the establishment of the surrender charge percentages. For other policies, there is a vesting schedule ranging from 10 to 14 years that applies
to the premium bonus and any interest earned on that premium bonus. Surrender charges and bonus vesting 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 enhances our ability to maintain profitability on such policies. Policyholders 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. Information
on surrender charge protection and net account values are as follows:
Annuity Surrender Charges:
Average years at issue
Average years remaining
Average surrender charge percentage remaining
Annuity Account Value (net of coinsurance)
2017
December 31,
2016
(Dollars in thousands)
2015
13.4
8.1
13.0%
13.5
8.6
13.8%
13.7
9.1
14.3%
$
48,400,755
$
45,204,015
$
41,249,647
3
Beginning in July 2007, substantially all of our fixed index annuity policies and many of our annual reset fixed rate deferred annuities 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 lifetime income benefit available is determined by the growth in the policy's income account value and the policyholder's
age at the time the policyholder elects to begin receiving lifetime income benefit payments. The growth in the policy's income account value
is based on the growth rate specified in the policy which ranges from 3% to 8% and the time period over which that growth rate is applied which
ranges from 5 to 20 years. Generally, the time period consists of an initial period of up to 10 years and the policyholder has the option to elect
to continue the time period for an additional period of up to 10 years. We have the option to increase the rider fee at the time the policyholder
elects to continue the time period. Lifetime income benefit payments may be stopped and restarted at the election of the policyholder. During
2013, we introduced new versions of our lifetime income benefit rider that had an optional wellbeing benefit or optional death benefit.
Policyholders have the choice of selecting a rider with a base level of benefit for no explicit fee or paying a fee for a rider that has a higher level
of benefits, and beginning in 2013 we introduced products where the addition of a rider to the policy is completely optional. Rider fees range
from 0.30% to 1.00% of the policy's account value. The additional value to the policyholder provided by this rider through the income account
value is not transferable to other contracts and we believe will improve the persistency of the contract.
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 our annuity 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 and the fixed rate strategy in our fixed index 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 on the respective policy anniversary dates, and new
options are purchased on each of the anniversary dates to fund the next annual index credits. All credited rates on annual reset fixed rate deferred
annuities and the fixed rate strategy in fixed index 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 and fixed index 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/Distribution
We market our products through a variable cost distribution network, including independent agents through national marketing organizations,
broker/dealers, banks and registered investment advisors. We emphasize high quality service to our agents, distribution partners and policyholders
along with the prompt payment of commissions to our agents and distribution partners. We believe this has been significant in building excellent
relationships with our distribution network.
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 senior leadership, giving us an edge in recruiting over larger and
foreign-owned competitors. We also emphasize our products, service and our focused fixed annuity expertise. 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 independent agent distribution system is comprised of insurance brokers and marketing organizations. We are pursuing a strategy to increase
the efficiency of our independent agent 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
generally do not enter into exclusive arrangements with these marketing organizations.
Agents contracted with us through two national marketing organizations accounted for more than 24% of the annuity deposits and insurance
premiums collected during 2017 by American Equity Life, 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 premium collected during 2017 were: Florida (7.9%), Texas
(7.1%), California (6.1%), Pennsylvania (5.9%) and North Carolina (5.6%).
Eagle Life's fixed index and fixed rate annuities are distributed pursuant to selling agreements with broker/dealers, banks and registered investment
advisors. Relationships with these firms are facilitated by wholesalers who promote Eagle Life and are compensated based upon the sales of
the firms that they have contracted with Eagle Life. American Equity Life to a lesser extent also sells through broker/dealers and we have
introduced products specifically for this distribution channel.
4
Competition and Ratings
We operate in a highly competitive industry. 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 products 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, index options, policy terms and conditions, service
provided to distribution channels and policyholders, ratings, reputation and distributor 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. 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:
A.M. Best Company
January 2011 - current
Standard & Poor's
August 2015 - current
June 2013 - August 2015
October 2011 - June 2013
Fitch Ratings
May 2013 - Current
Financial Strength Rating
Outlook Statement
A-
A-
BBB+
BBB+
BBB+
Stable
Stable
Positive
Stable
Stable
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 December 2017, A.M. Best affirmed its rating outlook on the U.S. life/annuity sector as 'negative', reflecting its view that factors including
a flattening yield curve, low treasury yields, declining annuity sales and evolving regulatory issues could negatively impact the U.S. life/annuity
sector. In December 2017, Fitch changed its outlook on the U.S. life insurance sector to 'stable' from 'negative', reflecting its view that better
than expected operating performance and a benign credit environment are likely to continue into 2018. In January 2018, Standard & Poor affirmed
its rating outlook on the U.S. life insurance sector as 'stable', reflecting its view that insurers continue to exhibit strong balance sheet fundamentals
and good earnings and liquidity, partially mitigating concerns over evolving issues that could negatively impact the U.S. life insurance sector.
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
"A-" is regarded as having strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions
than are higher rated insurers.
Fitch Rating's insurer financial strength ratings currently range from "AAA (exceptionally strong)" to "C (distressed)." Ratings of "BBB-" and
higher are considered to be "secure," and those of "BB+" and lower are considered to be "vulnerable."
A.M. Best Company, Standard & Poor's and Fitch 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, as well as an increase in the cost of debt or equity financing.
5
Reinsurance
We follow the industry practice of reinsuring a portion of our annuity risks with unaffiliated reinsurers. Our reinsurance agreements play a part
in managing our regulatory capital.
Coinsurance
American Equity Life has three coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in
Bermuda. One agreement ceded 20% of certain of American Equity Life's fixed index annuities issued from January 1, 2009 through March 31,
2010. The business reinsured under this agreement is no longer eligible for recapture. The second agreement ceded 80% of American Equity
Life's multi-year rate guaranteed annuities issued from July 1, 2009 through December 31, 2013 and 80% of Eagle Life's multi-year rate guaranteed
annuities issued from November 20, 2013 through December 31, 2013. The business reinsured under this agreement may not be recaptured.
The third agreement cedes 80% of American Equity Life's and Eagle Life's multi-year rate guaranteed annuities issued on or after January 1,
2014, 80% of Eagle Life's fixed index annuities issued prior to January 1, 2017, 50% of Eagle Life's fixed index annuities issued from January
1, 2017 through December 31, 2018 and 80% of certain of American Equity Life's fixed index annuities issued from August 1, 2016 through
December 31, 2016. The reinsurance agreement specifies that the coinsurance percentage for Eagle Life's fixed index annuities decreases to
20% for policies issued on or after January 1, 2019. The business reinsured under this agreement may not be recaptured. American Equity Life
is an intermediary for reinsurance of Eagle Life's business ceded to Athene. American Equity Life and Eagle Life 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 held in trusts and American Equity Life is named as the sole beneficiary of the trusts. The assets in the trusts 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 trust accounts would ever be 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 the trusts for the amount of any shortfall. Athene has received a financial strength
rating of "A" (Excellent) with a stable outlook from A.M. Best Company. None of the coinsurance deposits with Athene are deemed by management
to be uncollectible.
American Equity Life has two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of
American Equity Life's 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. 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.
Financing Arrangements
American Equity Life has a reinsurance agreement with Hannover Life Reassurance Company of America, ("Hannover"), which is treated as
reinsurance under statutory accounting practices and as a financing arrangement under U.S. generally accepted accounting principles ("GAAP").
The statutory surplus benefit under this agreement is 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 agreement became effective July 1, 2013 and is a yearly
renewable term reinsurance agreement for statutory purposes covering 45.6% of waived surrender charges related to penalty free withdrawals,
deaths and lifetime income benefit rider payments as well as lifetime income benefit rider payments in excess of policy fund values on certain
business. We may recapture the risks reinsured under this agreement as of the end of any quarter after December 31, 2020 and the agreement,
as amended, makes it punitive to us if we do not recapture the business ceded by the first quarter of 2021.
For more information regarding reinsurance, see Note 7 to our audited consolidated financial statements. For risks involving reinsurance see
"Item 1A. Risk Factors."
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:
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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.
6
Our life subsidiaries are subject to periodic examinations by state regulatory authorities. In 2015, the Iowa Insurance Division completed financial
examinations of American Equity Life and Eagle Life for the five-year period ending December 31, 2013. There were no adjustments to American
Equity Life's or Eagle Life's statutory financial statements as a result of these examinations. In 2017, the New York Insurance Department
completed its financial examination of American Equity Investment Life Insurance Company of New York for the three-year period ending
December 31, 2013. There were no adjustments to American Equity Investment Life Insurance Company of New York's statutory financial
statements as a result of this examination.
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 2018, up to $377.1 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 $1.7 billion of
statutory earned surplus at December 31, 2017.
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
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 may 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 Financial Stability Oversight Council ("FSOC").
On April 6, 2016, the U.S. Department of Labor (“DOL”) released a final regulation which substantially expands the range of activities that will
be considered to be fiduciary advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986. As
released, the final regulation provided for a phased implementation beginning April 10, 2017, with full implementation by January 1, 2018. On
April 7, 2017, the DOL issued a final rule delaying the applicability date of the regulation and related exemptions. The new definition of fiduciary
and the impartial conduct standards became effective on June 9, 2017. Following the issuance of an additional final rule on November 29, 2017,
compliance with the remaining conditions and related exemptions is not required until July 1, 2019. Insurance agents are permitted to rely on
Prohibited Transaction Exemption 84-24 until July 1, 2019 for all annuity sales. Additionally, the DOL issued a temporary enforcement policy
covering the transition period between June 9, 2017 and July 1, 2019, during which the DOL will not pursue claims against advisers who are
working diligently and in good faith to comply with their fiduciary duties and the conditions of the prohibited transaction exemptions. Additional
changes to the regulation’s requirement are possible prior to full implementation on July 1, 2019.
State insurance regulators and the National Association of Insurance Commissioners ("NAIC") are continually reexamining existing laws and
regulations and developing new legislation for 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:
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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;
suitability/best interest standard;
the implementation of non-statutory guidelines and the circumstances under which dividends may be paid;
principles-based reserving;
own risk solvency and enterprise risk management assessment;
cybersecurity assessments;
product approvals;
agent licensing;
underwriting and suitability practices; and
life insurance and annuity sales practices.
7
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, 2017, indicated that American Equity Life's ratio of total adjusted capital to the highest level at which
regulatory action might be initiated was 378%.
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.
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.
Employees
As of December 31, 2017, we had 515 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 and credit spreads 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 and credit spreads may result in fluctuations in the income derived from our investments. These and other factors
could have an 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 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.
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 or prepayments of commercial mortgage loans 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 or prepaid investments, 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 could result in greater investment income on new investments but would also indicate growing concern about the ability of credit
issuers to service their debt which could result in additional other than temporary impairments. If credit spreads tighten significantly it could
result in reduced net investment income from new purchases of fixed maturity securities or fundings of commercial mortgage loans.
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.
8
Credit and cash flow assumption risk is the risk that issuers of securities, mortgagees on mortgage loans or other parties, including 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 and exposure 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 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 with our counterparties which allow us to require our counterparties to post collateral 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 certain investments such as privately placed securities and 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 securities
and loans at attractive prices or in a timely manner, or both.
Fluctuations in interest rates and investment spread could adversely affect our financial condition, results of operations and cash flows.
A key component of our net income is the investment spread. A narrowing of investment spreads may adversely affect operating results. Although
we have the right to adjust interest crediting rates (cap, participation or asset fee rates for fixed index annuities) on most products, changes to
crediting rates may not be sufficient to maintain targeted investment spreads in all economic and market environments. In general, our ability
to lower crediting rates is subject to minimum crediting rates filed with and approved by state regulators. In addition, competition and other
factors, including the potential for increases in surrenders and withdrawals, may limit our ability to adjust or maintain crediting rates at levels
necessary to avoid the narrowing of spreads under certain market conditions. Our policy structure generally provides for resetting of policy
crediting rates at least annually and imposes withdrawal penalties for withdrawals during the first 5 to 17 years a policy is in force.
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 cost 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
financial instruments with potentially higher returns to fund retirement. In times of low interest rates, such as we have been experiencing since
2010 and which we may continue to experience in 2018, 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 invest
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 and commercial mortgage loans 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 adversely affect our liquidity and financial condition.
Periods of rising interest rates may cause increased policy surrenders and withdrawals as policyholders seek financial instruments 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 business. Alternatively, if we seek to maintain profitability
of our products in rising interest rate environments it may be difficult to position our products to offer attractive rates and benefits to customers
which may limit sales growth of interest sensitive products.
9
Our valuation of fixed maturity securities may include methodologies, estimates and assumptions which are subject to differing
interpretations and could result in changes to investment valuations that may adversely affect our results of operations or financial
condition.
Fixed maturity 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 pricing services or independent
broker quotes 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 changes in the 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 conditions could negatively 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 an adverse
effect on our results of operations or financial condition.
Defaults on commercial mortgage loans and volatility in performance may adversely affect our business, financial condition and results
of operations.
Commercial mortgage loans have the potential to face heightened delinquency and default risk depending on economic conditions which could
have 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 as 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.
Conditions in the U.S. and global capital markets and economies could deteriorate in the near future and affect our financial position
and our level of earnings from our operations.
Despite modest economic improvement in 2017, the U.S. government remains accommodative in policy to support the economic expansion,
however signs have developed that indicate the Federal Reserve may need to raise short-term rates to maintain inflation within their target range.
In addition, the U.S. government remains accommodative in regard to its security purchases program, reinvesting principal payments from its
investment portfolio. While these strategies appear to be successful, any future economic downturn or market disruption could negatively impact
our ability to invest funds. Specifically, if market conditions deteriorate in 2018 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.
Sources of additional capital in normal markets include the issuance by us of short and long-term instruments, including equity, debt or other
types of securities.
We face competition from companies that have greater financial resources, broader arrays of products and higher ratings, 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 fixed index, fixed rate and variable annuities sold by other insurance companies and also with mutual fund products, traditional
bank products 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 distributor
compensation.
10
While we compete with numerous other companies, we view the following as our most significant competitors:
• AIG Companies;
• Allianz Life Insurance Company of North America;
• Athene USA Corp;
• Great American Life Insurance Company;
• Midland National Life Insurance Company;
• Nationwide; and
•
Security Benefit Life.
Our ability to compete depends in part on returns and other benefits we make available to our policyholders through our annuity contracts. We
will not be able to accumulate and retain assets under management for our products if our investment results underperform the market or the
competition, since such underperformance likely would result in lower rates to policyholders which could lead to withdrawals and reduced sales.
Our ability to compete also depends on financial strength ratings we receive from rating agencies. 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.
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 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
three coinsurance agreements with Athene covering $4.2 billion of policy benefit reserves at December 31, 2017 and two coinsurance agreements
with EquiTrust covering $0.6 billion of policy benefit reserves at December 31, 2017. Since Athene is an unauthorized reinsurer, the annuity
deposits ceded to Athene are held in trusts and American Equity Life is named as the sole beneficiary of the trusts. The assets in the trusts 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 assets in the trusts would ever be 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 the trusts 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 financing arrangements. Should any of these reinsurers fail to
meet the obligations assumed under such contracts, we remain liable with respect to the statutory liabilities ceded.
Any disruption in our ability to maintain our reinsurance program may hinder our ability to manage our regulatory capital.
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 or a decrease in our statutory
surplus, reduce the amount of business we write or develop other alternatives to reinsurance.
11
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.
Our results of operations and financial condition depend on the accuracy of management assumptions and estimates.
Assumptions and estimates are made regarding expenses and interest rates, tax liability, contingent liabilities, investment performance and other
factors related to our business and anticipated results. We rely on these assumptions and estimates when determining period end accruals, future
earnings and various components of our consolidated balance sheet. All assumptions and estimates utilized incorporate many factors, none of
which can be predicted with certainty. Our actual experiences, as well as changes in estimates, are used to prepare our consolidated statement
of operations. To the extent our actual experience and changes in estimates differ from original estimates, our results of operations and financial
condition could be adversely affected.
The calculations we use to estimate various components of our consolidated balance sheet and consolidated statement of operations are necessarily
complex and involve analyzing and interpreting large quantities of data. The assumptions and estimates required for these calculations involve
judgment and by their nature are imprecise and subject to changes and revisions over time. Accordingly, our results may be adversely affected
from time to time by actual results differing from assumptions, by changes in estimates and by changes resulting from implementing more
sophisticated administrative systems and procedures that facilitate the calculation of more precise estimates.
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 and our assumptions regarding policyholders' utilization of lifetime income
benefit riders.
The expected 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 an 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 benefit payments 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.
In determining the liability from period to period of our lifetime income benefit riders, we must make significant assumptions such as expected
index credits, the age when a policyholder may begin to utilize the rider and the number of policyholders that may not utilize the rider at all.
Changes in these assumptions can be significant. Our experience regarding policyholder activity is limited as we began issuing policies with
this rider in 2007. Accordingly, our results of operations could be adversely affected from time to time by actual index credits being different
than expected, actual policyholder behavior varying from what we have assumed in determining the liability associated with these riders and by
changes in estimates based on this policyholder behavior.
If our estimated gross profits decrease 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 are costs that vary with and primarily relate to the successful 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 and rider fees. 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.
12
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 and further 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 an adverse effect on our business, financial condition or results of operations. In addition, 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.
Our operations support complex transactions and are highly dependent on the proper functioning of information technology and
communication systems. Any failure of our information technology or communications systems may result in an adverse effect on our
results of operations and corporate reputation.
While systems and processes are designed to support complex transactions and avoid systems failure, fraud, information security failures,
processing errors and breaches of regulation, any failure could have an adverse effect on our business, results of operations and financial condition.
In addition, we must commit significant resources to maintain and enhance our existing systems in order to keep pace with industry standards
and customer preferences. If we fail to keep up-to-date information systems, we may not be able to rely on information for product pricing, risk
management and underwriting decisions. In addition, even though backup and recovery systems and contingency plans are in place, we cannot
assure investors that interruptions, failures or breaches in security of these processes and systems will not occur, or if they do occur, that they
can be remediated promptly. The occurrence of any of these events could have an adverse effect on our business, results of operations and
financial condition.
An information technology failure or security breach may disrupt our business, damage our reputation and adversely affect our results
of operations, financial condition and cash flows.
We use information technology ("IT") to store, retrieve, evaluate and utilize customer and company data and information. Our business is highly
dependent on our ability to access IT systems to perform necessary business functions such as providing customer support, making changes to
existing policies, filing and paying claims, managing our investment portfolios and producing financial statements. While we maintain
comprehensive policies, procedures, automation and backup plans, and a broad range of information security technical and human controls
designed to prevent or limit the effect of a failure, all IT systems are vulnerable to disruptions or data breaches as the result of natural or man-
made disasters, criminal activity, pandemics or other events beyond an organization's control. The failure of our IT for any of these reasons
could disrupt our operations, cause reputational harm resulting in the loss of customers, or otherwise negatively impact our business operations
and financial condition.
We retain confidential information within our IT, and we rely on sophisticated commercial control 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 contained with the accessed systems, including personally identifiable policyholder information and proprietary business information.
The NAIC has adopted the Insurance Data Security Model Law which established the standards for data security and investigation and notification
of a breach of data security for insurance companies, and an increasing number of states require that affected persons be notified if a security
breach results in the disclosure of their personally identifiable information. Any compromise of the security of our computer systems that results
in the 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. While there have been attempts to penetrate our IT security defenses, there is no evidence that any the attacks have been successful
or that an IT breach has occurred.
If we are unable to attract and retain national marketing organizations, independent agents, broker/dealers, banks and registered
investment advisors, sales of our products may be reduced.
We must attract and retain marketing organizations and distributors, including 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. We are developing a network of broker/dealers, banks and registered investment advisors to
distribute our products. If we are unable to attract and retain sufficient marketers, agents, broker/dealers, banks and registered investment advisors
to sell our products, our ability to compete and our sales would suffer.
13
We may require additional capital to support our business and sustain 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 Iowa and New York. 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. 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. 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 Financial Stability Oversight Council ("FSOC"). The FSOC may designate 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 Dodd-Frank Act also established a Federal Insurance
Office under the U.S. Treasury Department to monitor all aspects of the insurance industry other than certain health insurance, certain long-term
care insurance and crop insurance. 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 adversely affect our business, financial condition or results of operations.
On April 6, 2016, the DOL released a final regulation which substantially expands the range of activities that will be considered to be fiduciary
advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986. As released, the final regulation
provided for a phased implementation beginning April 10, 2017, with full implementation by January 1, 2018. On April 7, 2017, the DOL issued
a final rule delaying the applicability date of the regulation and related exemptions. The new definition of fiduciary and the impartial conduct
standards became effective on June 9, 2017. Following the issuance of an additional final rule on November 29, 2017, compliance with the
remaining conditions and related exemptions is not required until July 1, 2019. Insurance agents are permitted to rely on Prohibited Transaction
Exemption 84-24 until July 1, 2019 for all annuity sales. Additionally, the DOL issued a temporary enforcement policy covering the transition
period between June 9, 2017 and July 1, 2019, during which the DOL will not pursue claims against advisers who are working diligently and
in good faith to comply with their fiduciary duties and the conditions of the prohibited transaction exemptions. Additional changes to the
regulation’s requirement are possible prior to full implementation on July 1, 2019.
14
Lawsuits are pending challenging the regulation and efforts continue to delay, repeal or revise the regulation. The success of efforts to overturn,
delay, repeal or revise the regulation cannot be predicted. We believe it could negatively impact our business and have an adverse effect on sales
of annuity products to individual retirement account (“IRA”) holders, particularly fixed index annuity products sold in the independent insurance
agent distribution channel. A significant portion of our annuity sales are to IRAs. The new regulation deems advisors, including independent
insurance agents, who sell fixed index annuities to IRAs, IRA rollovers or 401(k) plans fiduciaries and prohibits them from receiving compensation
unless they comply with a prohibited transaction exemption.
Although the precise impact of the regulation is difficult to assess, compliance with the prohibited transaction exemptions will likely result in
increased regulatory burdens, decreases in sales, changes to our compensation practices and product offerings and increased litigation risk, which
could negatively impact our business, financial condition or results of operations.
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 or the ability of our agents to sell certain products. Any changes in these laws and
regulations could adversely affect our business, financial condition or results of operations.
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 instruments, such as certificates of deposit and taxable bonds, the increase in value is generally
taxed each year as it is realized. Decreases in individual income tax rates would decrease the advantage of deferring the inside build-up.
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.
We face risks relating to litigation and regulatory examination, including the costs of such litigation or examination, management
distraction and the potential for damage awards, fines, penalties or other required remediation, 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.
A downgrade in our credit or financial strength ratings may increase our 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 with a stable outlook from Standard & Poor's, a BB+ rating with a stable
outlook from Fitch Ratings, and a "bbb-" rating with a stable outlook from A.M. Best Company. 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 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 increase the number of policy or contract surrenders we experience,
as well as our ability to obtain reinsurance or obtain reasonable pricing on reinsurance.
Financial strength ratings are measures of an insurance company's ability to meet contractholder and policyholder obligations and generally
involve quantitative and qualitative evaluations by rating agencies of a company's financial condition and operating performance. Generally,
rating agencies base their ratings upon information furnished to them by the insurer and upon their own investigations, studies and assumptions.
Ratings are based upon factors of concern to agents, policyholders and intermediaries and are not directed toward the protection of investors
and are not recommendations to buy, sell or hold securities.
Item 1B. Unresolved Staff Comments
None.
15
Item 2. Properties
We lease commercial office space in two buildings in West Des Moines, Iowa, one for our principal offices under an operating lease that expires
on November 30, 2026 and one for our investment operations under a lease that expires on March 15, 2023. We are fully utilizing these facilities
and believe these locations to be sufficient to house our operations for the foreseeable future.
Item 3. Legal Proceedings
See Note 13 to our audited consolidated financial statements.
Item 4. Mine Safety Disclosures
None
16
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 sales prices of our common stock for each quarterly period within the two most recent fiscal years as quoted on the NYSE.
