Jul 30, 2015
Executives
Julie LaFollette - Director of Investor Relations John Matovina - Chief Executive Officer Ted Johnson - Chief Financial Officer Ronald Grensteiner - President-Life Company
Analysts
Mark Hughes - SunTrust Robinson Humphrey Steven Schwartz - Raymond James & Associates, Inc. John Barnidge - Sandler O'Neill & Partners, L.P
Operator
Welcome to American Equity Investment Life Holding Company’s Second Quarter 2015 Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Director of Investor Relations.
Julie LaFollette
Good morning and welcome to American Equity Investment Life Holding Company’s conference call to discuss second quarter 2015 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.
Presenting on today’s call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer; and Ron Grensteiner, President of the Life Company. Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act.
There are number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC.
An audio