PART II
2017
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2016
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
Low
$28.00
$26.65
$29.43
$32.54
$23.65
$16.96
$18.32
$23.41
$21.66
$22.23
$25.43
$28.06
$12.65
$12.77
$13.07
$15.39
As of February 14, 2018, there were approximately 25,500 holders of our common stock. In 2017 and 2016, we paid an annual cash dividend
of $0.26 and $0.24, 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 and Eagle 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 to our audited consolidated financial statements, which are incorporated by reference in this Item 5.
Issuer Purchases of Equity Securities
The following table presents the amount of our share purchase activity for the periods indicated:
Period
January 1, 2017 - January 31, 2017
February 1, 2017 - February 28, 2017
March 1, 2017 - March 31, 2017 (a)
April 1, 2017 - April 30, 2017
May 1, 2017 - May 31, 2017
June 1, 2017 - June 30, 2017
July 1, 2017 - July 31, 2017
August 1, 2017 - August 31, 2017
September 1, 2017 - September 30, 2017
October 1, 2017 - October 31, 2017
November 1, 2017 - November 30, 2017
December 1, 2017 - December 31, 2017 (b)
Total
Total Number of
Shares Purchased
Average Price
Paid Per Share
— $
— $
269
$
— $
— $
— $
— $
— $
— $
— $
— $
15,058
$
15,327
—
—
26.69
—
—
—
—
—
—
—
—
31.00
(a) Includes the number of shares of common stock utilized to execute certain stock incentive awards.
(b) The shares purchased in December 2017 were purchased from American Equity Life, which held the shares to fund a deferred compensation
plan no longer in effect.
17
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.
Year ended December 31,
2017
2016
2015
2014
2013
(Dollars in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues
Premiums and other considerations
$
34,228
$
43,767
$
36,048
$
32,623
$
45,347
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
Insurance policy benefits and change in future policy
benefits
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 and loan payable and subordinated
debentures
Other operating costs and expenses
Total benefits and expenses
Income before income taxes
Income tax expense
Net income
Per Share Data:
Earnings per common share
Earnings per common share - assuming dilution
Dividends declared per common share
200,494
1,991,997
1,677,871
173,579
136,168
118,990
1,849,872
1,692,192
1,531,667
164,219
(336,146)
504,825
103,591
1,383,927
1,076,015
10,509
(4,630)
11,524
(22,679)
10,211
(19,536)
(4,003)
(2,627)
40,561
(6,234)
3,891,652
2,220,282
1,518,937
2,168,973
2,610,692
43,219
2,023,668
919,735
52,483
725,472
543,465
45,458
968,053
41,815
53,071
1,473,700
1,272,867
(464,698)
32,321
133,968
432,576
625,178
495,504
294,997
618,581
44,492
111,691
41,206
102,231
41,088
96,218
48,492
81,584
50,958
91,915
3,575,381
2,090,035
1,181,623
1,972,909
2,221,360
316,271
141,626
130,247
47,004
337,314
117,484
196,064
70,041
389,332
136,049
174,645
$
83,243
$
219,830
$
126,023
$
253,283
$
1.96
1.93
0.26
$
0.98
0.97
0.24
$
2.78
2.72
0.22
$
1.69
1.58
0.20
3.86
3.38
0.18
$
$
Non-GAAP Financial Measures (a):
Reconciliation from net income to non-GAAP operating income:
Net income
$
174,645
$
83,243
$
219,830
$
126,023
$
253,283
Net realized investment (gains) losses, including OTTI
(5,093)
7,188
5,737
4,429
(18,170)
Change in fair value of derivatives and embedded derivatives -
fixed index annuities
Change in fair value of derivatives and embedded derivatives - debt
Extinguishment of debt
Litigation reserve
Income taxes
Non-GAAP operating income
Non-GAAP operating income per common share
Non-GAAP 0perating income per common share - assuming dilution
121,846
(1,224)
—
—
(5,124)
285,050
3.20
3.16
$
$
56,634
(1,265)
—
(1,957)
(21,499)
122,344
1.44
1.43
$
$
(44,055)
1,296
—
—
13,012
195,820
2.48
2.42
$
$
79,053
104
12,503
(1,418)
(30,048)
190,646
2.56
2.39
$
$
(153,267)
(2,038)
32,515
30
51,067
163,420
2.49
2.18
$
$
18
Consolidated Balance Sheet Data:
Total investments
Total assets
Policy benefit reserves
Notes and loan payable
Subordinated debentures
Accumulated other comprehensive income ("AOCI")
As of and for the Year Ended December 31,
2017
2016
2015
2014
2013
(Dollars in thousands, except per share data)
$ 50,300,705
$ 44,757,568
$ 39,570,332
$ 35,981,858
$ 30,346,654
62,030,736
56,053,472
49,029,392
43,976,689
39,605,843
56,142,673
51,637,026
45,495,431
39,802,861
35,789,655
494,093
242,565
724,599
493,755
241,853
339,966
393,227
241,452
201,663
413,805
241,072
721,401
539,639
240,713
46,196
Total stockholders' equity
2,850,157
2,291,595
1,944,535
2,139,876
1,384,687
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
Book value per share (b)
Book value per share, excluding AOCI (b)
3,260,328
2,933,193
2,593,472
2,327,335
1,995,658
565,295
386,274
31.91
23.79
144,159
80,699
26.04
22.17
227,865
132,723
23.83
21.36
467,923
344,666
27.93
18.52
305,628
205,112
19.40
18.75
(a) In addition to net income, we have consistently utilized non-GAAP operating income, non-GAAP operating income per common share and
non-GAAP 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. Non-GAAP operating income equals net income adjusted to eliminate
the impact of items that fluctuate from year to year in a manner unrelated to core operations and we believe measures excluding their impact
are useful in analyzing operating trends. The most significant adjustments to arrive at non-GAAP operating income eliminate the impact
of fair value accounting for our fixed index annuity business and are not economic in nature but rather impact the timing of reported results.
In addition, 2017 includes a $35.9 million adjustment to arrive at non-GAAP operating income resulting from the Tax Cuts and Jobs Act
of 2017, which was enacted on December 22, 2017 and required a revaluation of our net deferred tax assets from 35% to 21%. We believe
the combined presentation and evaluation of non-GAAP operating income together with net income provides information that may enhance
an investor's understanding of our underlying results and profitability. The amounts included in the reconciliation of net income to non-
GAAP operating income are presented net of related adjustments to amortization of deferred sales inducements and deferred policy
acquisition costs.
(b) Book value per share and book value per share excluding AOCI, non-GAAP financial measures, are calculated as total stockholders' equity
and total stockholders' equity excluding AOCI divided by the total number of shares of common stock outstanding. Since AOCI fluctuates
from year to year due to unrealized changes in the fair value of available for sale investments, we believe these non-GAAP financial measures
provide useful supplemental information.
19
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, 2017 and 2016, and our consolidated results
of operations for the three years in the period ended December 31, 2017, and where appropriate, factors that may affect future financial
performance. This analysis 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 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
Excellent customer service teamed with our ability to offer innovative insurance products that provide principal protection and lifetime income
continued to result in significant sales of our annuity products. In 2017, our sales were $4.2 billion which has resulted in cash and investments
in excess of $51 billion at December 31, 2017. Our sales for the last five years have ranged from $4.2 billion to $7.1 billion. 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.
The economic and personal investing environments continued 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. However, our sales
slowed in the last half of 2016 and throughout 2017 due to continued competitive pressures within each of our distribution channels and an
industry wide slowdown in fixed index annuity sales. We continue to face headwinds from low interest rates, strong equity markets and the
DOL conflict of interest fiduciary rule.
We are currently in the midst of an unprecedented period of low interest rates and low yields for investments with the credit quality we prefer
which presents a strong headwind to achieving our target rate for investment spread. In response to this persistent low interest rate environment,
we have been reducing policyholder crediting rates for new annuities and existing annuities since the fourth quarter of 2011 and starting in 2017
have begun focusing on investments with less liquidity that provide higher yields and have a track record of positive credit performance over
time. Spread results for 2017, 2016 and 2015 reflect the benefit from these actions; however, the reductions in cost of money have been less
than and were offset by continued lower yields from investment purchases.
On June 16, 2017, we issued $500 million aggregate principal amount of senior unsecured notes due 2027 which bear interest at 5.0% per year
and will mature on June 15, 2027 (the “2027 Notes”). We used the net proceeds from the issuance of the 2027 Notes to prepay our $100
million term loan that was scheduled to mature in 2019 on June 16, 2017, and to redeem our $400 million notes due 2021 (the “2021 Notes”)
on July 17, 2017. We paid $413.3 million to redeem the 2021 Notes which included a redemption premium equal to 3.313% of the $400
million principal amount of the 2021 Notes. We incurred a loss of $18.4 million on the redemption of the 2021 Notes.
Our Business and Profitability
We specialize in the sale of individual annuities (primarily fixed index deferred annuities). Under U.S. generally accepted accounting principles
("GAAP"), premium collections for deferred annuities are reported as deposit liabilities instead of as revenues. Similarly, cash payments to
policyholders are reported as decreases in the liabilities for policyholder account balances and not as expenses. Sources of revenues for products
accounted for as deposit liabilities are net investment income, surrender charges assessed against policy withdrawals and fees deducted from
policyholder account balances for lifetime income benefit riders, 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 and changes in lifetime income benefit rider reserves), 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.
20
Our business model contemplates continued growth in invested assets and non-GAAP operating income while maintaining a high quality
investment portfolio that will not experience significant losses from impairments of invested assets. We are committed to maintaining a high
quality investment portfolio with limited exposure to below investment grade securities and other riskier assets. Growth in invested assets is
predicated on a continuation of our high sales achievements of the last five years while at the same time maintaining a high level of retention
of the funds received. The economic and personal investing environments continued 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. However, our sales have slowed since the first half of 2016 as competition in our distribution channels escalated, rates from several of
our competitors were appreciably above prior levels, and there continues to be uncertainty regarding the DOL conflict of interest fiduciary rule.
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 paid to agents and distribution partners and bonuses
credited to policyholders), and
• our ability to manage our operating expenses and
• Income taxes.
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
2017
4.46%
1.74%
2.72%
0.08%
0.06%
Year Ended December 31,
2016
4.51%
1.90%
2.61%
0.06%
0.01%
2015
4.73%
1.96%
2.77%
0.08%
0.04%
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.
We are currently in the midst of an unprecedented period of low interest rates and low yields for investments with the credit quality we prefer
which presents a strong headwind to achieving our target rate for investment spread. In response to this persistent low interest rate environment,
we have been reducing policyholder crediting rates for new annuities and existing annuities since the fourth quarter of 2011 and starting in 2017
have begun focusing on investments with less liquidity that provide higher yields and have a track record of positive credit performance over
time. Spread results for the 2017 and 2016 periods reflect the benefits from these actions. We continue to have flexibility to reduce our crediting
rates if necessary and could decrease our cost of money by approximately 49 basis points if we reduce current rates to guaranteed minimums.
Investment yields available to us in 2017 increased compared to 2016, however they remain below our portfolio rate. Investment yields at these
levels will continue to put downward pressure on our investment spread and product returns.
21
Results of Operations for the Three Years Ended December 31, 2017
Annuity deposits by product type collected during 2017, 2016 and 2015, were as follows:
Product Type
Fixed index annuities
Annual reset fixed rate annuities
Multi-year fixed rate annuities
Single premium immediate annuities
Total before coinsurance ceded
Coinsurance ceded
Net after coinsurance ceded
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
3,966,839
$
5,724,758
$
6,791,689
74,829
110,596
24,946
4,177,210
387,280
64,317
1,303,273
35,851
7,128,199
1,736,054
$
3,789,930
$
5,392,145
$
45,182
214,356
32,752
7,083,979
471,822
6,612,157
Over these years, we have remained consistently in the top four companies for sales of fixed index annuities according to Wink's Sales and
Market Report published by Wink, Inc. We attribute our leading position to our attractive product offerings, our consistent presence in the fixed
index annuity market, our continued strong relationships with and excellent service provided to our distribution partners, the increased
attractiveness of safe money products in volatile markets and lower interest rates on competing products such as bank certificates of deposit.
Annuity deposits before coinsurance ceded decreased 41% during 2017 compared to 2016 and increased 1% during 2016 compared to 2015.
Annuity deposits after coinsurance ceded decreased 30% during 2017 as compared to 2016 and decreased 18% in 2016 as compared to 2015.
The decrease in sales in 2017 primarily reflects continued competitive pressures within each of our distribution channels. In addition, low interest
rates, strong equity markets and uncertainty surrounding the DOL conflict of interest fiduciary rule continue to be headwinds for sales of
guaranteed income products. The relatively smaller decline in net sales compared to gross sales is due to a decrease in coinsurance ceded
premiums as a result of significantly lower sales of multi-year rate guaranteed ("MYGA") fixed annuity product which are substantially coinsured,
a reduction in the portion of Eagle Life's fixed index annuity sales that are coinsured and lower sales of Eagle Life's fixed index annuity products.
2016 sales levels were supported by sales of MYGA fixed annuity products. These products are often emphasized by banks which are an
expanding source of distribution for Eagle Life. Our rates on these products were more competitive during the first half of 2016 and together
with the larger number of bank distribution relationships, translated into a significant increase in sales of those products. In 2015, we had robust
sales of fixed index annuities by independent agents during the final three quarters of 2015 following the withdrawal in the first quarter of 2015
of a competitor’s guaranteed income product that had been the source of significant competition. This competitor returned to the market in 2016
and in general the market in the independent agent distribution channel was more competitive in 2017 and 2016 than it was in 2015.
We coinsure 80% of the annuity deposits received from MYGA fixed annuity products and 50% of the fixed index annuities sold by Eagle Life
through broker/dealers and banks. Prior to January 1, 2017, we coinsured 80% of the annuity deposits received from MYGA fixed annuity
products and 80% of the fixed index annuities sold by Eagle Life. The changes in coinsurance ceded premiums are attributable to changes in
premiums from these sources.
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 account balances outstanding (net of annuity liabilities ceded under coinsurance agreements) increased
8% to $46.8 billion for the year ended December 31, 2017 compared to $43.5 billion in 2016 and 14% for the year ended December 31, 2016
compared to $38.1 billion in 2015. Our investment spread measured in dollars was $1.2 billion, $1.0 billion, and $924.8 million for the years
ended December 31, 2017, 2016 and 2015, respectively. As previously mentioned, our investment spread has been negatively impacted by the
extended low interest rate environment (see Net investment income).
Net income for the year ended December 31, 2017 was negatively impacted by $35.9 million related to the revaluation of our net deferred tax
assets using the newly enacted federal tax rate as a result of the Tax Cuts and Jobs Act of 2017.
Net income for the year ended December 31, 2017 was also negatively impacted by an $18.4 million pretax loss on the extinguishment of our
2021 Notes, which reduced net income by $10.8 million. See Note 9 to our audited consolidated financial statements.
Net income is also impacted by the change in fair value of derivatives and embedded derivatives which fluctuates from year to year based upon
changes in fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in interest rates used to
discount the embedded derivative liability. Net income for the years ended December 31, 2017 and 2016 was negatively impacted by decreases
in the discount rates used to estimate our embedded derivative liabilities, while net income for the year ended December 31, 2015 was positively
impacted by increases in the discount rates used to estimate our embedded derivative liabilities.
22
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. In addition, we periodically revise the assumptions
used in determining reserves held for lifetime income benefit riders as experience develops that is different from our assumptions.
Net income includes effects from unlocking and revisions to assumptions used in determining reserves for lifetime income benefit riders as
follows:
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
Increase (decrease) in amortization of deferred sales inducements
$
(34,274) $
35,760
$
Increase (decrease) in amortization of deferred policy acquisition costs
Increase in interest sensitive and index product benefits
Increase (decrease) in net income
(48,198)
21,608
39,196
48,164
42,002
(81,224)
(5,612)
(10,970)
18,313
(1,117)
The unlocking adjustments in 2017 decreased amortization of deferred policy acquisition costs by $48.2 million and amortization of deferred
sales inducements by $34.3 million. During the third quarter of 2017, the most significant revisions to such assumptions were account balance
true-ups which were favorable to us due to stronger index credits than we assumed due to strong equity market performance and adjustments to
generally decrease lapse rate assumptions to reflect better persistency experienced than assumed. The favorable impact of the account balance
true-ups and lapse rate assumption changes was partially offset by reductions in estimated future gross profits attributable to revisions to
assumptions used in determining reserves held for lifetime income benefit riders as well as an increase in estimated expenses associated with a
reinsurance agreement with an unaffiliated reinsurer.
The unlocking adjustments in 2016 increased amortization of deferred policy acquisition costs by $48.2 million and amortization of deferred
sales inducements by $35.8 million. During the first quarter of 2016, we made adjustments to lower future spread assumptions as actual investment
spreads being earned showed investment spread and gross profits being less than what we were assuming in our models due to decreases in the
average yield on invested assets resulting from the continued low interest rate environment. We made further adjustments in the third quarter of
2016 to extend the period of time in which we assume investment spread will grade up to our long-term spread targets by an additional two years
as yields obtained on investments purchased in the third quarter of 2016 were much lower than we had anticipated as a result of the overall
decline in investment yields that followed the Brexit vote. In addition, during the third quarter of 2016, revisions to assumptions used in
determining reserves held for living income benefit riders resulted in a decrease in estimated future gross profits.
The unlocking adjustments in 2015 decreased amortization of deferred policy acquisition costs by $11.0 million and amortization of deferred
sales inducements by $5.6 million and included the impact of account balance true-ups as of September 30, 2015, which were favorable to us
due to stronger equity market performance than we assumed, favorable adjustments to lapse assumptions to reflect better persistency experienced
than assumed and unfavorable adjustments to investment spread to reflect lower spreads being earned than assumed. The favorable impact of
the account balance true-up and lapse assumption change was largely offset by reductions in estimated future gross profits attributable to revisions
to assumptions used in determining reserves held for lifetime income benefit riders.
The 2017, 2016 and 2015 revisions to reserves for lifetime income benefit riders were consistent with unlocking for deferred policy acquisition
costs and deferred sales inducements described above. The 2017 revisions were primarily due to the lapse rate assumption changes described
above and changes to our account value growth projections. The 2016 revisions were primarily due to actual index credits on policies being
lower than projected over the past four quarters. The most significant assumption change generating the 2015 negative impact on net income
was an increase to the primary election age to begin receiving lifetime income from 67 to 70 as our experience has shown that age 70 is the most
popular age at which policyholders elect to begin receiving lifetime income benefit payments. The lifetime income benefit payments are
determined by applying a payout factor to the rider's benefit base. The payout factors vary by the age at the time the lifetime income is elected.
In early versions of the rider, the age band for payout factors was 10 years (i.e. 60-69; 70-79). As a result, policyholders have an incentive to
defer their lifetime income election until age 70, when the payout factor stepped up. Subsequent versions of the rider reduced the age bands
between payout factors to five years and the rider we currently sell has a different payout factor for every age. With these structures, assumption
revisions from any further developments in our experience for primary election age should have a smaller impact than what was experienced in
2015.
Non-GAAP operating income, a non-GAAP financial measure (see reconciliation to net income in Item 6. Selected Consolidated Financial
Data) increased 133% to $285.1 million in 2017 and decreased 38% to $122.3 million in 2016 from $195.8 million in 2015.
In addition to net income, we have consistently utilized non-GAAP operating income, a non-GAAP financial measure commonly used in the
life insurance industry, as an economic measure to evaluate our financial performance. Non-GAAP operating income equals net income adjusted
to eliminate the impact of items that fluctuate from year to year in a manner unrelated to core operations, and we believe measures excluding
their impact are useful in analyzing operating trends. The most significant adjustments to arrive at non-GAAP operating income eliminate the
impact of fair value accounting for our fixed index annuity business and are not economic in nature but rather impact the timing of reported
results. In addition, 2017 includes a $35.9 million adjustment to arrive at non-GAAP operating income resulting from the Tax Cuts and Jobs Act
of 2017, which was enacted on December 22, 2017 and required a revaluation of our net deferred tax assets from 35% to 21%. We believe the
combined presentation and evaluation of non-GAAP operating income together with net income provides information that may enhance an
investor's understanding of our underlying results and profitability.
23
Non-GAAP operating income is not a substitute for net income determined in accordance with GAAP. The adjustments made to derive non-
GAAP operating income are important to understanding our overall results from operations and, if evaluated without proper context, non-GAAP
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 non-GAAP 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 reviews 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 examines net income as part of their review of our overall financial results.
Non-GAAP operating income in 2017, 2016 and 2015 includes effects from unlocking and revisions to assumptions used in determining reserves
for living income benefit riders as follows:
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
Increase (decrease) in amortization of deferred sales inducements
$
(31,317) $
36,127
$
Increase (decrease) in amortization of deferred policy acquisition costs
Increase in interest sensitive and index product benefits
Increase (decrease) in non-GAAP operating income
(43,716)
21,608
34,405
47,765
42,002
(81,202)
(478)
(4,260)
18,313
(8,756)
Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for
lifetime income benefit riders) increased 16% to $200.5 million in 2017 and 27% to $173.6 million in 2016 from $136.2 million in 2015. The
components of annuity product charges are set forth in the table that follows:
Surrender charges
Lifetime income benefit riders (LIBR) fees
Withdrawals from annuity policies subject to surrender charges
Average surrender charge collected on withdrawals subject to surrender charges
Fund values on policies subject to LIBR fees
Weighted average per policy LIBR fee
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
54,624
145,870
200,494
456,084
12.0%
$
$
$
51,577
122,002
173,579
429,090
12.0%
$
$
$
46,614
89,554
136,168
373,166
12.5%
20,440,431
$
17,809,659
$
14,296,046
0.71%
0.69%
0.63%
$
$
$
$
The increases in annuity product charges were primarily attributable to increases in fees assessed for lifetime income benefit riders due to a
larger volume of business in force subject to the fee and an increase in the average fees being charged due to higher fees on new products as
compared to prior periods. See Interest sensitive and index product benefits below for corresponding expense recognized on lifetime income
benefit riders. Surrender charges increased in 2017 and 2016 due to an increase in withdrawals from annuity policies subject to surrender charges
as compared to prior years.
Net investment income increased 8% to $2.0 billion in 2017 and 9% to $1.8 billion in 2016 from $1.7 billion in 2015. 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 9% to $44.8 billion in 2017 and 15% to $41.1 billion in 2016 compared to $35.9
billion in 2015. The average yield earned on average invested assets was 4.46%, 4.51% and 4.73% for 2017, 2016 and 2015, respectively.
The decrease in yield earned on average invested assets in 2017, 2016 and 2015 was attributable to investment of new premiums and portfolio
cash flows during those periods at rates below the overall portfolio yield. The average yield on fixed income securities purchased and commercial
mortgage loans funded was 4.16%, 3.66% and 3.87% for the years ended December 31, 2017, 2016 and 2015, respectively. The average balance
for cash and short-term investments was $0.2 billion, $0.9 billion and $0.3 billion in 2017, 2016 and 2015, respectively. The average yield on
our cash and short-term investments was 0.55%, 0.05% and 0.07% in 2017, 2016 in 2015, respectively. The unfavorable impact from these
items was offset by non-trendable investment income items which added eight, six and eight basis points to the average yield on invested assets
in 2017, 2016 and 2015, respectively.
24
Change in fair value of derivatives consists of call options purchased to fund annual index credits on fixed index annuities, the 2015 notes
hedges related to our 2015 notes and an interest rate swap and interest rate caps that hedge our floating rate subordinated debentures. The
components of change in fair value of derivatives are as follows:
Call options:
Gain (loss) on option expiration
Change in unrealized gains/losses
2015 notes hedges
Interest rate swap
Interest rate caps
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
1,062,328
$
(282,574) $
615,955
447,603
—
255
(667)
—
(482)
(328)
(464,027)
136,106
(4,516)
(2,341)
(1,368)
1,677,871
$
164,219
$
(336,146)
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,
2017
2016
2015
1.0 - 13.3%
0.1 - 10.6%
0.0 - 17.0%
0.0 - 5.9%
0.0 - 8.2%
0.0 - 8.3%
0.0 - 5.0%
0.0 - 10.0%
0.0 - 8.9%
0.0 - 9.0%
0.0 - 12.1%
0.0 - 10.0%
The change in fair value of derivatives is also influenced by the aggregate costs of options purchased. The aggregate cost of options has increased
primarily due to an increased amount of fixed index annuities in force. The aggregate cost of options is also influenced by the amount of
policyholder funds allocated to the various indices and market volatility which affects option pricing. See Critical Accounting Policies - Policy
Liabilities for Fixed Index Annuities.
Our 2015 notes matured and were extinguished on September 15, 2015, and the 2015 notes hedges expired on that same date. The fair value of
the 2015 notes hedges changed 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
changed based upon these same factors and the conversion option obligation was accounted for as an embedded derivative liability with changes
in fair value reported in the Change in fair value of embedded derivatives. The amount of the change in fair value of the 2015 notes hedges
was typically equal to the amount of the change in the related embedded derivative liability and there typically was an offsetting expense in the
change in fair value of embedded derivatives. See Note 5 to our audited consolidated financial statements for a discussion of the unwind
agreements, the 2015 notes hedges and the 2015 notes embedded derivative conversion liability.
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. See
Note 3 to our audited consolidated financial statements for a detailed presentation of the types of investments that generated the gains (losses).
Losses on available for sale fixed maturity securities were realized primarily due to strategies to reposition the fixed maturity security portfolio
that resulted in improved net investment income, risk or duration profiles as they pertain to our asset liability management. Securities were sold
at losses in 2017, 2016 and 2015 due to our long-term fundamental concern with the issuers' ability to meet their future financial obligations.
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 $4.6 million in 2017 and increased to $22.7 million in 2016 from $19.5 million in
2015. The impairments recognized in 2017 were primarily on a corporate security with exposure to the industrial sector in Latin America and
additional impairments on previously impaired residential mortgage backed securities. The impairments recognized in 2016 were primarily on
three corporate securities with exposure to the telecommunications, materials and energy sectors and two asset-backed securities with exposure
to the energy sector. The impairments recognized in 2015 were primarily on two corporate securities with exposure to the metals and mining
sector and one asset-backed security with exposure to the energy sector. See Financial Condition - Other Than Temporary Impairments and Note
3 to our audited consolidated financial statements for additional discussion of write downs of securities for other than temporary impairments.
25
Interest sensitive and index product benefits increased 179% to $2.0 billion in 2017 and decreased 25% to $0.7 billion in 2016 from $1.0
billion in 2015. The components of interest sensitive and index product benefits are summarized as follows:
Index credits on index policies
Interest credited (including changes in minimum guaranteed interest for fixed index annuities)
Lifetime income benefit riders
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
1,594,722
$
267,995
$
257,896
171,050
276,032
181,445
2,023,668
$
725,472
$
$
$
587,705
258,870
121,478
968,053
The changes in index credits were attributable to changes in the level of 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 $1.6 billion, $272.3 million and $602.4 million for the years
ended December 31, 2017, 2016 and 2015, respectively. The decrease in interest credited in 2017 was primarily due to a decrease in the average
rate credited to the annuity liabilities outstanding receiving a fixed rate of interest. The increase in interest credited in 2016 was primarily due
to an increase in the total account value 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 8% to $46.8 billion in 2017 and 14% to $43.5
billion in 2016 from $38.1 billion in 2015. The decrease in benefits recognized for lifetime income benefit riders in 2017 was due to the impact
of revisions to assumptions used in determining reserves held for lifetime income benefit riders being less in 2017 than it was in 2016 which
was partially offset by an increase in the number of policies with lifetime income benefit riders which correlates to the increase in fees discussed
in Annuity product charges. The 2016 increase in benefits recognized for lifetime income benefit riders was 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, and the impact of
revisions to assumptions used in determining reserves held for lifetime income benefit riders. See Net income above for discussion of the impact
of changes in the assumptions used in determining reserves for lifetime income benefit riders for the years ended December 31, 2017, 2016 and
2015.
Amortization of deferred sales inducements, in general, 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 87%, 88% and 89% of our
net annuity account values at December 31, 2017, 2016 and 2015, respectively. The increases in amortization from these factors have been
affected by amortization associated with (1) fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity
business, (2) net realized gains (losses) on investments and net OTTI losses recognized in operations and (3) changes in litigation reserves. 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:
Amortization of deferred sales inducements before gross profit adjustments
Gross profit adjustments:
Fair value accounting for derivatives and embedded derivatives
Net realized gains (losses) on investments, net OTTI losses recognized in operations
and changes in litigation reserves
Amortization of deferred sales inducements after gross profit adjustments
$
$
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
240,562
$
274,309
$
209,051
(64,219)
(21,678)
1,976
269
(1,465)
176,612
$
251,166
$
(1,637)
209,390
See Net income and Non-GAAP 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, 2017, 2016 and 2015. See Critical Accounting Policies—Deferred
Policy Acquisition Costs and Deferred Sales Inducements.
26
Change in fair value of embedded derivatives includes changes in the fair value of our fixed index annuity embedded derivatives and changes
in the fair value of the embedded derivative related to the conversion option of our 2015 notes (see Notes 5 and 9 to our audited consolidated
financial statements). The components of change in fair value of embedded derivatives are as follows:
Fixed index annuities—embedded derivatives
Other changes in difference between policy benefit reserves computed using derivative
accounting vs. long-duration contracts accounting
2015 notes embedded conversion derivative
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
174,154
$
145,045
$
(825,668)
745,581
—
398,420
—
365,486
(4,516)
919,735
$
543,465
$
(464,698)
$
$
The change in fair value of the fixed index annuity embedded derivatives 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 those index credits discussed above
in Change in fair value of derivatives; (ii) changes in discount rates used in estimating our embedded derivative liabilities; and (iii) the growth
in the host component of the policy liability. The amounts presented as "Other changes in difference between policy benefit reserves computed
using derivative accounting vs. long-duration contracts accounting" represents the total 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, less the change in fair value of our fixed index annuities embedded derivative. See Critical Accounting Policies—Policy Liabilities
for Fixed Index Annuities. The primary reasons for the increase in the change in fair value of the fixed index annuity embedded derivatives for
2017 were a higher level on index credits during 2017 as compared to 2016 and larger decreases in the discount rates used in estimating the fair
value of the liability during 2017 as compared to 2016. The primary reasons for the increase in the change in fair value of the fixed index annuity
embedded derivatives for 2016 were decreases in the discount rates used in estimating our embedded derivative liabilities and increases in the
expected index credits on the next policy anniversary dates resulting from increases in the fair value of the call options acquired to fund these
index credits during 2016 as compared to 2015. The discount rates used in estimating our embedded derivative liabilities fluctuate from year to
year based on changes in the general level of interest rates and credit spreads.
As discussed above under Change in fair value of derivatives, the fair value of the 2015 notes embedded conversion derivative changes based
upon the same factors effecting the changes in the 2015 notes hedges and, in general, the amount for the change in the fair value of the 2015
notes embedded conversion derivative was equal to the amount for the change in fair value of the 2015 notes hedges.
Interest expense on notes and loan payable increased 8% to $30.4 million in 2017 and decreased 2% to $28.2 million in 2016 from $28.8
million in 2015. Interest expense by debt instrument is as follows:
2027 Notes
2021 Notes
Convertible senior notes due 2015
Term loan due 2019
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
13,801
$
— $
15,024
—
1,543
27,540
—
708
30,368
$
28,248
$
$
$
—
27,465
1,384
—
28,849
The increase in interest expense in 2017 was attributable to interest expense on the $100 million variable rate term loan originated on September
30, 2016 and prepaid on June 16, 2017 and interest expense on the 2027 Notes issued on June 16, 2017 which were partially offset by a decrease
in interest expense as a result of the redemption of the 2021 Notes on July 17, 2017. The decrease in interest expense in 2016 was primarily
attributable to the extinguishment of $22 million principal amount of our convertible senior notes in 2015, which was partially offset in 2016
by interest expense on the $100 million variable rate term loan originated on September 30, 2016. See Note 9 to our audited consolidated
financial statements.
27
Amortization of deferred policy acquisition costs, in general, 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 increases in amortization from these factors have
been affected by amortization associated with (1) fair value accounting for derivatives and embedded derivatives utilized in our fixed index
annuity business, (2) net realized gains (losses) on investments and net OTTI losses recognized in operations and (3) changes in litigation reserves.
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:
Amortization of deferred policy acquisition costs before gross profit adjustments
Gross profit adjustments:
Fair value accounting for derivatives and embedded derivatives
Net realized gains (losses) on investments, net OTTI losses recognized in operations
and changes in litigation reserves
Amortization of deferred policy acquisition costs after gross profit adjustments
$
$
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
340,191
$
387,089
$
293,676
(84,744)
(11,447)
(5,611)
517
(1,630)
255,964
$
374,012
$
(1,951)
286,114
See Net income and non-GAAP 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, 2017, 2016 and 2015. See Critical Accounting Policies—
Deferred Policy Acquisition Costs and Deferred Sales Inducements.
Other operating costs and expenses increased 9% to $111.7 million in 2017 and increased 6% to $102.2 million in 2016 from $96.2 million
in 2015 and are summarized as follows:
Salary and benefits
Risk charges
Other
Total other operating costs and expenses
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
58,043
$
53,479
$
29,104
24,544
28,276
20,476
111,691
$
102,231
$
$
$
48,328
21,950
25,940
96,218
Salary and benefits expense increased in 2017 as compared to 2016 as a result of an increase in salary and benefits of $3.3 million due to an
increased number of employees related to our growth, an increase of $3.7 million related to expense recognized under our short-term incentive
compensation program and other bonus programs as a result of the short-term incentive compensation program being paid out at a higher
percentage of target than in 2016 and an increase of $0.8 million related to a deferred compensation liability that is based on the value of our
common stock. These increases were partially offset by a decrease of $3.2 million in expenses related to a retirement agreement with our former
executive chairman.
Salary and benefits expense increased in 2016 as compared to 2015 as a result of increase in salary and benefits of $6.6 million due to an increased
number of employees related to our growth as well as an expense of $2.6 million related to assumption changes and the execution of an amended
and restated retirement agreement with our Executive Chairman. These 2016 increases were partially offset by a decrease of $3.9 million related
to expense recognized under our short-term incentive compensation program and other bonus programs during 2016 as compared to 2015
primarily as a result of the short-term incentive compensation program being paid out at a lower percentage of target in 2016 than in 2015.
The increases in reinsurance risk charges expense during 2017 and 2016 were due to the growth in our policyholder liabilities subject to a
reinsurance agreement pursuant to which we cede excess regulatory reserves to an unaffiliated reinsurer. The increase in risk charge expense
in 2017 due to growth in the policyholder liabilities subject to the reinsurance was partially offset by a lower risk charge percentage which was
included in an October 1, 2016 amendment to the reinsurance agreement. The regulatory reserves ceded at December 31, 2017, 2016 and 2015
were $737.3 million, $638.1 million and $480.7 million, respectively.
Other expenses increased in 2017 as compared to 2016 due primarily to 2016 benefiting from the release of a litigation liability of $2.8 million
and the release of a guaranty fund assessment liability of $2.3 million. Other expenses adjusted for these nonrecurring items from 2016 decreased
in 2017 as compared to 2016 due to decreases in general expenses that vary from period to period based on the level of annuity deposits collected.
Other expenses decreased in 2016 as compared to 2015 as 2016 benefited from the release of a litigation liability of $2.8 million and the release
of a guaranty fund assessment liability of $2.3 million.
Income tax expense increased in 2017 due to changes in income before income taxes and the impact of the Tax Cuts and Jobs Act of 2017 ("Tax
Reform") and decreased in 2016 primarily due to changes in income before income taxes. The effective income tax rates were 44.8%, 36.1%
and 34.8% for 2017, 2016 and 2015, respectively.
28
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 (the "non-life insurance group") is generally taxed at an effective tax rate of 41.5% reflecting the
combined federal / state income tax rates. The effective tax rates resulting from the combination of the income tax provisions for the life / non-
life sources of income (loss) vary from year to year based primarily on the relative size of pretax income (loss) from the two sources.
Tax expense for the year ended December 31, 2017 was increased by $35.9 million related to the revaluation of our net deferred tax assets using
the newly enacted federal tax rate as a result of Tax Reform. The effective tax rate for 2017 adjusted to exclude the impact of Tax Reform was
32.3%
The effective tax rate adjusted to exclude the impact of Tax Reform decreased in 2017 as compared to 2016 as the portion of taxable income
from the non-life insurance group decreased significantly and the level of permanent tax adjustments, including tax exempt investment income,
compared to pretax income increased as compared to 2016. In addition, the effective income tax rate for 2017 was impacted by a change in
accounting for income taxes related to share-based compensation that reduced income tax expense by approximately $2.8 million during 2017.
The effective income tax rate increased in 2016 because the portion of total taxable income from non-life insurance subsidiaries increased
significantly, as well as tax exempt investment income decreasing significantly from the prior year.
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, residential and commercial mortgage
backed securities, other asset backed 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,
2017
2016
Carrying
Amount
Percent
Carrying
Amount
Percent
(Dollars in thousands)
11,876
1,305,017
4,166,812
239,360
29,956,012
1,105,567
5,544,850
3,120,536
45,450,030
2,665,531
1,568,380
616,764
—% $
2.6%
8.3%
0.5%
59.6%
2.2%
11.0%
6.2%
90.4%
5.3%
3.1%
1.2%
11,805
1,344,787
3,926,950
236,341
27,191,243
1,254,835
5,365,235
1,806,123
41,137,319
2,480,956
830,519
308,774
—%
3.0%
8.8%
0.5%
60.8%
2.8%
12.0%
4.0%
91.9%
5.5%
1.9%
0.7%
$
50,300,705
100.0% $
44,757,568
100.0%
Fixed maturity securities:
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
Total fixed maturity securities
Mortgage loans on real estate
Derivative instruments
Other investments
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. The largest portion of our fixed maturity securities are in investment grade (NAIC designation
1 or 2) publicly traded or privately placed corporate securities.
29
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
Ca and lower
Total below investment grade
December 31,
2017
2016
Carrying
Amount
Percent of Fixed
Maturity Securities
Carrying
Amount
Percent of Fixed
Maturity Securities
(Dollars in thousands)
$
$
27,909,879
16,048,610
43,958,489
1,035,676
130,857
134,586
190,422
1,491,541
45,450,030
61.4% $
35.3%
96.7%
2.3%
0.3%
0.3%
0.4%
3.3%
100.0% $
26,431,700
13,002,964
39,434,664
1,048,379
155,619
79,763
418,894
1,702,655
41,137,319
64.3%
31.6%
95.9%
2.5%
0.4%
0.2%
1.0%
4.1%
100.0%
The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day credit quality assessment and the valuation of fixed maturity
securities owned by state regulated insurance companies. The purpose of such assessment and valuation is for determining regulatory capital
requirements and regulatory reporting. Insurance companies report ownership 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
Ca and lower
For most of the bonds held in our portfolio the NAIC designation matches the NRSRO equivalent rating. However, for certain loan-backed and
structured securities, as defined by the NAIC, the NAIC rating is not always equivalent to the NRSRO rating presented in the previous table.
The NAIC has adopted revised rating methodologies for certain loan-backed and structured securities comprised of non-agency residential
mortgage backed securities ("RMBS") and commercial mortgage backed securities ("CMBS"). The NAIC’s objective with the revised rating
methodologies for these structured securities is to increase the accuracy in assessing expected losses and use the improved assessment to determine
a more appropriate capital requirement for such structured securities. The revised methodologies reduce regulatory reliance on rating agencies
and allow for greater regulatory input into the assumptions used to estimate expected losses from structured securities.
The use of this process by the SVO may result in certain non-agency RMBS and CMBS being assigned an NAIC designation that is higher than
the equivalent NRSRO rating. The NAIC designations for non-agency RMBS and CMBS are based on security level expected losses as modeled
by an independent third party (engaged by the NAIC) and the statutory carrying value of the security, including any purchase discounts or
impairment charges previously recognized. Evaluation of non-agency RMBS and CMBS held by insurers using the NAIC rating methodologies
is performed on an annual basis.
As stated previously, our fixed maturity security portfolio is managed to minimize risks such as defaults or impairments while earning a sufficient
and stable return on our investments. Our strategy has been to invest primarily in investment grade fixed maturity securities. Investment grade
is NAIC 1 and 2 securities and Baa3/BBB- and better securities on the NRSRO scale. This strategy meets the objective of minimizing risk while
also managing asset capital charges on a regulatory capital basis.
30
A summary of our fixed maturity securities by NAIC designation is as follows:
December 31, 2017
December 31, 2016
NAIC
Designation
Amortized
Cost
Fair Value
Carrying
Amount
Percentage
of Total
Carrying
Amount
Amortized
Cost
Fair Value
Carrying
Amount
1
2
3
4
5
6
(Dollars in thousands)
(Dollars in thousands)
$ 26,669,427
$ 28,274,379
$ 28,274,379
62.2% $ 25,607,268
$ 26,507,798
$ 26,507,798
15,198,551
15,869,219
15,869,219
34.9%
13,037,592
13,295,648
13,295,648
1,161,737
1,157,420
1,158,001
134,838
17,015
12,232
117,542
20,927
9,962
117,542
20,927
9,962
2.5%
0.3%
0.1%
—%
1,201,059
1,155,702
1,163,761
154,226
17,475
13,160
137,188
24,664
8,260
137,188
24,664
8,260
Percentage
of Total
Carrying
Amount
64.5%
32.3%
2.8%
0.3%
0.1%
—%
$ 43,193,800
$ 45,449,449
$ 45,450,030
100.0% $ 40,030,780
$ 41,129,260
$ 41,137,319
100.0%
The amortized cost and fair value of fixed maturity securities at December 31, 2017, 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.
31
Unrealized Losses
The amortized cost and fair value of fixed maturity 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, 2017
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:
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
December 31, 2016
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:
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
4
18
48
2
92
55
63
31
165
20
310
146
954
$
8,443
$
(147) $
8,296
1,035,489
176,831
64,313
1,090,077
468,505
657,599
344,196
1,693,343
75,159
2,473,034
996,531
(31,730)
(3,596)
(2,025)
(33,178)
(14,324)
(13,000)
(12,620)
(72,565)
(2,471)
(69,840)
(13,405)
1,003,759
173,235
62,288
1,056,899
454,181
644,599
331,576
1,620,778
72,688
2,403,194
983,126
$
9,083,520
$
(268,901) $
8,814,619
1
$
77,041
$
(581) $
76,460
3
18
113
4
175
155
137
63
301
25
407
112
$
7,693
$
(288) $
1,042,461
485,802
54,626
2,101,158
1,568,588
1,511,082
687,650
3,417,783
87,169
3,266,304
918,403
(46,913)
(22,393)
(5,080)
(78,144)
(57,577)
(50,835)
(20,810)
(161,407)
(3,554)
(117,014)
(20,703)
7,405
995,548
463,409
49,546
2,023,014
1,511,011
1,460,247
666,840
3,256,376
83,615
3,149,290
897,700
1,513
$
15,148,719
$
(584,718) $
14,564,001
1
$
76,825
$
(8,059) $
68,766
The decrease in unrealized losses from December 31, 2016 to 2017 was primarily due to a decrease in interest rates in addition to price
improvements due to tighter credit spreads during the year ended December 31, 2017. The 10-year U.S. Treasury yield rates at December 31,
2017 and 2016 were 2.40% and 2.45%, respectively. The 30-year U.S. Treasury yields at December 31, 2017 and 2016 were 2.74% and 3.06%,
respectively.
32
The following table sets forth the composition by credit quality (NAIC designation) of fixed maturity securities with gross unrealized losses:
NAIC Designation
December 31, 2017
1
2
3
4
5
6
December 31, 2016
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)
$
$
$
5,433,608
2,809,981
540,320
94,004
11,130
2,617
61.1% $
31.6%
6.1%
1.1%
0.1%
—%
(158,991)
(64,369)
(23,166)
(17,972)
(1,460)
(3,524)
8,891,660
100.0% $
(269,482)
8,754,856
5,091,437
657,549
119,986
8,744
8,254
59.8% $
34.8%
4.5%
0.8%
0.1%
—%
(330,920)
(176,557)
(60,689)
(17,786)
(1,920)
(4,905)
$
14,640,826
100.0% $
(592,777)
59.0%
23.9%
8.6%
6.7%
0.5%
1.3%
100.0%
55.8%
29.8%
10.3%
3.0%
0.3%
0.8%
100.0%
Our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting
of 955 and 1,514 securities, respectively) have been in a continuous unrealized loss position at December 31, 2017 and 2016, 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.
33
The amortized cost and fair value of fixed maturity 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, 2017
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
December 31, 2016
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
409
$
3,550,774
$
3,520,164
$
27
430
866
32
12
45
89
257,924
4,668,838
8,477,536
201,885
36,595
444,545
683,025
249,690
4,486,239
8,256,093
194,821
34,619
405,546
634,986
(30,610)
(8,234)
(182,599)
(221,443)
(7,064)
(1,976)
(38,999)
(48,039)
955
$
9,160,561
$
8,891,079
$
(269,482)
1,265
$
12,767,396
$
12,374,177
$
(393,219)
69
90
669,022
970,424
621,784
901,674
1,424
14,406,842
13,897,635
15
10
65
90
132,087
80,535
606,080
818,702
126,236
72,830
536,066
735,132
(47,238)
(68,750)
(509,207)
(5,851)
(7,705)
(70,014)
(83,570)
1,514
$
15,225,544
$
14,632,767
$
(592,777)
34
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 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
Gross
Unrealized
Losses
(Dollars in thousands)
December 31, 2017
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, 2016
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
$
8,597
$
6,931
$
(1,666)
3
—
—
3
1
1
4
6
9
—
—
8,597
11,021
3,523
55,647
70,191
—
—
6,931
8,275
2,674
37,591
48,540
$
78,788
$
55,471
$
—
—
(1,666)
(2,746)
(849)
(18,056)
(21,651)
(23,317)
—
—
—
—
(3,969)
—
(27,395)
(31,364)
(31,364)
— $
— $
— $
—
—
—
1
—
10
11
11
—
—
—
19,930
—
85,831
105,761
—
—
—
15,961
—
58,436
74,397
$
105,761
$
74,397
$
35
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, 2017
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
Commercial mortgage backed securities
Other asset backed securities
December 31, 2016
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
Commercial mortgage backed securities
Other asset backed securities
International Exposure
Available for sale
Held for investment
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
(Dollars in thousands)
$
— $
— $
— $
463,667
1,996,166
1,937,009
1,141,954
5,538,796
75,159
2,473,034
996,531
454,062
1,945,474
1,881,162
1,074,913
5,355,611
72,688
2,403,194
983,126
—
—
—
77,041
77,041
—
—
—
—
—
—
—
76,460
76,460
—
—
—
$
$
9,083,520
$
8,814,619
$
77,041
$
76,460
— $
— $
— $
177,550
4,943,504
2,736,298
3,019,491
172,375
4,806,216
2,621,945
2,832,860
10,876,843
10,433,396
87,169
3,266,304
918,403
83,615
3,149,290
897,700
—
—
—
76,825
76,825
—
—
—
—
—
—
—
68,766
68,766
—
—
—
$
15,148,719
$
14,564,001
$
76,825
$
68,766
We hold fixed maturity securities with international exposure. As of December 31, 2017, 20% of the carrying value 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.
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, 2017
Amortized
Cost
Carrying Amount/
Fair Value
(Dollars in thousands)
Percent
of Total
Carrying
Amount
$
265,641
$
433,851
3,146,233
294,041
1,348,686
767,307
2,526,985
$
8,782,744
$
291,464
455,671
3,298,662
310,952
1,428,786
780,403
2,560,051
9,125,989
0.6%
1.0%
7.3%
0.7%
3.2%
1.7%
5.6%
20.1%
(1) Greece, Ireland, Italy, Portugal and Spain ("GIIPS"). 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.
36
All of the securities presented in the table above are denominated in U.S. dollars and all are investment grade (NAIC designation of either 1 or
2), except for the following:
GIIPS
Asia/Pacific
Non-GIIPS Europe
Latin America
Non-U.S. North America
Watch List
December 31, 2017
Amortized Cost
Carrying Amount/
Fair Value
$
$
(Dollars in thousands)
19,512
$
11,000
157,501
61,594
89,770
339,377
$
22,072
9,663
157,259
58,855
93,825
341,674
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 residential and commercial mortgage backed securities as we
monitor all of our residential and commercial mortgage backed securities 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, 2017, the amortized cost and fair value of securities on the watch list (all fixed maturity securities) are as follows:
General Description
Below investment grade
Corporate securities:
Energy
Industrials
Materials
Telecommunications
Other asset backed securities:
Financials
Number of
Securities
Amortized
Cost
Unrealized
Losses
Fair Value
(Dollars in thousands)
Months in
Continuous
Unrealized
Loss Position
Months
Unrealized
Losses
Greater
Than 20%
4
1
1
1
2
9
$
29,055
$
(4,966) $
24,089
7 - 56
0 - 36
2,500
3,990
2,100
(150)
770
480
6,141
(3,524)
$
43,786
$
(7,390) $
2,350
4,760
2,580
2,617
36,396
38
—
—
—
—
—
55 - 81
0 - 36
We have determined that the unrealized losses of the securities on the watch list are 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 recovery of their amortized cost. Our analysis of these securities and their
credit performance at December 31, 2017 is as follows:
Corporate securities:
Energy, Industrials and Materials: The decline in the value of these securities relates to continued operational pressure due to a decline in certain
commodity prices specific to their businesses. The decline in these commodity prices creates financial challenges as the companies realign to
accommodate the lower prices. These issuers will be stressed greater than the average company due to their price sensitivity and the specific
position they hold in the supply chain. While values have declined, improving commodity prices have provided better financial performance
for these companies. We recognized an other than temporary impairment on one security during the fourth quarter of 2017 and one security
during the third quarter of 2016 due to our evaluation of the operating performance and the credit worthiness of the issuers. While the remaining
issuers have seen their financial and profitability profile weakened, we have determined that the remaining securities were not other than
temporarily impaired due to our evaluation of the operating performance and the credit worthiness of the issuer.
37
Telecommunications: The decline in the value of this security is the result of regional economic recessionary pressure in Brazil and an increase
in competition in the markets it operates. This issuer has seen weakened performance and heightened risk. We recognized an other than temporary
impairment on this security during the first quarter of 2016 due to our evaluation of the operating performance and the credit worthiness of the
issuer.
Other asset backed securities:
Financials: The decline in value of one of the asset backed securities is due to poor performance in the underlying pool of student loans. The
investment is backed by a guarantee from the for-profit education services provider. We have determined that this security was not other than
temporarily impaired, because the guarantee is in good standing and all required payments have been made, including hyper-amortization
payments triggered by the performance of the student loan portfolio. The decline in value of the other asset backed security is related directly
to the decline in oil prices and the financial stability of its operator. The issuer has direct exposure to the oil market as its primary business is
deep water drilling. As oil prices have declined the operator of the deep water vessel has experienced financial pressure on its balance sheet.
We recognized other than temporary impairments on this security during the second quarter of 2017, the second quarter of 2016 and the third
quarter of 2015.
Other Than Temporary Impairments
We have a policy and process to identify securities in our investment portfolio for which we should recognize impairments. See Critical
Accounting Policies—Evaluation of Other Than Temporary Impairments. During the years ended December 31, 2017, 2016 and 2015, we
recognized other than temporary impairment on corporate securities, residential mortgage backed securities, commercial mortgage backed
securities and other asset backed securities, all of which are available for sale fixed maturity securities. In addition, in all periods presented we
recognized credit losses on residential mortgage backed securities, and on one other asset backed security in 2016, that resulted in a reclassification
of OTTI loss from accumulated other comprehensive income to net income.
In 2017, we recognized a $2.5 million OTTI loss in operations due to our concern regarding a corporate security issued by a Latin America
engineering and construction company as developments in 2017 led us to the conclusion that we will not be able to recover our amortized cost
basis. We recognized an OTTI of $0.3 million on a residential mortgage backed security that had not been previously impaired and we recognized
additional credit losses on previously impaired residential mortgage backed securities during 2017 as several factors led us to believe the full
recovery of amortized cost is not expected on the residential mortgage backed securities. Also in 2017, we recognized an additional impairment
of $0.3 million on an asset backed security as sales of similar assets during 2017 led us to conclude that the asset backing our security was worth
less than our previous estimates.
In 2016, we recognized a $3.9 million OTTI loss in operations due to our concern regarding a corporate security issued by a Brazilian
telecommunications company as developments in 2016 led us to the conclusion that we will not be able to fully recover our amortized cost basis
due to liquidity concerns. A $3.0 million OTTI loss was recognized in operations due to our concern regarding a corporate security issued by
a Brazilian metals and mining company as developments during 2016 led us to the conclusion that we will not be able to fully recover our
amortized cost basis. We recognized a $9.2 million OTTI loss in operations on a corporate security and an other asset backed security as a result
of the parent of both entities announcement that it is committed to exiting the power generation business and could potentially enter the facilities
into bankruptcy. In 2016, we recognized an additional impairment of $3.5 million on an other asset backed security due to the asset supporting
the cash flows being taken out of production which was first impaired during 2015. The OTTI that we recognized in 2016 on commercial
mortgage backed securities were due to our intent to sell the securities, which were in an unrealized loss position at the reporting date of the
period in which the decision to sell these securities was made.
In 2015, we recognized a $4.9 million OTTI loss in operations on an other asset backed security due to the asset supporting the cash flows being
taken out of production. A total of $12.4 million was recognized as OTTI loss in operations on corporate securities issued by a company in iron
ore production that had long standing contract issues that gave us concern as to their future cash flow and liquidity.
Several factors led us to believe that full recovery of amortized cost is not expected on the securities for which we recognized credit losses and
reclassified OTTI from accumulated other comprehensive income to net income. A discussion of these factors, our policy and process to identify
securities that could potentially have impairment that is other than temporary and 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.
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, net of loan loss allowances and deferred
prepayment fees. At December 31, 2017 and 2016, the largest principal amount outstanding for any single mortgage loan was $21.2 million
and $20.9 million, respectively, and the average loan size was $3.5 million and $3.2 million, respectively. In addition, the average loan to value
ratio for the overall portfolio was 53.6% and 53.7%, at December 31, 2017 and 2016, 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 either calculate a value of the collateral using a capitalization method or obtain a third party 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.
38
In the normal course of business, we commit to fund commercial mortgage loans up to 90 days in advance. At December 31, 2017, we had
commitments to fund commercial mortgage loans totaling $62.0 million, with fixed interest rates ranging from 4.00% to 6.09%. During 2017
and 2016, due to historically low interest rates, the commercial mortgage loan industry has been very competitive. This competition has resulted
in a number of borrowers refinancing with other lenders. For the year ended December 31, 2017, we received $230.4 million in cash for loans
being paid in full compared to $301.7 million for the year ended December 31, 2016. Some of the loans being paid off have either reached their
maturity or are nearing maturity; however, some borrowers are paying the prepayment fee and refinancing at a lower rate.
See Note 4 to our audited consolidated financial statements for a presentation of our specific and general loan loss allowances, impaired loans,
foreclosure activity and troubled debt restructure analysis.
We have 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 (based on most recent information collected)
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, 2017
December 31, 2016
Principal
Outstanding
(Dollars in
thousands)
$
$
1,826,596
638,299
148,881
60,539
2,674,315
Percent of Total
Principal
Outstanding
Principal
Outstanding
(Dollars in
thousands)
Percent of Total
Principal
Outstanding
68.3% $
1,781,928
23.9%
5.6%
2.2%
517,697
122,115
68,879
100.0% $
2,490,619
71.5%
20.8%
4.9%
2.8%
100.0%
Approximately 94% of our mortgage loans (based on principal outstanding) that have a debt service coverage ratio of less than 1.0 are performing
under the original contractual loan terms at December 31, 2017.
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).
Impaired mortgage loans with an allowance
Impaired mortgage loans with no related allowance
Allowance for probable loan losses
Net carrying value of impaired mortgage loans
December 31,
2017
2016
(Dollars in thousands)
$
$
5,445
$
1,436
(1,418)
5,463
$
4,640
1,591
(1,327)
4,904
At December 31, 2017, we had no commercial mortgage loans that were delinquent (60 days or more past due at the reporting date) in their
principal and interest payments.
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.
None of our derivatives qualify for hedge accounting, thus, any change in the fair value of the derivatives that are not classified as equity is
recognized immediately in the consolidated statements of operations. 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.
39
Liabilities
Our liability for policy benefit reserves increased to $56.1 billion at December 31, 2017 compared to $51.6 billion at December 31, 2016,
primarily due to additional annuity sales as discussed above and interest and index credits credited to policyholders during 2017. 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. Our lifetime income benefit rider also reduces the risk of early withdrawal or
surrender of the policies as it provides an additional liquidity option to policyholders as the policyholder can elect to receive guaranteed payments
for life from their contract without requiring them to annuitize their contract value and the rider is not transferable to other contracts.
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 and loan payable and borrowings under repurchase agreements.
See Note 10 to our audited consolidated financial statements for additional information concerning our subordinated debentures payable to, and
the preferred securities issued by, our 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 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 and bonus vesting, which help limit and discourage early withdrawals. Our lifetime income benefit rider also limits the risk
of early withdrawals as it provides an additional liquidity option to policyholders as the policyholder can elect to receive guaranteed payments
for life from their contract without requiring them to annuitize their contract value and the rider is not transferable to other contracts. At
December 31, 2017, approximately 94% of our annuity liabilities were subject to penalty upon surrender, with a weighted average remaining
surrender charge period of 8.1 years and a weighted average surrender charge percentage of 13.0%.
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
$1.3 billion for the year ended December 31, 2017 compared to $3.2 billion for the year ended December 31, 2016 with the decrease attributable
to a $1.6 billion decrease in net annuity deposits after coinsurance and a $311.6 million (after coinsurance) increase 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.
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 (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. Payments under our investment advisory
agreements and tax allocation agreement with our subsidiaries provide adequate cash flow for 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 2018.
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 2018, up to $377.1 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 $1.7
billion of statutory earned surplus at December 31, 2017.
40
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 and Standard and Poor's. 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, 2017, 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 rating agency modifies its rating criteria and 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 June 30, 2016, 2) 50% of the statutory net income for each fiscal quarter ending after June 30, 2016, and 3) 50% of all capital contributed
to American Equity Life after June 30, 2016. American Equity Life's risk-based capital ratio was 378% at December 31, 2017. Under this
agreement, we are also required to maintain a maximum ratio of adjusted debt to total adjusted capital of 0.35.
Cash and cash equivalents of the parent holding company at December 31, 2017, were $21.0 million. In addition, as discussed in Note 9 to our
audited consolidated financial statements we have a $150 million revolving line of credit agreement, with no borrowings outstanding at December
31, 2017. This revolving line of credit terminates on September 30, 2021, and borrowings are available for general corporate purposes of the
parent company and its subsidiaries. We also 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.
As discussed above under Executive Summary, we issued the 2027 Notes on June 16, 2017. We used the net proceeds from the issuance of
the 2027 Notes to prepay our $100 million term loan that was scheduled to mature in 2019 on June 16, 2017, and to redeem the 2021 Notes on
July 17, 2017. We paid $413.3 million to redeem the 2021 Notes which included an early redemption premium equal to 3.313% of the $400
million principal amount of the 2021 Notes.
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, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015 is included in Note 12
to our audited consolidated financial statements.
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, 2017.
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)
$
59,219,810
$
3,683,218
$
12,071,486
$
8,221,285
$
35,243,821
Notes and loan payable, including interest payments (2)
Subordinated debentures, including interest payments (3)
Operating leases
Mortgage loan funding and other investments
739,197
558,297
15,374
121,038
25,463
13,721
1,998
73,177
50,925
27,443
4,014
47,861
50,309
27,443
3,517
—
612,500
489,690
5,845
—
Total
$
60,653,716
$
3,797,577
$
12,201,729
$
8,302,554
$
36,351,856
(1) Amounts shown in this table are projected payments through the year 2037 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. It is not possible to calculate the effect such changes in interest rates, if any, have had on our operating results.
41
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 six 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 and equity securities 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
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, 2017 and 2016, respectively:
December 31, 2017
Priced via third party pricing services
Priced via independent broker quotations
Priced via other methods
% of Total
December 31, 2016
Priced via third party pricing services
Priced via independent broker quotations
Priced via other methods
% of Total
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
(Dollars in thousands)
Total
290,645
$
45,150,229
$
— $
45,440,874
—
—
34,750
189,794
—
—
34,750
189,794
290,645
$
45,374,773
$
— $
45,665,418
0.6%
99.4%
—%
100.0%
5,387
$
41,016,054
$
— $
41,021,441
—
—
36,436
10,617
—
—
36,436
10,617
5,387
$
41,063,107
$
— $
41,068,494
—%
100.0%
—%
100.0%
$
$
$
$
Management's assessment of all available data when determining fair value of our investments is necessary to appropriately apply fair value
accounting.
42
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.
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 multiple broker quotes and take the average of the 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 using 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, 2017 and 2016.
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 materially lower than its amortized
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 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 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 fair 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.
43
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 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 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 an 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 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 in net income
and amortized cost is written down to fair value. 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 allowance 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 on a quantitative
and qualitative basis. 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.
We rate each of the mortgage loans in our portfolio based on factors such as historical operating performance, loan to value ratio and economic
outlook, among others. We calculate a loss factor to apply to each rating based on historical losses we have recognized in our mortgage loan
portfolio. We apply the loss factors to the total principal outstanding within each rating category to determine an appropriate estimate of the
general loan loss allowance. We also assess the portfolio quantitatively and apply a loss rate to all loans without a specific allowance based on
management's assessment of economic conditions, and we apply an additional amount of loss allowance to a group of loans that we have identified
as having higher risk of loss.
44
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, 2017 were to increase by 100 basis points, our reserves for fixed index annuities would decrease by $579.5 million
recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of
$339.4 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 $645.8 million 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 $374.8 million recorded through operations as a decrease in amortization of deferred policy acquisition
costs and deferred sales inducements.
Liability for Lifetime Income Benefit Riders
Beginning in July 2007, substantially all of our fixed index annuity policies and many of our annual reset fixed rate deferred annuities were
issued with a lifetime income benefit rider.
The liability for lifetime income benefit riders is based on estimates of the value of benefit payments expected to be paid in excess of projected
policy values recognizing the excess over the expected lives of the underlying policies based on actual and expected assessments including
spreads and product charges and fees. The inputs used in the calculation of the liability for lifetime income benefit riders include actual policy
values, actual income account values, actual payout factors, actual roll-up rates and our best estimate assumptions for future policy growth,
future policy decrements, the ages at which policyholders are expected to elect to begin to receive lifetime income benefit payments, the percentage
of policyholders who elect to receive lifetime income benefit payments and the type of income benefit payments selected upon election. The
assumptions are reviewed quarterly and revisions to the assumptions are made based on historical results and our best estimates of future
experience. The liability for lifetime income benefit riders is included in policy benefit reserves in the consolidated balance sheets and the change
in the liability is included in interest sensitive and index product benefits in the consolidated statements of operations. See Results of Operations
for the Three Years Ended December 31, 2017 in this Item 7. for a discussion and presentation of the actual effects of assumption revisions.
A key assumption in the calculation of the liability for lifetime income benefit riders is the percentage of policyholders who elect to receive
lifetime income benefit payments. If the percentage of policyholders who elect to receive lifetime income benefit payments under our fee based
rider was increased by an additional 10% at December 31, 2017, our liability for lifetime income benefit riders would increase by $94 million
recorded through operations as an increase in interest sensitive and index product benefits. A decrease by an additional 10% in the percentage
of policyholders who elect to receive lifetime income benefit payments under our fee based rider would decrease our liability for lifetime income
benefit riders by $92 million recorded through operations as a decrease in interest sensitive and index product benefits.
45
Deferred Policy Acquisition Costs and Deferred Sales Inducements
Costs relating 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. 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.
For annuity products, these 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 net of expected excess payments for lifetime
income benefit riders, and mortality and expense margins. 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. See Results of Operations for the Three Years Ended December 31, 2017 in this Item 7. for a discussion and
presentation of the actual effects of unlocking.
Estimated future gross profits vary based on a number of sources including investment spread margins, lifetime income benefit rider fees and
benefits, 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,
2017 were to increase by 10%, our combined balance for deferred policy acquisition costs and deferred sales inducements at December 31, 2017
would increase by $194.1 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 $215.1 million decrease in
the combined December 31, 2017 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 audited 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 capital 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-9, which is incorporated by reference in this
Item 7, for new accounting pronouncement disclosures.
46
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.
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, 2017, of which $85.5 million has been swapped to a fixed rate for seven years
which began in March 2014 and $79.0 million has been capped for seven years which began in July 2014 (See Note 5 to our 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 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% (27 basis points) from levels at December 31, 2017, we estimate that the fair value of our fixed maturity
securities would decrease by approximately $1.0 billion. 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 $306.8
million in accumulated other comprehensive income and a decrease in stockholders' equity. The 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, 2017, 37% of our fixed income securities have call features, of which 2.7% ($1.2 billion) were subject to call redemption.
Another 0.2% ($90.1 million) will become subject to call redemption during 2018. Approximately 73% of our fixed income securities that have
call features are not callable until within six months of their stated maturities. During the years ended December 31, 2017 and 2016, we received
$0.6 billion and $1.2 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 annuity liabilities, we have the ability to reduce crediting rates (caps,
participation rates or asset fees for index annuities) on most of our annuity liabilities to maintain the spread at our targeted level. At December 31,
2017, approximately 99% of our annuity liabilities were subject to annual adjustment of the applicable crediting rates at our discretion, limited
by minimum guaranteed crediting rates specified in the policies. At December 31, 2017, approximately 5% of our annuity liabilities were at
minimum guaranteed crediting rates.
We purchase call options on the applicable indices to fund the annual index credits on our fixed index 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 fixed index products. The difference
between proceeds received at expiration of these options and index credits, as shown in the following table, is primarily due to over-hedging as
a result of policyholder behavior being different than our expectations.
47
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
Annual index credits to policyholders on their anniversaries
$
1,594,722
$
267,995
$
Proceeds received at expiration of options related to such credits
1,623,346
272,277
587,705
602,436
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 audited consolidated financial statements are included as a part of this report on Form 10-K on pages F-1 through F-52.
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(e) and 15d-15(e), 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, 2017 in
recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or
submit 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 Rules 13a-15(f) and 15d-15(f). 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, 2017
based upon criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on the assessment, management has determined that we maintained effective internal control over
financial reporting as of December 31, 2017.
The Company's independent registered public accounting firm, KPMG LLP, who audited the consolidated financial statements included in this
annual report on Form 10-K, has issued an attestation report on the effectiveness of management's internal control over financial reporting as
of December 31, 2017. This report appears on page F-2 of this annual report on Form 10-K.
(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, 2017, 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, 2017 which has not been previously reported.
48
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 7, 2018 to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2017.
PART III
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 audited 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 audited consolidated financial statements or notes thereto.
Exhibits.
Exhibit No.
Description
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
Articles of Incorporation, including Articles of Amendment (Incorporated by reference to Exhibit 3.1 to Post-Effective Amendment No. 1 to
the Registration Statement on Form 10, filed on July 22, 1999, File No. 000-25985)
Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3.1 to Form 10-Q for the period ended June 30, 2000
filed on August 14, 2000, File No. 000-25985)
Articles of Amendment to Articles of Incorporation (Incorporated by reference to Exhibit 3.2 to Pre-Effective Amendment No. 1 to the Registration
Statement on Form S-1 filed on October 20, 2003, File No. 333-108794)
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, File No. 333-148681)
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, File No. 001-31911)
Third Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to Form 8-K filed on September 2, 2008, File No. 001-31911)
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 Exhibit 10.19 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 Exhibit 10.20 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 Exhibit 10.21 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 4.13 to Form 10-Q for the period ended September 30, 2004 filed on November 9, 2004)
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 4.14 to Form 10-Q for the period ended September 30, 2004 filed on November
9, 2004)
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 4.15 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 4.16 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 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)
49
Exhibit No.
Description
4.15
4.16
4.17
4.18
4.19
4.20
4.21
4.22
4.23
4.24
10.1 *
10.2 *
10.3 *
10.4 *
10.5 *
10.6 *
10.7
10.8 *
10.9
10.10 *
10.11
10.12 *
10.13 *
10.14 *
10.15 *
10.16 *
10.17 *
10.18 *
10.19
10.20
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)
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)
Senior Amended and Restated Indenture, dated as of April 22, 2004, between American Equity Investment Life Holding Company and U.S.
Bank National Association, as trustee (Incorporated by reference to Exhibit 4.1 to Amendment No.1 to Form S-3 filed on April 22, 2004).
First Supplemental Indenture, dated July 17, 2013, among American Equity Investment Life Holding Company, U.S. Bank National Association,
and Wells Fargo Bank, National Association, as trustee (Incorporated by reference to Exhibit 4.2 to Form 8-K filed on July 17, 2013)
Second Supplemental Indenture, dated as of July 17, 2013, between American Equity Investment Life Holding Company and Wells Fargo Bank,
National Association, as trustee (Incorporated by reference to Exhibit 4.3 to Form 8-K filed on July 17, 2013)
Third Supplemental Indenture, dated as of June 16, 2017, between American Equity Investment Life Holding Company and U.S. Bank National
Association, as trustee (Incorporated by reference to Exhibit 4.2 to Form 8-K filed on June 16, 2017)
Deferred Compensation Agreement between American Equity Investment Life Holding Company and David S. Mulcahy dated December 31,
1997 (Incorporated by reference to Exhibit 10.5 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)
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)
Form of Change in Control Agreement between American Equity Investment Life Holding Company and John M. Matovina (Incorporated by
reference to the Registration Statement on Form S-1, File No. 333-108794, including all pre-effective amendments thereto)
Form of Amendment to Change in Control Agreement between American Equity Investment Life Holding Company and John M. Matovina
(Incorporated by reference to Exhibit 10.11-A to Form 10-K for the year ended December 31, 2012 filed on March 7, 2013)
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)
Amended and Restated Retirement Benefit Agreement by and between American Equity Investment Life Holding Company and David J. Noble
(Incorporated by reference to Exhibit 10.3 to Form 10-Q for the period ended March 31, 2016 filed on May 10, 2016)
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)
American Equity Investment Life Holding Company 2011 Director Stock Option Plan (Incorporated by reference to the Appendix A to the
Company's proxy statement on Form DEF 14A filed on April 25, 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, Jeffrey D. Lorenzen and Renee D. Montz (Incorporated by reference to Exhibit 10.1 to Form 8-K filed on December 14, 2012)
American Equity Investment Life Holding Company Short-Term Performance Incentive Plan adopted April 15, 2013, as amended and restated
(Incorporated by reference to Exhibit 10.1 to Form 8-K filed on April 18, 2013)
Form of Restricted Stock Award Agreement with respect to Common Stock of American Equity Investment Life Holding Company-
Nonperformance Based (Incorporated by reference to Exhibit 10.1 to Form 10-Q for the period ended March 31, 2013 filed on May 8, 2013)
Form of Performance Restricted Stock Unit Award Agreement (Incorporated by reference to Exhibit 10.2 to Form 10-Q for the period ended
March 31, 2013 filed on May 8, 2013)
Form of First Amendment to the Performance Restricted Stock Unit Award Agreement (Incorporated by reference to Exhibit 10.1 to Form 10-
Q for the period ended March 31, 2016 filed on May 10, 2016)
Form of Change in Control Agreement between American Equity Investment Life Holding Company and each of Jennifer L. Bryant and Scott
A. Samuelson (Incorporated by reference to Exhibit 10.3 to Form 10-Q for the period ended June 30, 2013 filed on August 8, 2013)
2013 Director Equity and Incentive Plan (Incorporated by reference to Exhibit 10.4 to Form 10-Q for the period ended June 30, 2013 filed on
August 8, 2013)
Credit Agreement dated September 30, 2016 among American Equity Life Investment Holding Company, JP Morgan Chase Bank, National
Association, SunTrust Bank, and Citibank, National Association and Royal Bank of Canada (Incorporated by reference to Exhibit 10.1 to Form
8-K filed on October 3, 2016)
Amended and Restated American Equity Investment Life Holding Company 2014 Independent Insurance Agent Restricted Stock and Restricted
Stock Unit Plan (Incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-3 filed on December 17, 2014)
50
Exhibit No.
Description
10.21
10.22 *
10.23 *
10.24 *
10.25 *
10.26 *
10.27 *
12.1
21.2
23.1
31.1
31.2
32.1
32.2
Amended and Restated American Equity Investment Life Holding Company 2014 Independent Insurance Agent Restricted Stock and Restricted
Stock Unit Plan, as amended (Incorporated by reference to the Appendix B to the Company's proxy statement on Form DEF 14A filed on April
18, 2016)
American Equity Investment Life Holding Company 2016 Employee Incentive Plan (Incorporated by reference to the Appendix A to the
Company's proxy statement on Form DEF 14A filed on April 18, 2016)
First Amendment to American Equity Investment Life Holding Company 2016 Employee Incentive Plan (Incorporated by reference to Exhibit
99.2 to Form S-8 filed on September 8, 2016)
Form of Restricted Stock Award Agreement with Respect to Common Stock of American Equity Investment Life Holding Company (Incorporated
by reference to Exhibit 10.1 to Form 8-K filed on June 8, 2016)
Form of Performance Restricted Stock Unit Award Agreement (Incorporated by reference to Exhibit 10.2 to Form 8-K filed on June 8, 2016)
Form of First Amendment to Employee Stock Option Agreements between American Equity Investment Life Holding Company and each of
David J. Noble and Debra J. Richardson (Incorporated by reference to Exhibit 10.2 to Form 10-Q for the period ended June 30, 2016 filed on
August 9, 2016)
American Equity Marketing Officers Deferred Compensation Agreement, dated as of January 1, 1998, between American Equity Investment
Life Insurance Company and Ronald J. Grensteiner
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
*
Denotes management contract or compensatory plan.
51
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 23rd day of February 2018.
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:
Signature
Title (Capacity)
Date
/s/ JOHN M. MATOVINA
John M. Matovina
/s/ TED M. JOHNSON
Ted M. Johnson
/s/ SCOTT A. SAMUELSON
Scott A. Samuelson
/s/ JOYCE A. CHAPMAN
Joyce A. Chapman
/s/ ALEXANDER M. CLARK
Alexander M. Clark
/s/ BRENDA J. CUSHING
Brenda J. Cushing
/s/ JAMES M. GERLACH
James M. Gerlach
/s/ ROBERT L. HOWE
Robert L. Howe
/s/ WILLIAM R. KUNKEL
William R. Kunkel
/s/ ALAN D. MATULA
Alan D. Matula
/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
Chairman of the Board, Chief Executive Officer and President
(Principal Executive Officer)
February 23, 2018
Chief Financial Officer and Treasurer
(Principal Financial Officer)
February 23, 2018
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
February 23, 2018
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
52
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
YEARS ENDED DECEMBER 31, 2017, 2016 and 2015
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Note 1. Significant Accounting Policies
Note 2. Fair Value of Financial Instruments
Note 3. Investments
Note 4. Mortgage Loans on Real Estate
Note 5. Derivative Instruments
Note 6. Deferred Policy Acquisition Costs, Deferred Sales Inducements and Lifetime Income Benefit Rider Reserves
Note 7. Reinsurance and Policy Provisions
Note 8. Income Taxes
Note 9. Notes and Loan Payable and Amounts Due Under Repurchase Agreements
Note 10. Subordinated Debentures
Note 11. Retirement and Share-based Compensation Plans
Note 12. Statutory Financial Information and Dividend Restrictions
Note 13. Commitments and Contingencies
Note 14. Earnings Per Share and Stockholders' Equity
Note 15. Quarterly Financial Information (Unaudited)
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-13
F-18
F-25
F-30
F-32
F-33
F-35
F-37
F-38
F-39
F-42
F-42
F-43
F-44
F-45
F-46
F-50
F-51
F-52
F-1
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
American Equity Investment Life Holding Company:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of American Equity Investment Life Holding Company and subsidiaries (the
Company) as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income (loss), changes in
stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial
statement schedules listed in the Index on page F-1 (collectively, the consolidated financial statements). We also have audited the Company’s
internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
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, 2017 and 2016, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2017, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control -
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinion
The Company’s management is responsible for these consolidated financial statements, 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 the Company’s consolidated financial
statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm
registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to
the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and
whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated
financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining,
on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the
accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements. 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.
Definition and Limitations of Internal Control Over Financial Reporting
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.
We have served as the Company’s auditor since 2005.
Des Moines, Iowa
February 23, 2018
/s/ KPMG LLP
F-2
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
December 31,
2017
2016
Assets
Investments:
Fixed maturity securities:
Available for sale, at fair value (amortized cost: 2017 - $43,116,759; 2016 - $39,953,955)
$
45,372,989
$
41,060,494
Held for investment, at amortized cost (fair value: 2017 - $76,460; 2016 - $68,766)
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 and loan payable
Subordinated debentures
Income taxes payable
Other liabilities
Total liabilities
Stockholders' equity:
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
2017 and 2016 - no shares issued and outstanding
Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
2017 - 89,331,087 shares (excluding 2,064,727 treasury shares);
2016 - 88,001,130 shares (excluding 2,887,082 treasury shares)
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
See accompanying notes to consolidated financial statements.
F-3
77,041
2,665,531
1,568,380
616,764
76,825
2,480,956
830,519
308,774
50,300,705
44,757,568
1,434,045
4,858,289
429,008
2,714,523
2,001,892
38,147
—
254,127
791,266
4,639,492
397,773
2,905,377
2,208,218
168,578
11,474
173,726
62,030,736
$
56,053,472
56,142,673
$
51,637,026
282,884
494,093
242,565
34,285
1,984,079
59,180,579
298,347
493,755
241,853
—
1,090,896
53,761,877
$
$
—
—
89,331
791,446
724,599
1,244,781
2,850,157
88,001
770,344
339,966
1,093,284
2,291,595
$
62,030,736
$
56,053,472
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31,
2017
2016
2015
$
34,228
$
43,767
$
200,494
1,991,997
1,677,871
10,509
(2,758)
(1,872)
(4,630)
(18,817)
3,891,652
43,219
2,023,668
176,612
919,735
30,368
14,124
255,964
111,691
3,575,381
316,271
141,626
174,645
1.96
1.93
88,982
90,311
$
$
$
$
$
$
173,579
1,849,872
164,219
11,524
(21,349)
(1,330)
(22,679)
—
36,048
136,168
1,692,192
(336,146)
10,211
(25,547)
6,011
(19,536)
—
2,220,282
1,518,937
52,483
725,472
251,166
543,465
28,248
12,958
374,012
102,231
2,090,035
130,247
47,004
83,243
0.98
0.97
84,793
85,605
$
$
$
45,458
968,053
209,390
(464,698)
28,849
12,239
286,114
96,218
1,181,623
337,314
117,484
219,830
2.78
2.72
78,937
80,961
Revenues:
Premiums and other considerations
Annuity product charges
Net investment income
Change in fair value of derivatives
Net realized gains on investments, excluding other than temporary impairment ("OTTI") losses
OTTI losses on investments:
Total OTTI losses
Portion of OTTI losses recognized in (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 and loan payable
Interest expense on subordinated debentures
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.
F-4
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
Net income
Other comprehensive income (loss):
Change in net unrealized investment gains/losses (1)
Noncredit component of OTTI losses (1)
Reclassification of unrealized investment gains/losses to net income (1)
Other comprehensive income (loss) before income tax
Income tax effect related to other comprehensive income (loss)
Other comprehensive income (loss)
Comprehensive income (loss)
Year Ended December 31,
2017
2016
2015
$
174,645
$
83,243
$
219,830
556,384
915
4,496
561,795
(177,162)
384,633
207,994
556
4,224
212,774
(74,471)
138,303
$
559,278
$
221,546
$
(797,374)
(2,927)
703
(799,598)
279,860
(519,738)
(299,908)
(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)
Balance at December 31, 2014
Net income for the year
Other comprehensive loss
Share-based compensation, including excess income tax
benefits
Issuance of common stock via public offering
Issuance of 944,504 shares of common stock under
compensation plans, including excess income tax benefits
Issuance of 47,868 shares of common stock to settle warrants
that have reached their expiration
Dividends on common stock ($0.22 per share)
Balance at December 31, 2015
Net income for the year
Other comprehensive income
Share-based compensation, including excess income tax
benefits
Issuance of common stock via settlement of forward sale
agreements
Issuance of 964,053 shares of common stock under
compensation plans, including excess income tax benefits
Issuance of 92,998 shares of common stock to settle warrants
that have reached their expiration
Dividends on common stock ($0.24 per share)
Balance at December 31, 2016
Net income for the year
Other comprehensive income
Share-based compensation
Issuance of 1,329,957 shares of common stock under
compensation plans
Dividends on common stock ($0.26 per share)
Common
Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income
Retained
Earnings
Total
Stockholders'
Equity
$
76,062
$
513,218
$
721,401
$
829,195
$
2,139,876
—
—
—
4,300
944
48
—
—
—
9,976
100,179
7,042
(48)
—
81,354
630,367
—
—
—
—
—
7,218
5,590
129,072
964
93
—
3,781
(94)
—
88,001
770,344
—
—
—
1,330
—
—
—
6,464
14,638
—
—
219,830
(519,738)
—
—
—
—
—
201,663
—
138,303
—
—
—
—
—
339,966
—
384,633
—
—
—
—
—
—
—
—
(17,874)
1,031,151
83,243
—
—
—
—
—
(21,110)
1,093,284
174,645
—
—
—
(23,148)
219,830
(519,738)
9,976
104,479
7,986
—
(17,874)
1,944,535
83,243
138,303
7,218
134,662
4,745
(1)
(21,110)
2,291,595
174,645
384,633
6,464
15,968
(23,148)
Balance at December 31, 2017
$
89,331
$
791,446
$
724,599
$
1,244,781
$
2,850,157
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 (benefits)
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
Mortgage loans on real estate
Derivative instruments
Other investments
Acquisitions of investments:
Fixed maturity securities - available for sale
Mortgage loans on real estate
Derivative instruments
Other investments
Purchases of property, furniture and equipment
Net cash used in investing activities
Year Ended December 31,
2017
2016
2015
$
174,645
$
83,243
$
219,830
2,023,668
176,612
(200,494)
919,735
(33)
(406,641)
255,964
3,948
15,431
18,817
(5,879)
(1,678,956)
(46,730)
6,464
(31,235)
45,759
448
(23,101)
772,181
(84,416)
(13,794)
725,472
251,166
(173,579)
543,465
12,724
(543,325)
374,012
3,879
1,070
—
11,155
(165,727)
(10,408)
6,692
(35,669)
18,125
1,812
(34,411)
414,655
(55,940)
(14,089)
1,922,393
1,414,322
968,053
209,390
(136,168)
(464,698)
5,097
(657,639)
286,114
4,610
(8,464)
—
9,325
334,300
41,916
7,373
(35,545)
(20,027)
71
(49,092)
(269,474)
75,794
(15,962)
504,804
1,911,991
351,255
1,697,948
10,571
2,746,510
1,612,121
383,763
284,470
14,045
468,102
640,467
16,792
(5,026,640)
(6,883,895)
(7,256,137)
(535,249)
(691,428)
(305,575)
(4,809)
(428,833)
(602,349)
(11,559)
(1,197)
(455,286)
(588,859)
(13,092)
(1,313)
(2,591,936)
(4,499,045)
(5,577,205)
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 policyholder account balances
$
4,152,264
$
7,092,348
$
7,051,227
Year Ended December 31,
2017
2016
2015
Coinsurance deposits
Return of annuity policyholder account balances
Financing fees incurred and deferred
Proceeds from issuance of notes payable
Repayment of notes payable
Repayment of loan payable
Proceeds from issuance of loan payable
Net proceeds from settlement of notes hedges and warrants
Acquisition of common stock
Excess tax benefits realized from share-based compensation plans
Proceeds from issuance of common stock
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
Non-cash operating activity:
Deferral of sales inducements
Non-cash investing activity:
Mortgage loan on real estate sold
Non-cash financing activity:
Common stock issued to settle warrants that have expired
See accompanying notes to consolidated financial statements.
(6,597)
(2,809,486)
(5,817)
499,650
(413,252)
(100,000)
—
—
—
—
14,028
4,680
(23,148)
(1,317,555)
(2,535,669)
(1,456)
—
—
—
100,000
—
—
527
139,654
21,501
(21,110)
1,312,322
3,478,240
642,779
791,266
393,517
397,749
$
1,434,045
$
791,266
$
(80,777)
(2,271,950)
—
—
(48,152)
—
—
25,775
(16)
3,649
112,481
(5,727)
(17,874)
4,768,636
(303,765)
701,514
397,749
$
55,445
$
39,647
$
142,627
39,066
39,118
91,887
216,172
353,966
486,924
—
—
—
93
4,879
48
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", "our" or "parent company"), 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, 2017. We operate solely in the insurance business.
We primarily market fixed index and fixed rate annuities. Annuity deposits (net of coinsurance) collected in 2017, 2016 and 2015, by product
type were as follows:
Product Type
Fixed index annuities
Annual reset fixed rate annuities
Multi-year fixed rate annuities
Single premium immediate annuities (SPIA)
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
3,668,121
$
5,035,818
$
6,491,981
74,572
22,291
24,946
63,582
256,894
35,851
44,715
42,709
32,752
3,789,930
$
5,392,145
$
6,612,157
Agents contracted with us through two national marketing organizations accounted for more than 10% of annuity deposits we collected during
2017 representing 14% and 10%, individually, of the annuity deposits collected. Agents contracted with us through one national marketing
organization accounted for more than 10% of annuity deposits we collected during 2016 representing 15% of the annuity deposits collected.
Agents contracted with us through one national marketing organization accounted for more than 10% of annuity deposits we collected during
2015 representing 22% of the annuity deposits 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.
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 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 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 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.
F-9
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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, 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 will 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 allowance
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, equity securities, 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. Equity
securities 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. 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 used 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.
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
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.
F-10
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 net of expected excess payments
for lifetime income benefit riders, and mortality and expense margins. 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.
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, 2017, 2016 and 2015, interest crediting rates for these products ranged
from 1.00% to 3.30%.
The liability for lifetime income benefit riders is based on estimates of the value of benefit payments expected to be paid in excess of projected
policy values recognizing the excess over the expected lives of the underlying policies based on actual and expected assessments including
spreads and product charges and fees. The inputs used in the calculation of the liability for lifetime income benefit riders include actual policy
values, actual income account values, actual payout factors, actual roll-up rates and our best estimate assumptions for future policy growth,
future policy decrements, the ages at which policyholders are expected to elect to begin to receive lifetime income benefit payments, the percentage
of policyholders who elect to receive lifetime income benefit payments and the type of income benefit payments selected upon election. See
Note 6 for more information on lifetime income benefit rider reserves.
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.
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. The effect on deferred income tax assets and liabilities resulting from a change in
the enacted marginal tax rate is recognized in income in the period that includes the enactment date. Deferred income tax expenses or benefits
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 pursuant to accounting by insurance companies for certain long-duration contracts. The change in fair value of the embedded
derivatives for fixed index annuities equals 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.
Considerations from immediate annuities and supplemental contract annuities with life contingencies are recognized as revenue when the policy
is issued.
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.
F-11
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other Comprehensive Income (Loss)
Other comprehensive income (loss) includes all changes in stockholders' equity during a period except those resulting from investments by and
distributions to stockholders. Other comprehensive income (loss) excludes net realized investment gains (losses) included in net income which
merely represents transfers from unrealized to realized gains and losses.
Adopted Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board ("FASB") issued an accounting standards update ("ASU") related to the accounting
for share-based payment transactions. The aspects of accounting guidance affected by this ASU are income taxes, classification of awards as
either equity or liabilities, and classification on the statement of cash flows. We adopted this ASU on January 1, 2017. The adoption of this
ASU resulted in an income tax benefit of $2.8 million being recognized in operations during the year ended December 31, 2017 due to the
requirement under this standard to recognize excess tax benefits related to share-based payment awards in income tax expense.
New Accounting Pronouncements
In May 2014, the FASB issued an ASU related to revenue arising from contracts with customers. This ASU, which replaces most current revenue
recognition guidance, including industry specific guidance, prescribes that an entity should recognize revenue to reflect the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods
or services. This ASU will be effective for us on January 1, 2018 and may be adopted using either a full retrospective or a modified retrospective
approach. This ASU will not have any immediate impact on our consolidated financial statements as revenues related to our insurance and
investment contracts are excluded from its scope.
In January 2016, the FASB issued an ASU that, among other aspects of recognition, measurement, presentation and disclosure of financial
instruments, primarily requires equity investments (except those accounted for under the equity method of accounting or those that result in
consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose
to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting
from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Additionally, it changes the
accounting for financial liabilities measured at fair value under the fair value option and eliminates some disclosures regarding fair value of
financial assets and liabilities measured at amortized cost. This ASU will be effective for us on January 1, 2018. This ASU will not have any
immediate impact on our consolidated financial statements or related financial statement disclosures.
In February 2016, the FASB issued an ASU that will require recognizing lease assets and lease liabilities on the balance sheet and disclosing
key information about leasing arrangements. This ASU affects accounting and disclosure more dramatically for lessees as accounting for lessors
is mainly unchanged. This ASU will be effective for us on January 1, 2019, with early adoption permitted. We are in the process of evaluating
the impact this guidance may have on our consolidated financial statements.
In June 2016, the FASB issued an ASU that significantly changes the impairment model for most financial assets that are measured at amortized
cost and certain other instruments from an incurred loss model to an expected loss model that requires these assets be presented at the net amount
expected to be collected. In addition, credit losses on available for sale debt securities should be recorded through an allowance account. This
ASU will be effective for us on January 1, 2020, with early adoption permitted. While we are still in the process of evaluating the full impact
this guidance will have on our consolidated financial statements, we believe the new impairment model will lead to earlier recognition of credit
losses for our commercial mortgage loans.
In August 2016, the FASB issued an ASU that clarifies how certain cash receipts and cash payments are to be presented and classified in the
statement of cash flows. This ASU will be effective for us on January 1, 2018 and requires a retrospective transition method. We expect the
immediate impact to our consolidated financial statements to be insignificant and limited to reclassification of certain cash flows from investing
activities to operating activities within our consolidated statements of cash flows.
In March 2017, the FASB issued an ASU that applies to certain callable debt securities where the amortized cost basis is at a premium to the
price repayable by the issuer at the earliest call date. Under this guidance, the premium will be amortized to the first call date. This ASU will be
effective for us on January 1, 2019, with early adoption permitted. We are in the process of evaluating the impact this guidance may have on
our consolidated financial statements.
In February 2018, the FASB issued an ASU that allows a reclassification from accumulated other comprehensive income to retained earnings
for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 ("Tax Reform"). This ASU will be effective for us on January 1, 2019,
with early adoption permitted. We plan to early adopt this ASU during the first quarter of 2018 and expect to reclassify $128 million between
accumulated other comprehensive income and retained earnings within our consolidated balance sheet.
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
Mortgage loans on real estate
Derivative instruments
Other investments
Cash and cash equivalents
Coinsurance deposits
Interest rate caps
Counterparty collateral
Liabilities
Policy benefit reserves
Single premium immediate annuity (SPIA) benefit reserves
Notes and loan payable
Subordinated debentures
Interest rate swap
December 31,
2017
2016
Carrying
Amount
Fair Value
Carrying
Amount
Fair Value
(Dollars in thousands)
$
45,372,989
$
45,372,989
$
41,060,494
$
41,060,494
77,041
2,665,531
1,568,380
616,764
1,434,045
4,858,289
415
186,108
76,460
2,670,037
1,568,380
605,894
1,434,045
4,347,990
415
186,108
76,825
2,480,956
830,519
308,774
791,266
4,639,492
1,082
145,693
68,766
2,522,035
830,519
300,918
791,266
4,150,792
1,082
145,693
55,786,011
46,344,931
51,280,331
43,104,183
282,563
494,093
242,565
789
292,153
521,800
244,117
789
297,724
493,755
241,853
2,113
308,028
519,440
225,106
2,113
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 any period presented.
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, 2017 and 2016 are presented below based on
the fair value hierarchy levels:
December 31, 2017
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
Other investments: equity securities, available for sale
Derivative instruments
Cash and cash equivalents
Interest rate caps
Counterparty collateral
Liabilities
Interest rate swap
Fixed index annuities - embedded derivatives, net
December 31, 2016
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
Other investments: equity securities, available for sale
Derivative instruments
Cash and cash equivalents
Interest rate caps
Counterparty collateral
Liabilities
Interest rate swap
Fixed index annuities - embedded derivatives
Total
Fair Value
Quoted
Prices
in Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
(Dollars in thousands)
Significant
Unobservable
Inputs
(Level 3)
$
11,876
$
5,640
$
6,236
$
1,305,017
4,166,812
239,360
29,878,971
1,105,567
5,544,850
3,120,536
292,429
1,568,380
1,434,045
415
186,108
48,854,366
789
8,790,427
8,791,216
—
—
—
5
—
—
—
285,000
—
1,434,045
—
—
1,305,017
4,166,812
239,360
29,878,966
1,105,567
5,544,850
3,120,536
7,429
1,568,380
—
415
186,108
$
$
$
1,724,690
$
47,129,676
— $
—
— $
789
—
789
$
$
$
11,805
$
5,381
$
6,424
$
1,344,787
3,926,950
236,341
27,114,418
1,254,835
5,365,235
1,806,123
8,000
830,519
791,266
1,082
145,693
—
—
—
6
—
—
—
—
—
791,266
—
—
1,344,787
3,926,950
236,341
27,114,412
1,254,835
5,365,235
1,806,123
8,000
830,519
—
1,082
145,693
42,837,054
2,113
6,563,288
6,565,401
$
$
$
796,653
$
42,040,401
— $
—
— $
2,113
—
2,113
$
$
$
$
$
$
$
$
$
$
F-14
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
8,790,427
8,790,427
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
6,563,288
6,563,288
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 quotes or prices from additional parties as needed. 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 using 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, 2017 and 2016.
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); 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 determined by our investment team 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
Available for sale equity securities are the only financial instruments included in other investments that are measured at fair value on a recurring
basis (see determination of fair value above). Financial instruments included in other investments that are not measured at fair value on a
recurring basis are policy loans, equity method investments 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 values of our equity method investments are obtained from third parties and are determined by calculating the present value
of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. As the risk spread and liquidity discount are unobservable
market inputs, the fair value of our equity method investments falls within Level 3 of the fair value hierarchy. The fair value of our COLI
approximates the cash surrender value of the policies and falls within Level 2 of the fair value hierarchy.
F-15
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 swap and our 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 swap and caps.
Counterparty collateral
Amounts reported in other assets 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.
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 issued 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 and loan payable
The fair values of our senior unsecured notes are 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. The fair value of our term loan is estimated using discounted
cash flow calculations based principally on observable inputs including our incremental borrowing rate, which reflects our credit rating, for a
similar type of borrowing with a maturity consistent with that remaining for the term loan. Notes and loan 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.
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.
Within this determination we have the following significant unobservable inputs: 1) the expected cost of annual call options we will purchase
in the future to fund index credits beyond the next policy anniversary and 2) our best estimates for future policy decrements, primarily lapse,
partial withdrawal and mortality rates. As of December 31, 2017 and 2016, we utilized an estimate of 3.10% for the expected cost of annual
call options, which are based on estimated long-term account value growth and a historical review of our actual option costs.
F-16
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our best estimate assumptions for lapse, partial withdrawal and mortality rates are based on our actual experience and our outlook as to future
expectations for such assumptions. These assumptions, which are consistent with the assumptions used in calculating deferred policy acquisition
costs and deferred sales inducements, are reviewed on a quarterly basis and are revised as our experience develops and/or as future expectations
change. Our mortality rate assumptions are based on 65% of the 1983 Basic Annuity Mortality Tables. The following table presents average
lapse rate and partial withdrawal rate assumptions, by contract duration, used in estimating the fair value of the embedded derivative component
of our fixed index annuity policy benefit reserves at each reporting date:
Contract Duration (Years)
December 31, 2017
December 31, 2016
December 31, 2017
December 31, 2016
Average Lapse Rates
Average Partial Withdrawal Rates
1 - 5
6 - 10
11 - 15
16 - 20
20+
1.83%
7.01%
11.31%
11.96%
11.62%
1.76%
6.58%
11.25%
12.04%
11.68%
3.32%
3.32%
3.34%
3.20%
3.20%
3.30%
3.30%
3.32%
3.18%
3.18%
Lapse rates are generally expected to increase as surrender charge percentages decrease. Lapse expectations reflect a significant increase in the
year in which the surrender charge period on a contract ends.
The following table provides a reconciliation of the beginning and ending balances for our Level 3 liabilities, which are measured at fair value
on a recurring basis using significant unobservable inputs for the years ended December 31, 2017 and 2016:
Fixed index annuities - embedded derivatives
Beginning balance
Premiums less benefits
Change in fair value, net
Ending balance
Year Ended December 31,
2017
2016
(Dollars in thousands)
$
$
6,563,288
$
5,983,622
2,052,985
174,154
434,621
145,045
8,790,427
$
6,563,288
The fair value of our fixed index annuities embedded derivatives is net of coinsurance ceded of $539.7 million and $398.1 million as of
December 31, 2017 and 2016, respectively. Change in fair value, 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, 2017, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $579.5 million
recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of
$339.4 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 $645.8 million recorded
through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $374.8
million to our combined balance for deferred policy acquisition costs and deferred sales inducements 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, 2017 and 2016, the amortized cost and fair value of fixed maturity securities were as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(Dollars in thousands)
Fair Value
December 31, 2017
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
$
11,861
$
162
$
(147) $
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
Other investments: equity securities, available for sale
December 31, 2016
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
Other investments: equity securities, available for sale
$
$
$
$
$
$
$
11,876
1,305,017
4,166,812
239,360
1,308,290
3,804,360
228,214
28,457
366,048
13,171
(31,730)
(3,596)
(2,025)
28,127,653
1,897,005
(145,687)
29,878,971
1,028,484
5,531,922
3,075,975
43,116,759
77,041
292,429
$
$
$
79,554
82,768
57,966
(2,471)
(69,840)
(13,405)
1,105,567
5,544,850
3,120,536
2,525,131
$
(268,901) $
45,372,989
— $
(581) $
76,460
— $
— $
292,429
11,864
$
229
$
(288) $
1,368,340
3,626,395
229,589
23,360
322,948
11,832
26,333,213
1,149,978
91,445
59,994
31,471
1,166,944
5,422,255
1,795,355
39,953,955
76,825
7,521
$
$
$
(46,913)
(22,393)
(5,080)
(368,773)
(3,554)
(117,014)
(20,703)
11,805
1,344,787
3,926,950
236,341
27,114,418
1,254,835
5,365,235
1,806,123
1,691,257
$
(584,718) $
41,060,494
— $
(8,059) $
68,766
479
$
— $
8,000
At December 31, 2017, 37% of our fixed income securities have call features, of which 2.7% ($1.2 billion) were subject to call redemption and
another 0.2% ($90.1 million) will become subject to call redemption during 2018. Approximately 73% of our fixed income securities that have
call features are not callable until within six months of their stated maturities.
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, 2017, 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.
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
Commercial mortgage backed securities
Other asset backed securities
Available for sale
Held for investment
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
$
197,449
$
201,079
$
— $
(Dollars in thousands)
4,958,029
10,556,868
9,214,395
8,553,637
33,480,378
1,028,484
5,531,922
3,075,975
5,114,727
10,827,764
10,080,377
9,378,089
35,602,036
1,105,567
5,544,850
3,120,536
—
—
—
77,041
77,041
—
—
—
—
—
—
—
76,460
76,460
—
—
—
$
43,116,759
$
45,372,989
$
77,041
$
76,460
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,
2017
2016
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
2,256,230
$
1,107,018
Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales
inducements
Deferred income tax valuation allowance reversal
Deferred income tax expense (a)
(1,206,078)
22,534
(348,087)
Net unrealized gains reported as accumulated other comprehensive income
$
724,599
$
(618,661)
22,534
(170,925)
339,966
(a) Includes $128 million related to the impact of Tax Reform that we expect to reclassify between accumulated other comprehensive income
and retained earnings within our consolidated balance sheet during the first quarter of 2018. For more information regarding the timing of
reclassification, see Note 1 to our audited consolidated financial statements.
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, we had 97% of our fixed maturity portfolio rated investment grade
at both December 31, 2017 and 2016, respectively.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
NAIC
Designation
1
2
3
4
5
6
December 31,
2017
2016
Amortized
Cost
Fair
Value
Amortized
Cost
(Dollars in thousands)
Fair
Value
$
26,669,427
$
28,274,379
$
25,607,268
$
26,507,798
15,198,551
15,869,219
13,037,592
13,295,648
1,161,737
134,838
17,015
12,232
1,157,420
117,542
20,927
9,962
1,201,059
154,226
17,475
13,160
1,155,702
137,188
24,664
8,260
$
43,193,800
$
45,449,449
$
40,030,780
$
41,129,260
F-19
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table shows our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that
individual securities (consisting of 955 and 1,514 securities, respectively) have been in a continuous unrealized loss position, at December 31,
2017 and 2016:
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, 2017
Fixed maturity securities:
Available for sale:
United States Government full faith and credit
$
1,565
$
(10) $
6,731
$
(137) $
8,296
$
(147)
United States Government sponsored agencies
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
Commercial mortgage backed securities
Other asset backed securities
44,794
44,736
49,663
456,244
222,985
395,183
152,941
729,124
39,771
1,096,757
765,531
(180)
(128)
(337)
(5,135)
(3,475)
(4,099)
(1,249)
(19,000)
(387)
958,965
128,499
12,625
600,655
231,196
249,416
178,635
891,654
32,917
(31,550)
1,003,759
(3,468)
(1,688)
173,235
62,288
(28,043)
(10,849)
(8,901)
(11,371)
(53,565)
(2,084)
1,056,899
454,181
644,599
331,576
1,620,778
72,688
(10,385)
1,306,437
(59,455)
2,403,194
(3,499)
217,595
(9,906)
983,126
(31,730)
(3,596)
(2,025)
(33,178)
(14,324)
(13,000)
(12,620)
(72,565)
(2,471)
(69,840)
(13,405)
$
3,999,294
$
(47,884) $
4,815,325
$
(221,017) $
8,814,619
$
(268,901)
Held for investment:
Corporate security:
Insurance
December 31, 2016
Fixed maturity securities:
Available for sale:
$
— $
— $
76,460
$
(581) $
76,460
$
(581)
United States Government full faith and credit
$
7,405
$
(288) $
— $
— $
7,405
$
(288)
United States Government sponsored agencies
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
Commercial mortgage backed securities
Other asset backed securities
995,548
463,409
29,158
1,940,107
1,199,420
1,401,650
637,121
2,539,519
81,762
3,148,395
751,533
(46,913)
(22,393)
(913)
(70,421)
(34,304)
(45,015)
(18,880)
(82,196)
(3,463)
(116,938)
(12,289)
—
—
—
—
20,388
(4,167)
82,907
311,591
58,597
29,719
716,857
1,853
895
(7,723)
(23,273)
(5,820)
(1,930)
(91)
(76)
146,167
(8,414)
995,548
463,409
49,546
2,023,014
1,511,011
1,460,247
666,840
(46,913)
(22,393)
(5,080)
(78,144)
(57,577)
(50,835)
(20,810)
83,615
3,149,290
897,700
(3,554)
(117,014)
(20,703)
(79,211)
3,256,376
(161,407)
Held for investment:
Corporate security:
Insurance
$ 13,195,027
$
(454,013) $
1,368,974
$
(130,705) $ 14,564,001
$
(584,718)
$
— $
— $
68,766
$
(8,059) $
68,766
$
(8,059)
Based on the results of our process for evaluating available for sale securities in unrealized loss positions for other-than-temporary-impairments,
which is discussed in detail later in this footnote, we have determined that the unrealized losses on the securities in the preceding table are
temporary. The unrealized losses at December 31, 2017 are principally related to timing of the purchases of these securities, which carry less
yield than those available at December 31, 2017.
F-20
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Approximately 83% and 86% of the unrealized losses on fixed maturity securities shown in the above table for December 31, 2017 and 2016,
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 on investments for the years ended December 31, 2017, 2016 and 2015 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/liability
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
$
$
7,478
1,149,691
(479)
1,149,212
(587,417)
(177,162)
(764,579)
$
$
3,186
508,410
166
508,576
(295,802)
(74,471)
(370,273)
(10,651)
(1,642,027)
17
(1,642,010)
842,412
279,860
1,122,272
Change in net unrealized gains on investments carried at fair value
$
384,633
$
138,303
$
(519,738)
Components of net investment income are as follows:
Fixed maturity securities
Equity securities
Mortgage loans on real estate
Cash and cash equivalents
Other
Less investment expenses
Net investment income
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
1,876,542
$
1,729,176
$
1,566,409
764
122,680
2,562
4,073
2,006,621
(14,624)
531
122,985
3,201
5,499
1,861,392
(11,520)
441
131,892
601
4,858
1,704,201
(12,009)
$
1,991,997
$
1,849,872
$
1,692,192
Proceeds from sales of available for sale securities for the years ended December 31, 2017, 2016 and 2015 were $0.7 billion, $1.0 billion and
$0.4 billion, respectively. Scheduled principal repayments, calls and tenders for available for sale fixed maturity securities for the years ended
December 31, 2017, 2016 and 2015 were $1.2 billion, $1.7 billion and $1.2 billion, respectively.
F-21
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 net OTTI losses are as follows:
Available for sale fixed maturity securities:
Gross realized gains
Gross realized losses
Available for sale equity securities:
Gross realized gains
Other investments:
Gain on sale of real estate
Loss on sale of real estate
Impairment losses on real estate
Mortgage loans on real estate:
Decrease (increase) in allowance for credit losses
Recovery of specific allowance
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
18,254
$
14,132
$
(9,058)
9,196
(4,036)
10,096
7,230
(5,787)
1,443
—
—
348
56
—
—
56
278
631
909
884
(93)
—
791
(4,846)
5,483
637
4,194
(575)
(1,297)
2,322
1,018
5,428
6,446
10,211
$
10,509
$
11,524
$
Losses on available for sale fixed maturity securities in 2017, 2016 and 2015 were realized primarily due to strategies to reposition the fixed
maturity security portfolio that result in improved net investment income, credit risk or duration profiles as they pertain to our asset liability
management. Securities were sold at losses in 2017, 2016, and 2015 due to our long-term fundamental concern with the issuers' ability to meet
their future financial obligations.
The following table summarizes the carrying value of our investments that have been non-income producing for 12 consecutive months:
December 31,
2017
2016
(Dollars in thousands)
Fixed maturity securities, available for sale
$
8,680
$
1,651
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 basis of each investment that has a fair value that is materially lower than its amortized
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 to identify securities that could potentially have impairments that are 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 mortgage and asset backed securities.
•
•
•
F-22
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 fair 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.
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 (loss).
The determination of the credit loss component of a 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 the 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 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 for the years ended December 31, 2017 and 2016, 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, 2017
Prime
Year ended December 31, 2016
Prime
Alt-A
2005
2006
2007
2005
2006
2007
2005
8%
14%
15%
8%
12%
18%
11%
22%
14%
27%
14%
13%
31%
11%
40%
40%
50%
50%
40%
50%
60%
50%
40%
60%
50%
50%
55%
60%
7.7%
7.3%
6.7%
7.7%
7.3%
6.4%
7.4%
7.0%
7.3%
6.2%
7.7%
6.5%
6.2%
7.4%
F-23
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
The following table summarizes other than temporary impairments by asset type:
Number
of Securities
Total
OTTI Losses
Portion of
OTTI Losses
Recognized in
(from)
Other
Comprehensive
Income
(Dollars in thousands)
Net OTTI
Losses
Recognized
in Operations
Year ended December 31, 2017
Fixed maturity securities, available for sale:
Corporate securities:
Industrial
Residential mortgage backed securities
Other asset backed securities
Year ended December 31, 2016
Fixed maturity securities, available for sale:
Corporate securities:
Energy
Materials
Telecommunications
Utilities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Year ended December 31, 2015
Fixed maturity securities, available for sale:
Corporate securities:
Industrial
Residential mortgage backed securities
Other asset backed securities
1
8
1
$
(2,485) $
— $
(273)
—
(1,585)
(287)
10
$
(2,758) $
(1,872) $
2
1
1
2
9
5
2
$
(642) $
— $
(4,554)
(4,462)
(6,961)
—
(1,540)
(3,190)
1,575
562
798
(783)
—
(3,482)
(1,330) $
22
$
(21,349) $
2
11
1
14
$
$
(15,414) $
2,975
$
(133)
(10,000)
(2,089)
5,125
(25,547) $
6,011
$
F-24
(2,485)
(1,858)
(287)
(4,630)
(642)
(2,979)
(3,900)
(6,163)
(783)
(1,540)
(6,672)
(22,679)
(12,439)
(2,222)
(4,875)
(19,536)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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,
2017
2016
(Dollars in thousands)
$
$
(166,375)
$
(2,758)
(1,872)
13,939
(145,824)
(18,414)
(4,265)
2,128
(157,066)
$
(166,375)
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,
2017 and 2016:
December 31, 2017
Fixed maturity securities, available for sale:
Corporate securities
Residential mortgage backed securities
Other asset backed securities
December 31, 2016
Fixed maturity securities, available for sale:
Corporate securities
Residential mortgage backed securities
Commercial mortgage backed securities
Other asset backed securities
Amortized Cost
OTTI Recognized
in Other
Comprehensive
Income
Change in
Fair Value Since
OTTI was
Recognized
(Dollars in thousands)
Fair Value
$
$
$
$
13,015
$
(4,263) $
10,739
$
297,582
4,567
(168,355)
(1,356)
201,620
(1,875)
315,164
$
(173,974) $
210,484
$
17,549
$
(5,910) $
13,566
$
368,862
6,596
6,683
(169,941)
—
(1,643)
205,854
(107)
(1,566)
19,491
330,847
1,336
351,674
25,205
404,775
6,489
3,474
399,690
$
(177,494) $
217,747
$
439,943
At December 31, 2017 and 2016, fixed maturity securities and short-term investments with an amortized cost of $47.5 billion and $43.5 billion,
respectively, were on deposit with state agencies to meet regulatory requirements. There are no restrictions on these assets.
At December 31, 2017 and 2016, 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 is summarized in the following table. There were commitments outstanding of $62.0 million at December 31, 2017.
Principal outstanding
Loan loss allowance
Deferred prepayment fees
Carrying value
F-25
December 31,
2017
2016
(Dollars in thousands)
$
$
2,674,315
$
2,490,619
(7,518)
(1,266)
(8,427)
(1,236)
2,665,531
$
2,480,956
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
Apartment
Mixed use/other
December 31,
2017
2016
Principal
Percent
Principal
Percent
(Dollars in thousands)
$
$
$
548,067
163,485
308,486
12,265
466,030
609,736
324,808
241,438
20.5% $
6.1%
11.5%
0.5%
17.4%
22.8%
12.2%
9.0%
635,434
151,640
235,932
12,724
385,683
519,065
325,447
224,694
25.5%
6.1%
9.5%
0.5%
15.5%
20.8%
13.1%
9.0%
2,674,315
100.0% $
2,490,619
100.0%
283,926
34,338
1,040,028
677,770
462,897
175,356
10.6% $
1.3%
38.9%
25.3%
17.3%
6.6%
308,578
50,780
886,942
700,644
375,837
167,838
12.4%
2.1%
35.6%
28.1%
15.1%
6.7%
$
2,674,315
100.0% $
2,490,619
100.0%
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.
We evaluate our mortgage loan portfolio for the establishment of a loan loss allowance 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 on a quantitative
and qualitative basis. 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.
We rate each of the mortgage loans in our portfolio based on factors such as historical operating performance, loan to value ratio and economic
outlook, among others. We calculate a loss factor to apply to each rating based on historical losses we have recognized in our mortgage loan
portfolio. We apply the loss factors to the total principal outstanding within each rating category to determine an appropriate estimate of the
general loan loss allowance. We also assess the portfolio qualitatively and apply a loss rate to all loans without a specific allowance based on
management's assessment of economic conditions, and we apply an additional amount of loss allowance to a group of loans that we have identified
as having higher risk of loss.
F-26
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents a rollforward of our specific and general valuation allowances for mortgage loans on real estate:
Year Ended December 31,
2017
2016
2015
Specific
Allowance
General
Allowance
Specific
Allowance
General
Allowance
Specific
Allowance
General
Allowance
(Dollars in thousands)
Beginning allowance balance
Charge-offs
Recoveries
Change in provision for credit losses
Ending allowance balance
$
$
(1,327)
$
(7,100)
$
(7,842) $
(6,300)
$
(12,333)
$
(10,300)
—
631
(722)
—
—
1,000
5,078
5,483
(4,046)
—
—
(800)
2,045
5,428
(2,982)
(1,418)
$
(6,100)
$
(1,327) $
(7,100)
$
(7,842)
$
—
—
4,000
(6,300)
The specific allowance represents the total credit loss allowances on loans which are individually evaluated for impairment. The general allowance
is for 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:
Individually evaluated for impairment
Collectively evaluated for impairment
Total loans evaluated for impairment
December 31,
2017
2016
2015
(Dollars in thousands)
$
$
5,445
2,668,870
2,674,315
$
$
4,640
2,485,979
2,490,619
$
$
21,277
2,428,632
2,449,909
Charge-offs include allowances that have been established on loans that were satisfied either by taking ownership of the collateral or by some
other means such as discounted pay-off or loan sale. When ownership of the property is taken it is recorded at the lower of the mortgage loan's
carrying value or the property's fair value (based on appraised values) less estimated costs to sell. The real estate owned is recorded 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. Recoveries are situations where we have received a payment from the borrower
in an amount greater than the carrying value of the loan (principal outstanding less specific allowance).
We did not own any real estate during the year ended December 31, 2017. The following table summarizes the activity in the real estate owned,
included in Other investments, which was obtained in satisfaction of mortgage loans on real estate:
Real estate owned at beginning of period
Additions
Sales
Impairments
Depreciation
Real estate owned at end of period
Year Ended December 31,
2016
2015
(Dollars in thousands)
$
$
6,485
$
—
(6,444)
—
(41)
— $
20,238
121
(12,322)
(1,297)
(255)
6,485
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
Collateral dependent
F-27
December 31,
2017
2016
(Dollars in thousands)
$
$
2,670,657
$
2,489,028
1,436
2,222
1,591
—
2,674,315
$
2,490,619
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 twelve months. In these situations new loan amortization schedules are calculated
based on the principal not collected during this twelve month workout period and larger payments are collected for the remaining term of each
loan. In all cases, the original interest rate and maturity date have not been modified, and we have not forgiven any principal amounts.
Mortgage loans are considered delinquent when they become 60 days or more past due. In general, 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 non-accrual status at December 31, 2017 totaled $2.2 million.
There were no loans in non-accrual status at December 31, 2016.
We define collateral dependent loans as those mortgage loans for which we will depend on the value of the collateral real estate to satisfy the
outstanding principal of the loan.
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 collateral 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 agreed 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, 2017
December 31, 2016
$
$
— $
2,737
$
— $
— $
— $
— $
— $
2,672,093
2,737
$
2,487,882
$
$
2,222
$
2,674,315
— $
2,490,619
Financing receivables summarized in the following two tables 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, 2017
Mortgage loans with an allowance
Mortgage loans with no related allowance
December 31, 2016
Mortgage loans with an allowance
Mortgage loans with no related allowance
Recorded
Investment
Unpaid Principal
Balance
Related
Allowance
(Dollars in thousands)
$
$
$
$
4,027
1,436
5,463
3,313
1,591
4,904
$
$
$
$
5,445
1,436
6,881
4,640
1,591
6,231
$
$
$
$
(1,418)
—
(1,418)
(1,327)
—
(1,327)
F-28
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2017
Mortgage loans with an allowance
Mortgage loans with no related allowance
December 31, 2016
Mortgage loans with an allowance
Mortgage loans with no related allowance
December 31, 2015
Mortgage loans with an allowance
Mortgage loans with no related allowance
Average Recorded
Investment
Interest Income
Recognized
(Dollars in thousands)
$
$
$
$
$
$
4,464
1,513
5,977
3,398
1,665
5,063
13,893
8,930
22,823
$
$
$
$
$
$
221
91
312
301
73
374
1,117
584
1,701
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 constitute a concession on our part. We analyze all loans where we have agreed 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.
Mortgage loan workouts, refinances or restructures that are classified as TDRs are individually evaluated and measured for impairment. A
summary of mortgage loans on commercial real estate with outstanding principal at December 31, 2017 and 2016 that we determined to be TDRs
are as follows:
Geographic Region
Year ended December 31, 2017
South Atlantic
East North Central
Year ended December 31, 2016
South Atlantic
East North Central
Number of
TDRs
Principal
Balance
Outstanding
Specific Loan
Loss Allowance
(Dollars in thousands)
Net
Carrying
Amount
$
$
$
$
2,947
1,933
4,880
3,004
2,020
5,024
$
$
$
$
— $
(467)
(467) $
— $
(467)
(467) $
2,947
1,466
4,413
3,004
1,553
4,557
1
1
2
1
1
2
F-29
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. Derivative Instruments
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
Interest rate caps
Liabilities
Policy benefit reserves - annuity products
Fixed index annuities - embedded derivatives, net
Other liabilities
Interest rate swap
December 31,
2017
2016
(Dollars in thousands)
$
$
$
$
1,568,380
$
830,519
415
1,568,795
$
1,082
831,601
8,790,427
$
6,563,288
789
2,113
8,791,216
$
6,565,401
The changes in fair value of derivatives included in the consolidated statements of operations are as follows:
Change in fair value of derivatives:
Call options
2015 notes hedges
Interest rate swap
Interest rate caps
Change in fair value of embedded derivatives:
Fixed index annuities - embedded derivatives (see Note 2)
Other changes in difference between policy benefit reserves computed using
derivative accounting vs. long-duration contracts accounting
2015 notes embedded conversion derivative (see Note 9)
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
$
$
1,678,283
$
165,029
$
(327,921)
—
255
(667)
1,677,871
174,154
745,581
—
$
$
—
(482)
(328)
164,219
145,045
398,420
—
$
$
919,735
$
543,465
$
(4,516)
(2,341)
(1,368)
(336,146)
(825,668)
365,486
(4,516)
(464,698)
The amounts presented as "Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration
contracts accounting" represents the total 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, less the change in fair value of
our fixed index annuities embedded derivatives that is presented as Level 3 liabilities in Note 2.
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.
F-30
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our strategy attempts to mitigate any potential risk of loss due to the nonperformance of the counterparties to these call options 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
Canadian Imperial Bank of Commerce
Citibank, N.A.
Credit Suisse
Deutsche Bank
J.P. Morgan
Morgan Stanley
Royal Bank of Canada
SunTrust
Wells Fargo
Exchange traded
Credit Rating
(S&P)
Credit Rating
(Moody's)
Notional
Amount
Fair Value
Notional
Amount
Fair Value
December 31,
2017
2016
A+
A
A
A+
A+
A
A-
A+
A+
AA-
A-
AA-
Aa3
A1
Aa3
A1
A1
A1
Baa2
Aa3
A1
A1
Baa1
Aa2
$
4,645,366
$
237,955
$
5,958,884
$
178,477
(Dollars in thousands)
4,135,537
1,411,989
2,808,030
4,104,666
3,538,855
—
1,753,649
3,408,179
3,027,469
2,331,168
4,036,255
296,840
154,127
73,650
84,268
219,900
137,384
—
109,689
184,323
104,141
90,399
162,781
9,763
3,441,832
1,199,265
—
4,038,528
2,130,710
25,935
1,785,583
2,543,421
3,384,310
2,375,418
3,850,842
313,354
$
35,498,003
$
1,568,380
$
31,048,082
$
89,721
19,598
—
97,094
44,242
892
19,645
64,425
103,510
72,990
130,545
9,380
830,519
As of December 31, 2017 and 2016, we held $1.6 billion and $827.8 million, respectively, of cash and cash equivalents and other securities 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 $11.9 million and $55.5 million at December 31, 2017 and 2016, 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 interest rate 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 ("LIBOR") 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
(Dollars in thousands)
March 15, 2021
$
85,500
LIBOR
2.415%
SunTrust
$
(789) $
(2,113)
December 31,
2017
2016
F-31
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Details regarding the interest rate caps are as follows:
December 31,
2017
2016
Maturity Date
July 7, 2021
July 8, 2021
July 29, 2021
Notional
Amount
$
$
40,000
12,000
27,000
79,000
Floating Rate
Cap Rate
Counterparty
Fair Value
Fair Value
LIBOR
LIBOR
LIBOR
2.50%
2.50%
2.50%
SunTrust
SunTrust
SunTrust
(Dollars in thousands)
207
$
62
146
415
$
542
163
377
1,082
$
$
The interest rate swap converts floating rates to fixed rates for seven years which began in March 2014. The interest rate caps cap our interest
rates for seven years which began in July 2014. As of December 31, 2017, we deposited $0.5 million of collateral with the counterparty to the
swap.
In September 2010, concurrently with the issuance of $200.0 million principal amount of 3.50% Convertible Senior Notes due September 15, 2015
(the "2015 notes"), we entered into hedge transactions (the "2015 notes hedges") with two counterparties whereby we would receive the cash
equivalent of the conversion spread on 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. The number of shares and strike price of the 2015 notes hedges were subject to adjustment based
on dividends we paid subsequent to their purchase. The 2015 notes hedges expired on September 15, 2015, and we received $25.8 million in
cash. The 2015 notes hedges were accounted for as derivative assets and were included in other assets in our consolidated balance sheets. The
2015 notes embedded conversion derivative liability was settled with the extinguishment of the 2015 notes (see Note 9) whereby we paid holders
of the notes a total of $25.8 million in cash to settle the conversion premium. The 2015 notes hedges and 2015 notes embedded conversion
derivative were adjusted to fair value each reporting period and unrealized gains and losses are reflected in our consolidated statements of
operations.
In separate transactions, we sold warrants (the "2015 warrants") to the 2015 notes hedges counterparties for the purchase of up to 16.0 million
shares of our common stock at a price of $16.00 per share. We received $15.6 million in cash proceeds from the sale of the 2015 warrants, which
was recorded as an increase in additional paid-in capital. The number of shares and strike price of the warrants were subject to adjustment based
on dividends we paid subsequent to selling the warrants. The warrants expired on various dates from December 2015 through June 2016.
Changes in the fair value of these warrants were not recognized in our consolidated financial statements as the instruments remain classified as
equity.
In December 2015, we began settling the 2015 warrants in net shares on a weekly basis, and completed the settlement of all warrants by June
30, 2016. 140,866 shares of our common stock were delivered to holders of the expiring warrants, of which 92,998 shares were issued during
2016. 2015 warrants remained outstanding on 1.6 million shares of our common stock at a strike price of $15.59 per share at December 31,
2015. As the average price of our common stock exceeded the strike price of the 2015 warrants while they were outstanding the dilutive effect
of the 2015 warrants has been included in diluted earnings per share for the years ended December 31, 2016 and 2015.
6. Deferred Policy Acquisition Costs, Deferred Sales Inducements and Lifetime Income Benefit Rider Reserves
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
Balance at end of year
December 31,
2017
2016
2015
(Dollars in thousands)
$
2,905,377
$
2,905,136
$
2,058,556
401,124
5,517
(255,964)
(341,531)
538,863
4,462
(374,012)
(169,072)
651,094
6,545
(286,114)
475,055
$
2,714,523
$
2,905,377
$
2,905,136
F-32
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,
2017
2016
2015
(Dollars in thousands)
$
$
2,208,218
$
2,232,148
$
1,587,257
216,172
(176,612)
(245,886)
353,966
(251,166)
(126,730)
486,924
(209,390)
367,357
2,001,892
$
2,208,218
$
2,232,148
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. In addition, we periodically revise the assumptions
used in determining reserves held for lifetime income benefit riders as experience develops that is different from our assumptions.
The unlocking adjustments in 2017 decreased amortization of deferred policy acquisition costs by $48.2 million and amortization of deferred
sales inducements by $34.3 million. During the third quarter of 2017, the most significant revisions to such assumptions were account balance
true-ups which were favorable to us due to stronger index credits than we assumed due to strong equity market performance and adjustments to
generally decrease lapse rate assumptions to reflect better persistency experienced than assumed. The favorable impact of the account balance
true-ups and lapse rate assumption changes was partially offset by reductions in estimated future gross profits attributable to revisions to
assumptions used in determining reserves held for lifetime income benefit riders as well as an increase in estimated expenses associated with a
reinsurance agreement with an unaffiliated reinsurer.
The unlocking adjustments in 2016 increased amortization of deferred policy acquisition costs by $48.2 million and amortization of deferred
sales inducements by $35.8 million. During the first quarter of 2016, we made adjustments to lower future spread assumptions as actual investment
spreads being earned showed investment spread and gross profits being less than what we were assuming in our models due to decreases in the
average yield on invested assets resulting from the continued low interest rate environment. We made further adjustments in the third quarter of
2016 to extend the period of time in which we assume investment spread will grade up to our long-term spread targets by an additional two years
as yields obtained on investments purchased in the third quarter of 2016 were much lower than we had anticipated as a result of the overall
decline in investment yields that followed the Brexit vote. In addition, during the third quarter of 2016, revisions to assumptions used in
determining reserves held for living income benefit riders resulted in a decrease in estimated future gross profits.
The unlocking adjustments in 2015 decreased amortization of deferred policy acquisition costs by $11.0 million and amortization of deferred
sales inducements by $5.6 million and included the impact of account balance true-ups as of September 30, 2015, which were favorable to us
due to stronger equity market performance than we assumed, favorable adjustments to lapse assumptions to reflect better persistency experienced
than assumed and unfavorable adjustments to investment spread to reflect lower spreads being earned than assumed. The favorable impact of
the account balance true-up and lapse assumption change was largely offset by reductions in estimated future gross profits attributable to revisions
to assumptions used in determining reserves held for lifetime income benefit riders.
The 2017, 2016 and 2015 revisions to reserves for lifetime income benefit riders were consistent with unlocking for deferred policy acquisition
costs and deferred sales inducements described above. The 2017 revisions increased interest sensitive and index product benefits by $21.6
million and were primarily due to the lapse rate assumption changes described above and changes to our account value growth projections. The
2016 revisions increased interest sensitive and index product benefits by $42.0 million and were primarily due to actual index credits on policies
being lower than projected over the past four quarters. The 2015 revisions increased interest sensitive and index product benefits by $18.3
million and were primarily due to an increase to the primary election age to begin receiving lifetime income from 67 to 70 as our experience
had shown that age 70 is the most popular age at which policyholders elect to begin receiving lifetime income benefit payments. The lifetime
income benefit payments are determined by applying a payout factor to the rider's benefit base. The reserve (net of coinsurance ceded) held for
lifetime income benefit riders was $704.4 million and $533.4 million at December 31, 2017 and 2016, respectively.
7. Reinsurance and Policy Provisions
Coinsurance
We have two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of American Equity Life's
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 $0.6 billion and $0.7
billion at December 31, 2017 and 2016, 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 $11.0 million and $9.7 million at December 31, 2017 and 2016,
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.
F-33
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We have three coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in Bermuda. One agreement
ceded 20% of certain of American Equity Life's fixed index annuities issued from January 1, 2009 through March 31, 2010. The business
reinsured under this agreement is no longer eligible for recapture. The second agreement ceded 80% of American Equity Life's multi-year rate
guaranteed annuities issued from July 1, 2009 through December 31, 2013 and 80% of Eagle Life's multi-year rate guaranteed annuities issued
from November 20, 2013 through December 31, 2013. The business reinsured under this agreement may not be recaptured. The third agreement
cedes 80% of American Equity Life's and Eagle Life's multi-year rate guaranteed annuities issued on or after January 1, 2014, 80% of Eagle
Life's fixed index annuities issued prior to January 1, 2017, 50% of Eagle Life's fixed index annuities issued from January 1, 2017 through
December 31, 2018 and 80% of certain of American Equity Life's fixed index annuities issued from August 1, 2016 through December 31, 2016.
The reinsurance agreement specifies that the coinsurance percentage for Eagle Life's fixed index annuities decreases to 20% for policies issued
on or after January 1, 2019. The business reinsured under this agreement may not be recaptured. Coinsurance deposits (aggregate policy benefit
reserves transferred to Athene under these agreements) were $4.2 billion and $3.9 billion at December 31, 2017 and 2016, respectively. American
Equity Life is an intermediary for reinsurance of Eagle Life's business ceded to Athene. American Equity Life and Eagle Life 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 held in trusts and American Equity Life is named as the sole beneficiary of the trusts. The assets in
the trusts 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 trust accounts would ever be 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 the trusts 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 $79.9 million and
$45.8 million at December 31, 2017 and 2016, 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.
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
Financing Arrangements
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
$
$
$
$
$
$
$
6,458
94,382
100,840
177,332
35,561
19,877
$
$
$
5,366
18,446
23,812
93,487
23,848
24,039
232,770
$
141,374
$
(387,280) $
(1,736,054) $
380,683
418,499
(6,597) $
(1,317,555) $
5,427
(14,360)
(8,933)
88,923
(22,616)
9,922
76,229
(471,822)
391,045
(80,777)
We have a reinsurance transaction with Hannover Life Reassurance Company of America ("Hannover"), which is treated as reinsurance under
statutory accounting practices and as a financing arrangement under GAAP. The statutory surplus benefit under this agreement is 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 transaction became effective July 1, 2013 (the "2013 Hannover Transaction").
The 2013 Hannover Transaction, which was amended effective October 1, 2016, is a yearly renewable term reinsurance agreement for statutory
purposes covering 45.6% of waived surrender charges related to penalty free withdrawals, deaths and lifetime income benefit rider payments as
well as lifetime income benefit rider payments in excess of policy fund values on certain business. We may recapture the risks reinsured under
this agreement as of the end of any quarter after December 31, 2020 and the agreement, as amended, makes it punitive to us if we do not recapture
the business ceded no later than the first quarter of 2021. The reserve credit recorded on a statutory basis by American Equity Life was $737.3
million and $638.1 million at December 31, 2017 and 2016, respectively. We pay quarterly reinsurance premiums under this agreement with
an experience refund calculated on a quarterly basis and a risk charge based on the pretax statutory benefit as of the end of each calendar quarter.
Risk charges attributable to the 2013 Hannover Transaction were $28.5 million, $27.7 million, and $21.0 million during 2017, 2016 and 2015,
respectively.
F-34
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 as
none of the receivables are deemed by management to be uncollectible.
8. Income Taxes
We file consolidated federal income tax returns that include all of our wholly-owned subsidiaries. Our income tax expense as presented in the
consolidated financial statements is summarized as follows:
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
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
$
188,356
$
57,412
$
(46,730)
141,626
177,162
—
(10,408)
47,004
74,471
(527)
Total income tax expense (benefit) included in consolidated financial statements
$
318,788
$
120,948
$
75,568
41,916
117,484
(279,860)
(3,649)
(166,025)
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:
State income taxes
Tax exempt net investment income
Impact of Tax Reform
Other
Income tax expense
Effective tax rate
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
$
$
316,271
110,695
$
$
1,961
(4,288)
35,932
(2,674)
$
$
130,247
45,586
2,559
(2,167)
—
1,026
337,314
118,060
2,924
(3,834)
—
334
$
141,626
$
47,004
$
117,484
44.8%
36.1%
34.8%
Tax Reform was enacted on December 22, 2017, reducing the statutory federal income tax rate from 35% to 21% effective January 1, 2018. The
primary impact on our 2017 financial results is the reduction in the U.S. statutory tax rate from 35% to 21% on our deferred tax balances as of
December 31, 2017.
F-35
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, 2017 and 2016, are as follows:
Deferred income tax assets:
Policy benefit reserves
Other than temporary impairments
Amounts due reinsurer
Other policyholder funds
Deferred compensation
Share-based compensation
State net operating loss carryforwards
Other
Gross deferred tax assets
Deferred income tax liabilities:
December 31,
2017
2016
(Dollars in thousands)
$
1,842,049
$
11,262
6,852
3,724
3,827
3,383
3,196
10,253
1,884,546
2,354,786
15,681
1,321
6,474
7,963
5,407
3,745
11,367
2,406,744
Deferred policy acquisition costs and deferred sales inducements
(1,212,509)
(1,951,333)
Net unrealized gains on available for sale fixed maturity and equity securities
Derivative instruments
Policy benefit reserves
Investment income items
Other
Gross deferred tax liabilities
Net deferred income tax asset
(220,533)
(179,776)
(197,233)
(34,849)
(1,499)
(1,846,399)
$
38,147
$
(170,925)
(75,405)
—
(39,118)
(1,385)
(2,238,166)
168,578
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. We have 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 be necessary to liquidate these securities at a
loss to meet cash flow needs.
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, 2017 and 2016.
There were no material income tax contingencies requiring recognition in our consolidated financial statements as of December 31, 2017. We
are no longer subject to income tax examinations by tax authorities for years prior to 2013.
At December 31, 2017, we have no non-life net operating loss carryforwards remaining for federal income tax purposes.
F-36
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Notes and Loan Payable and Amounts Due Under Repurchase Agreements
Notes and loan payable includes the following:
Senior notes due 2027
Principal
Unamortized debt issue costs
Unamortized discount
Senior notes due 2021
Principal
Unamortized debt issue costs
Term loan due 2019
Principal
Unamortized debt issue costs
December 31,
2017
2016
(Dollars in thousands)
$
500,000
$
(5,572)
(335)
—
—
—
—
$
494,093
$
—
—
—
400,000
(5,733)
100,000
(512)
493,755
On June 16, 2017, we issued $500 million aggregate principal amount of senior unsecured notes due 2027 which bear interest at 5.0% per year
and will mature on June 15, 2027 (the “2027 Notes”). The 2027 Notes were issued at a $0.3 million discount, which is being amortized over
the term of the 2027 Notes using the effective interest method. Contractual interest is payable semi-annually in arrears each June 15th and
December 15th. The initial transaction fees and costs totaling $5.8 million were capitalized as deferred financing costs and are being amortized
over the term of the 2027 Notes using the effective interest method. We used the net proceeds from the issuance of the 2027 Notes to prepay
our $100 million term loan (the "Term Loan") that was scheduled to mature in 2019 on June 16, 2017, and to redeem our $400 million notes
that were scheduled to mature in 2021 (the "2021 Notes") on July 17, 2017. We paid $413.3 million to redeem the 2021 Notes which included
a redemption premium equal to 3.313% of the $400 million principal amount of the 2021 Notes. We incurred a loss of $18.4 million on the
redemption of the 2021 Notes.
On September 30, 2016, we entered into a credit agreement with six banks that provided for a $150 million unsecured revolving line of credit
(the "Revolving Facility") that terminates on September 30, 2021 and a $100 million term loan that was scheduled to terminate on September
30, 2019 but was repaid on June 16, 2017 without penalty. We utilized the proceeds from the Term Loan to make a contribution to the capital
and surplus of our subsidiary, American Equity Life. Any proceeds from the Revolving Facility will be used to finance our general corporate
purposes. Interest was payable quarterly on the Term Loan. The interest rate for all borrowings under the credit agreement 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 based on the available unused portion
of the Revolving Facility. The applicable margin and commitment fee rate are based on our credit rating and can change throughout the period
of the borrowings. Based upon our current credit rating, the applicable margin is 0.75% for alternate base rate borrowings and 1.75% for adjusted
LIBOR rate borrowings, and the commitment fee is 0.275%. The interest rate in effect on the Term Loan was 3.125% and 2.625% in 2017 and
2016, respectively. Under this agreement, we are required to maintain a minimum risk-based capital ratio at our subsidiary, American Equity
Life, of 275%, a maximum ratio of adjusted debt to total adjusted capital of 0.35, and a minimum level of statutory surplus at American Equity
Life equal to the sum of 1) 80% of statutory surplus at June 30, 2016, 2) 50% of the statutory net income for each fiscal quarter ending after
June 30, 2016, and 3) 50% of all capital contributed to American Equity Life after June 30, 2016. The Revolving Facility contains an accordion
feature that allows us, on up to three occasions and subject to credit availability, to increase the credit facility by an additional $50 million in
the aggregate. We also have the ability to extend the maturity date of the Revolving Facility by an additional one year past the initial maturity
date of September 30, 2021 with the consent of the extending banks. There are currently no guarantors of the Revolving Facility, but certain of
our subsidiaries must guarantee our obligations under the credit agreement if such subsidiaries guarantee other material amounts of our debt.
No amounts were outstanding under the Revolving Facility at December 31, 2017. As of December 31, 2017, $723.2 million is unrestricted and
could be distributed to shareholders and still be in compliance with all covenants under this credit agreement.
The preceding replaced a $140 million unsecured revolving line of credit agreement with five banks dated November 22, 2013 that was scheduled
to terminate on November 22, 2017.
On July 17, 2013, we issued $400 million aggregate principal amount of senior unsecured notes due 2021 which bore interest at 6.625% per
year and would have matured on July 15, 2021 had we not redeemed them in 2017. Contractual interest was payable semi-annually in arrears
each January 15th and July 15th. The initial transaction fees and expenses totaling $9.0 million were capitalized as deferred financing costs and
were being amortized over the term of the 2021 Notes using the effective interest method.
F-37
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In September 2010, we issued $200.0 million principal amount of 2015 notes (the "2015 Notes"). The 2015 Notes had a coupon interest rate of
3.5% per year, matured on September 15, 2015, and were settled in cash on the maturity date. Contractual interest was 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 were amortized over the term of the 2015 Notes using the effective interest method.
The conversion option of the 2015 Notes (the "2015 notes embedded conversion derivative") was an embedded derivative that required bifurcation
from the 2015 notes and was accounted for as a derivative liability, which was 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
as the original debt discount for purposes of accounting for the debt component of the 2015 Notes. This discount was amortized and recognized
as interest expense using the effective interest method over the term of the 2015 Notes.
The 2015 Notes, that had not previously been extinguished, matured and were extinguished on September 15, 2015. Total consideration paid
to holders of the 2015 Notes at maturity was $48.2 million in cash, which included $22.4 million principal amount and $25.8 million conversion
premium. See Note 5 for a discussion of the settlement of the 2015 notes embedded derivative liability.
As part of our investment strategy, we enter into securities repurchase agreements (short-term collateralized borrowings). The maximum amount
borrowed during 2017, 2016 and 2015 was $274.5 million, $113.0 million and $40.6 million, respectively. 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 $40.0 million, $4.5 million and $0.5 million for the years ended
December 31, 2017, 2016 and 2015, respectively. The weighted average interest rate on amounts due under repurchase agreements was 0.84%,
0.66% and 0.39% for the years ended December 31, 2017, 2016 and 2015, respectively.
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, 2017 and 2016:
December 31,
2017
2016
Interest Rate
Due Date
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
Unamortized debt issue costs
(Dollars in thousands)
$
77,298
$
77,061
5%
27,840
12,372
10,830
20,620
15,470
20,620
20,620
41,238
246,908
(4,343)
$
242,565
$
June 1, 2047
April 29, 2034
27,840
*LIBOR + 3.90%
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
246,671
(4,818)
241,853
*—three month London Interbank Offered Rate
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.
F-38
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 annual contribution of $18,000 in 2017, 2016 and 2015) 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 $1.4 million, $1.3 million and $0.4 million for the years
ended December 31, 2017, 2016 and 2015, respectively.
The following table summarizes compensation expense recognized for employees and directors as a result of share-based compensation:
ESOP
Employee Incentive Plans
Director Equity and Incentive Plan and Stock Option Plan
Year Ended December 31,
2017
2016
2015
$
$
(Dollars in thousands)
1,474
$
2,522
$
2,155
812
1,207
685
4,441
$
4,414
$
2,604
1,911
613
5,128
The principal purpose of the American Equity Investment Employee Stock Ownership Plan ("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 two years of service. Our contribution to the ESOP is determined by the Board of Directors.
In 2016, we adopted the 2016 Employee Incentive Plan which authorized the issuance of up to 2,500,000 shares of our Common stock in the
form of grants of options, stock appreciation rights, restricted stock awards and restricted stock units. At December 31, 2017, we had 2,101,954
shares of common stock available for future grant under the 2016 Employee Incentive Plan. The 2009 Employee Incentive Plan, which expired
in June 2014, authorized the issuance of up to 2,500,000 shares of our common stock in the form of grants of options, stock appreciation rights,
restricted stock awards and restricted stock units. All options granted under this plan had six or ten year terms and a three year vesting period
after which they become fully exercisable immediately.
We have a long-term performance incentive plan under which certain members of our senior management team are granted restricted stock units
pursuant to the 2016 Employee Incentive Plan or the 2009 Employee Incentive Plan. During 2017, 2016 and 2015, we granted 84,476, 208,565
and 60,947 restricted stock units under these plans, respectively. For the 2017 grant, vesting is tied to threshold, target and maximum performance
goals for the three year period ending December 31, 2019. Fifty percent of the restricted stock units will vest if we meet threshold goals, 100%
of the restricted stock units will vest if we meet target performance goals and 150% of the restricted stock units will vest if we meet maximum
performance goals. For the 2016 and 2015 grants, vesting is tied to threshold and target performance goals for the three year periods ending
December 31, 2018 and December 31, 2017, respectively. Fifty percent of the restricted stock units will vest if we meet threshold goals and
100% of the restricted stock units will vest if we meet target performance goals. Compensation expense is recognized over the three year vesting
period based on the likelihood of meeting threshold and target goals. Restricted stock units that ultimately vest are payable in an equal number
of shares of our common stock. Restricted stock units are accounted for as equity awards and the estimated fair value of restricted stock units
is based upon the closing price of our common stock on the date of grant. During 2016, the 2015 restricted stock unit award agreements were
amended and the restricted stock units granted during 2015 will be settled in cash. This amendment was due to an administrative issue related
to the grant, which was made under an expired equity plan.
During 2017, 2016 and 2015, we issued 39,826, 43,373 and 25,784, respectively, shares of restricted common stock under the 2016 Employee
Incentive Plan or the 2009 Employee Incentive Plan to certain employees. These shares will generally vest on the date three years following
the grant date provided the participant remains employed with us. The 2017 grant includes 6,727 shares that will vest on the date one year
following the grant date provided the participant remains employed with us. Compensation expense is recognized over the one year or three
year vesting period. Shares vest immediately for participants over 65 years of age with 10 years of service with us, and compensation expense
under this plan for these participants was recognized upon approval of the incentive award by the compensation committee. During 2016, the
shares of restricted stock granted during 2015 were canceled due to an administrative issue related to the grant, which was made under an expired
equity plan. During 2016, we issued 21,806 shares of common stock to the employees impacted by the cancellation taking into consideration
the canceled 2015 grants.
The 2013 Director Equity and Incentive Plan authorizes the grant of options, stock appreciation rights, restricted stock awards and restricted
stock units convertible into or based upon our common stock of up to 250,000 shares to our Directors. During 2017, 2016 and 2015, we issued
33,000, 47,500 and 22,000 shares of common stock, respectively, all of which are restricted stock, and which vest the earlier of the next annual
meeting date or one year from the grant date provided the individual remains a Director during that time period. At 2017, we had 83,500 shares
of common stock available for future grant under the 2013 Director and Equity Incentive Plan.
F-39
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our 1996 Stock Option Plan, 2000 Employee Stock Option Plan, 2000 Directors Stock Option Plan and 2011 Director Stock Option Plan
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 ten year terms and a six month or three year vesting period after which they become fully exercisable immediately.
At December 31, 2017, we had 18,000 shares of common stock available for future grant under the 2011 Director Stock Option Plan.
During 2014, we established the 2014 Independent Insurance Agent Restricted Stock and Restricted Stock Unit Plan, which was amended during
2016. Under the amended plan, agents of American Equity Life may receive grants of restricted stock and restricted stock units based upon
their individual sales. The plan authorizes grants of up to 1,800,000 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 restricted stock and restricted stock units as they
are earned.
In January 2017, American Equity Life's agents were granted 363,624 restricted stock units based on their production during 2016, and we
recorded commission expense (capitalized as deferred policy acquisition costs) of $2.6 million in 2016. In January 2018, agents vested in 138,820
restricted stock units granted in January 2017 based on their continued service as an independent agent and their 2017 individual sales of our
products, and for which we recorded commission expense (capitalized as deferred policy acquisition costs) of $1.3 million in 2017.
In January 2016, American Equity Life's agents were granted 650,683 restricted stock units based on their production during 2015, and we
recorded commission expense (capitalized as deferred policy acquisition costs) of $3.5 million in 2015. In January 2017, agents vested in 246,532
restricted stock units granted in January 2016 based on their continued service as an independent agent and their 2016 individual sales of our
products, and for which we recorded commission expense (capitalized as deferred policy acquisition costs) of $1.7 million in 2016. In January
2018, agents vested in 100,586 restricted stock units granted in January 2016 based on their continued service as an independent agent and their
2017 individual sales of our products, and for which we recorded commission expense (capitalized as deferred policy acquisition costs) of $2.2
million in 2017. 20% of the restricted stock units will vest one year from the grant date if the agent is in good standing with American Equity
Life at that date. The remaining 80% of the restricted stock units granted to retirement eligible individuals will vest over a three year period if
the agent remains in good standing with American Equity Life. The remaining 80% of the restricted stock units granted to non-retirement eligible
individuals will vest based on the agent's individual sales and continued service as an independent agent over a period of time not to exceed five
years.
In January 2015, American Equity Life's agents were granted 27,985 shares of restricted stock and 221,489 restricted stock units based on their
production during 2014, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $1.9 million in 2014. In
January 2016, agents vested in 85,104 restricted stock units granted in January of 2015 based on their continued service as an independent agent
and their 2015 individual sales of our products, and for which we recorded commission expense (capitalized as deferred policy acquisition costs)
of $1.3 million in 2015. In January 2017, agents vested in 36,609 restricted stock units granted in January 2015 based on their continued service
as an independent agent and their 2016 individual sales of our products, and for which we recorded commission expense (capitalized as deferred
policy acquisition costs) of $0.6 million in 2016. In January 2018, agents vested in 32,815 restricted stock units granted in January 2015 based
on their continued service as an independent agent and their 2017 individual sales of our products, and for which we recorded commission
expense (capitalized as deferred policy acquisition costs) of $0.8 million in 2017. The restricted stock was granted to retirement eligible individuals
and vested immediately upon grant. 20% of the restricted stock units vested one year from the grant date if the agent was in good standing with
American Equity Life at that date. The remaining 80% of the restricted stock units granted will vest based on the agent's individual sales and
continued service as an independent agent over a period of time not to exceed five years.
During 2007, 2010 and 2012 we established Independent Insurance Agent Stock Option plans. Under these plans, agents of American Equity
Life received 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.
F-40
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Changes in the number of stock options outstanding during the years ended December 31, 2017, 2016 and 2015 are as follows:
Outstanding at January 1, 2015
Granted
Canceled
Exercised
Outstanding at December 31, 2015
Granted
Canceled
Exercised
Outstanding at December 31, 2016
Granted
Canceled
Exercised
Outstanding at December 31, 2017
Number of
Shares
Weighted-Average
Exercise Price
per Share
Total
Exercise
Price
(Dollars in thousands, except per share data)
4,044,175
$
15.02
$
—
(47,300)
(552,884)
3,443,991
—
(24,700)
(500,345)
2,918,946
—
(57,200)
(881,481)
1,980,265
—
10.54
14.51
15.17
—
14.83
9.97
16.06
—
13.66
15.90
16.20
$
60,760
—
(499)
(8,021)
52,240
—
(366)
(4,989)
46,885
—
(781)
(14,020)
32,084
The following table summarizes information about stock options outstanding at December 31, 2017:
Range of Exercise Prices
$5.07 - $8.02
$9.27 - $11.35
$12.04 - $24.79
$5.07 - $24.79
Stock Options Outstanding and Vested
Number of
Awards
Remaining
Life (yrs)
Weighted-Average
Exercise Price
Per Share
182,500
575,055
1,222,710
1,980,265
$
1.36
1.75
2.53
2.20
6.85
10.15
20.44
16.20
The aggregate intrinsic value for stock options outstanding and vested awards was $28.8 million at December 31, 2017. For the years ended
December 31, 2017, 2016 and 2015, the total intrinsic value of options exercised by officers, directors and employees was $1.5 million,
$4.0 million and $1.4 million, respectively. 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, 2017, 2016 and 2015 was $14.0 million, $5.0 million and $8.1 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 both December 31, 2017 and 2016, these individuals have earned, and we have
reserved for future issuance, 364,000 shares of common stock, respectively, pursuant to these arrangements. No deferred compensation
arrangements were in effect during 2017 or 2016. We incurred expense of $102,000 for the year ended December 31, 2015, under one of these
arrangements.
We have deferred compensation agreements with certain officers whereby these individuals have deferred certain salary and bonus compensation
which is deposited into the American Equity Officer Rabbi Trust (Officer Rabbi Trust). The amounts deferred for certain employees 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 $2.0 million and $3.5 million at December 31, 2017 and 2016, respectively. The Officer Rabbi Trust held 34,539 shares and
102,932 shares of our common stock at December 31, 2017 and 2016, respectively, which are treated as treasury shares.
F-41
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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
$
375,900
$
75,035
$
131,452
Statutory capital and surplus for our primary life insurance subsidiary was as follows:
Year Ended December 31,
2017
2016
2015
(Dollars in thousands)
American Equity Life
December 31,
2017
2016
(Dollars in thousands)
$
3,005,654
$
2,726,664
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
Ratio of adjusted capital to Company Action Level RBC
December 31,
2017
2016
(Dollars in thousands)
$
3,260,328
$
2,933,193
861,419
378%
857,321
342%
Prior approval of regulatory authorities is required for the payment of dividends to the 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 gains/losses for the
preceding calendar year or, (2) 10% of the American Equity Life's 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 is $377.1 million as of December 31, 2017.
No dividends were paid by any of our insurance subsidiaries for any of the years presented in these financial statements.
The Parent Company relies on its subsidiaries for cash flow, which has primarily been in the form of investment management fees. 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, 2017,
2016 and 2015 totaled $2.9 million, $2.8 million and $2.7 million, respectively. At December 31, 2017, the aggregate future minimum lease
payments are $15.4 million. The following represents payments due by period for operating lease obligations as of December 31, 2017 (dollars
in thousands):
Year Ending December 31:
2018
2019
2020
2021
2022
2023 and thereafter
$
1,998
1,981
2,033
1,837
1,680
5,845
F-42
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
There can be no assurance that any pending or future litigation will not have a material adverse effect on our business, financial condition, or
results of operations.
In addition to our commitments to fund mortgage loans, we have unfunded commitments at December 31, 2017 to limited partnerships of $47.9
million and to secured bank loans of $11.2 million.
14. Earnings Per Share and Stockholders' Equity
Earnings Per Share
The following table sets forth the computation of earnings per common share and earnings per common share—assuming dilution:
Year Ended December 31,
2017
2016
2015
(Dollars in thousands, except per share data)
Numerator:
Net income—numerator for earnings per common share
$
174,645
$
83,243
$
219,830
Denominator:
Weighted average common shares outstanding (1)
88,982,442
84,793,151
78,936,828
Effect of dilutive securities:
Equity forward sale agreements
2015 warrants
Stock options and deferred compensation agreements
Restricted stock and restricted stock units
—
—
945,612
382,954
—
15,136
456,236
340,646
Denominator for earnings per common share—assuming dilution
90,311,008
85,605,169
67,575
759,723
1,040,922
155,520
80,960,568
Earnings per common share
Earnings per common share - assuming dilution
$
$
1.96
1.93
$
$
0.98
0.97
$
$
2.78
2.72
(1) Weighted average common shares outstanding include shares vested under the NMO Deferred Compensation Plan.
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, 2017
Year ended December 31, 2016
Year ended December 31, 2015
Number of
Shares
—
1,054,091
1,061,541
Range of
Exercise Prices
Minimum
Maximum
$—
$24.79
$24.79
$—
$24.79
$24.79
F-43
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Stockholders' Equity
In August 2015, we completed an underwritten public offering of 8,600,000 shares of our common stock at a public offering price of $25.25 per
share, of which 4,300,000 shares were subject to a forward sale agreement. The underwriters exercised in full their option to purchase 1,290,000
additional shares of common stock, which were subject to a separate forward sale agreement. We settled the forward sale agreements on August
1, 2016 and issued 5,590,000 shares of our common stock and received $134.7 million in net proceeds. We contributed the net proceeds from
the settlement to the capital and surplus of American Equity Life.
The forward sale agreements had no initial fair value since they were entered into at the then market price of the common stock. The forward
sale agreements were equity instruments and qualified for an exception from derivative and fair value accounting.
15. Quarterly Financial Information (Unaudited)
Unaudited quarterly results of operations are summarized below.
2017
Premiums and product charges
Net investment income
Change in fair value of derivatives
Net realized gains on investments, excluding OTTI losses
Net OTTI losses recognized in operations
Loss on extinguishment of debt
Total revenues
Net income
Earnings per common share
Earnings per common share - assuming dilution
2016
Premiums and product charges
Net investment income
Change in fair value of derivatives
Net realized gains 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)
$
52,974
$
56,323
$
60,500
$
485,597
386,533
2,338
(141)
—
927,301
53,939
0.61
0.60
493,489
266,820
3,873
(949)
(428)
819,128
26,946
0.30
0.30
500,202
362,525
1,579
(464)
(18,389)
905,953
56,957
0.64
0.63
$
43,850
$
52,582
$
60,406
$
450,826
(74,065)
2,687
(5,694)
417,604
(44,841)
(0.55)
(0.55)
459,830
39,099
2,737
(4,446)
549,802
14,708
0.18
0.18
463,583
103,794
5,256
(2,979)
630,060
(7,420)
(0.09)
(0.09)
64,925
512,709
661,993
2,719
(3,076)
—
1,239,270
36,803
0.41
0.41
60,508
475,633
95,391
844
(9,560)
622,816
120,796
1.37
1.35
Earnings (loss) per common share for each quarter is computed independently of earnings (loss) per common share for the year. As a result, the
sum of the quarterly earnings (loss) per common share amounts may not equal the earnings (loss) per common share for the year.
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:
2017
2016
Quarter Ended
March 31,
June 30,
September 30,
December 31,
(Dollars in thousands)
$
7,069
$
37,075
$
30,806
$
62,822
34,215
6,054
3,518
(66,618)
F-44
Schedule I—Summary of Investments—
Other Than Investments in Related Parties
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
December 31, 2017
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
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
$
11,861
$
11,876
$
11,876
1,308,290
3,804,360
228,214
1,305,017
4,166,812
239,360
1,305,017
4,166,812
239,360
28,127,653
29,878,971
29,878,971
1,028,484
5,531,922
3,075,975
1,105,567
5,544,850
3,120,536
1,105,567
5,544,850
3,120,536
43,116,759
45,372,989
45,372,989
77,041
43,193,800
2,665,531
373,244
616,764
76,460
77,041
45,449,449
45,450,030
2,670,037
1,568,380
2,665,531
1,568,380
616,764
$
46,849,339
$
50,300,705
(1) On the basis of cost adjusted for other than temporary impairments, 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-45
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
Investment in and advances to subsidiaries
Total assets
Liabilities and Stockholders' Equity
Liabilities:
Notes and loan payable
Subordinated debentures payable to subsidiary trusts
Federal income tax payable
Other liabilities
Total liabilities
Stockholders' equity:
Common stock
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
December 31,
2017
2016
$
22,486
$
36,394
7,429
166
7,945
1,059
1,566
40,651
3,550,405
7,422
182
9,528
—
2,540
56,066
2,992,217
$
3,591,056
$
3,048,283
$
494,093
$
242,565
—
4,241
740,899
89,331
791,446
724,599
1,244,781
2,850,157
493,755
241,853
3,614
17,466
756,688
88,001
770,344
339,966
1,093,284
2,291,595
$
3,591,056
$
3,048,283
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-46
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
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 and loan payable
Interest expense on subordinated debentures issued to subsidiary trusts
Other operating costs and expenses
Total expenses
Income before income taxes and equity in undistributed income of subsidiaries
Income tax expense
Income before equity in undistributed income of subsidiaries
Equity in undistributed income of subsidiaries
Net income
Year Ended December 31,
2017
2016
2015
$
$
492
410
83,941
4,080
(412)
(18,817)
69,694
—
30,368
14,124
9,234
53,726
15,968
6,895
9,073
165,572
78
$
384
75,706
4,080
(810)
—
79,438
—
28,248
12,958
8,551
49,757
29,681
12,073
17,608
65,635
$
174,645
$
83,243
$
62
363
65,957
4,080
(8,225)
—
62,237
(4,516)
28,849
12,239
8,195
44,767
17,470
7,338
10,132
209,698
219,830
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-47
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 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
Accrual of discount on contingent convertible notes
Change in fair value of derivatives
Loss on extinguishment of debt
Accrual of discount on debenture issued to subsidiary trust
Share-based compensation
Deferred income taxes
Changes in operating assets and liabilities:
Receivable from subsidiaries
Federal income tax recoverable/payable
Other assets
Other liabilities
Net cash provided by operating activities
Investing activities
Capital contributions to subsidiaries
Purchases of property, plant and equipment
Net cash used in investing activities
Financing activities
Financing fees incurred and deferred
Repayment of notes payable
Repayment of loan payable
Proceeds from issuance of notes payable
Proceeds from issuance of loan payable
Proceeds from issuance of common stock
Net proceeds from settlement of notes hedges and warrants
Dividends paid
Net cash provided by (used in) financing activities
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 and loan payable
Interest on subordinated debentures
Non-cash financing activity:
Year Ended December 31,
2017
2016
2015
$
174,645
$
83,243
$
219,830
—
1,610
(7)
—
1,946
(7)
(4,516)
1,613
(6)
(165,572)
(65,635)
(209,698)
—
(657)
18,817
236
951
1,583
16
(4,673)
158
(12,427)
14,680
—
(698)
—
221
818
2,117
(125)
11,361
(326)
2,546
35,461
698
6,377
—
207
1,026
8,967
93
2,683
(4)
(1,664)
25,606
$
$
$
$
— $
(255,000) $
(120,000)
(45)
(45)
(54)
—
(255,054)
(120,000)
(5,817) $
(1,456) $
(413,252)
(100,000)
499,650
—
14,028
—
(23,152)
(28,543)
(13,908)
36,394
—
—
—
100,000
139,654
—
(21,114)
217,084
(2,509)
38,903
22,486
$
36,394
$
—
(48,152)
—
—
—
112,481
25,775
(17,946)
72,158
(22,236)
61,139
38,903
$
40,537
14,573
$
27,164
12,454
27,283
11,833
Common stock issued to settle warrants that have expired
—
93
48
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-48
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Note to Condensed Financial Statements
December 31, 2017
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-49
Schedule III—Supplementary Insurance Information
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Column A
As of December 31, 2017:
Life insurance
As of December 31, 2016:
Life insurance
As of December 31, 2015:
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)
$
$
$
2,714,523
2,905,377
2,905,136
$
$
$
56,142,673
51,637,026
45,495,431
$
$
$
— $
282,884
— $
298,347
— $
324,850
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)
For the year ended December 31, 2017:
Life insurance
For the year ended December 31, 2016:
Life insurance
For the year ended December 31, 2015:
Life insurance
$
$
$
234,722
217,346
172,216
$
$
$
1,991,997
1,849,872
1,692,192
$
$
$
3,163,234
1,572,586
758,203
$
$
$
255,964
374,012
286,114
$
$
$
156,183
143,437
137,306
See accompanying Report of Independent Registered Public Accounting Firm.
F-50
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, 2017
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life, accident and health insurance, and
life contingent immediate annuity premiums
Year ended December 31, 2016
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life, accident and health insurance, and
life contingent immediate annuity premiums
Year ended December 31, 2015
Life insurance in force, at end of year
Insurance premiums and other considerations:
Annuity product charges
Traditional life, accident and health insurance, and
life contingent immediate annuity premiums
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
1,942,129
206,952
33,938
240,890
1,996,446
178,945
43,521
222,466
2,036,690
141,595
35,715
$
$
$
$
$
$
$
$
9,378
6,458
215
6,673
10,045
5,366
251
5,617
10,677
5,427
256
177,310
$
5,683
$
57,965
$
1,990,716
2.91%
— $
200,494
—
1.48%
0.22%
—
1.14%
0.23%
2,044,250
2.83%
— $
173,579
34,228
234,722
43,767
217,346
505
505
57,849
$
$
497
497
56,882
$
$
2,082,895
2.73%
— $
136,168
589
589
$
36,048
172,216
—
1.63%
0.34%
See accompanying Report of Independent Registered Public Accounting Firm.
F-51
Schedule V—Valuation and Qualifying Accounts
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Year ended December 31, 2017
Valuation allowance on mortgage loans
Year ended December 31, 2016
Valuation allowance on mortgage loans
Year ended December 31, 2015
Valuation allowance on mortgage loans
$
$
$
Balance
January 1,
Charged to Costs
and Expenses
Translation
Adjustment
Write-offs/
Payments/Other
Balance
December 31,
(Dollars in thousands
(8,427) $
278
$
— $
631
$
(7,518)
(14,142) $
(4,846) $
— $
10,561
$
(8,427)
(22,633) $
1,018
$
— $
7,473
$
(14,142)
See accompanying Report of Independent Registered Public Accounting Firm.
F-52
Exhibit 12.1
Ratio of Earnings to Fixed Charges
2017
2016
2015
2014
2013
Year Ended December 31,
Consolidated income before income taxes
$
316,271
$
130,247
$
337,314
$
196,064
$
389,332
Interest sensitive and index product benefits and amortization of
deferred sales inducements
Interest expense on notes and loan 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
2,200,280
30,368
14,124
334
967
976,638
28,248
12,958
30
920
1,177,443
1,605,119
1,525,980
28,849
12,239
2
902
36,370
12,122
18
896
38,870
12,088
139
843
$
2,562,344
$
1,149,041
$
1,556,749
$
1,850,589
$
1,967,252
Interest sensitive and index product benefits and amortization of
deferred sales inducements
Interest expense on notes and loan 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
$
2,200,280
$
976,638
$
1,177,443
$
1,605,119
$
1,525,980
30,368
14,124
334
967
28,248
12,958
30
920
28,849
12,239
2
902
36,370
12,122
18
896
38,870
12,088
139
843
$
2,246,073
$
1,018,794
$
1,219,435
$
1,654,525
$
1,577,920
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
1.1
7.9
1.1
4.1
1.3
9.0
1.1
5.0
1.2
8.5
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 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
AERL, L.C.
American Equity Advisors, Inc.
Exhibit 21.2
State of
Incorporation
Iowa
New York
Iowa
Iowa
Iowa
Iowa
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
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. 333-213544, No. 333-207077, No. 333-201008, No. 333-184162,
No. 333-183504, No. 333-171161, No. 333-149854, and No. 333-148681) on Form S-3 and the registration statements (No. 333-214885, No.
333-213545, No. 333-175355, No. 333-167755, and No. 333-127001) on Form S-8 of American Equity Investment Life Holding Company of
our report dated February 23, 2018, with respect to the consolidated balance sheets of American Equity Investment Life Holding Company and
subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income (loss), changes
in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and all related financial statement
schedules, and the effectiveness of internal control over financial reporting as of December 31, 2017, which report appears in the December 31,
2017 annual report on Form 10 K of American Equity Investment Life Holding Company.
Des Moines, Iowa
February 23, 2018
/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: February 23, 2018
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: February 23, 2018
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, 2017 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: February 23, 2018
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, 2017 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: February 23, 2018
By:
/s/ TED M. JOHNSON
Ted M. Johnson, Chief Financial Officer and Treasurer
(Principal Financial Officer)
(This page has been left blank intentionally.)
(This page has been left blank intentionally.)
(This page has been left blank intentionally.)
Letter from the Chairman and CEO
JOHN M. MATOVINA
Our leadership in guaranteed income
remained strong. In September, we
adapted to our independent agents’
increasing emphasis on accumulation
by raising caps and participation rates
on our Choice series of accumulation-
focused fixed index annuities. This effort
was successful, as Choice accounted
for 33 percent of American Equity
Investment Life Insurance Company
sales in the fourth quarter of 2017.
In the second half of the year, we began
expanding our investment universe
beyond our historical concentration in
public corporate debt to support the
higher caps and participation rates.
These new focus areas, including
asset-backed securities and private
corporate debt, tend to be less liquid
but have demonstrated excellent credit
performance over time. The current
liquidity in our investment portfolio
supports our ability to allocate new
money to less liquid credit structures
while maintaining our commitment to
a sound investment philosophy.
A merican Equity enjoyed a solid
2017: we delivered strong
financial performance despite
a challenging sales environment,
continued to grow our policyholder
funds under management and deployed
our sound investment strategy to
minimize impairment losses. Some
key highlights include:
• 7.1 percent increase in policyholder
funds under management.
• Record non-GAAP operating
income1 of $285 million or $3.16
per diluted share.
• Non-GAAP operating return on
average equity1 of 14.0 percent.
• Investment impairment losses of
less than 0.2 percent of average
equity after the effects of deferred
acquisition costs and income taxes.
Reflecting industry headwinds and
increased competition, our fixed index
annuity sales dropped to $4.0 billion
last year from $5.7 billion in 2016.
1
9764_Cover.indd 2
American Equity Investment
Life Holding Company®
Board of Directors
JOHN M. MATOVINA
Chairman, Chief Executive Officer,
and President
JOYCE A. CHAPMAN
Retired Banking Executive and
Community Volunteer
ALEXANDER M. CLARK
Senior Managing Director
Griffin Financial Group
BRENDA J. CUSHING
Consultant and
Retired Executive
JAMES M. GERLACH
Retired Executive
ROBERT L. HOWE
Consultant and Retired Deputy Commissioner
Iowa Insurance Division
WILLIAM R. KUNKEL
General Counsel
Archdiocese of Chicago
ALAN D. MATULA
Chief Information Officer
Weber-Stephen Products LLC
DAVID S. MULCAHY
Chairman
Monarch Materials Group, Inc.
GERARD D. NEUGENT
Co-Chair and Chief Executive Officer
Knapp Properties, Inc.
DEBRA J. RICHARDSON
Retired Executive
A.J. STRICKLAND, III
Professor of Strategic Management
University of Alabama School of Business
Shareholder Information
To learn more about American Equity
Investment Life Holding Company®, you
can request news releases, annual reports,
financial supplements, and Forms 10-K
and 10-Q by contacting:
STEVEN D. SCHWARTZ, CFA
VICE PRESIDENT – INVESTOR RELATIONS
6000 Westown Parkway
West Des Moines, IA 50266
(515) 273-3763 • Fax (515) 221-0744
Email: sschwartz@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 news releases,
conference calls, stock price information,
quarterly reports, SEC filings, management
presentations and more.
ANNUAL SHAREHOLDERS MEETING
June 7, 2018, 1:30 p.m.
AEL Headquarters
CORPORATE HEADQUARTERS
American Equity Investment
Life Holding Company®
6000 Westown Parkway
West Des Moines, IA 50266
(515) 221-0002 • www.american-equity.com
STOCK TRANSFER 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
4/6/18 2:06 AM
American Equity Investment Life Holding Company | 2017 ANNUAL REPORT & FORM 10-K2017 ANNUAL REPORT & FORM 10-K6000 Westown Parkway | West Des Moines, Iowa 50266515-221-0002 | 888-221-1234 | www.american-equity.comAEL-AR-179764_Cover.indd 14/6/18 2:06 AM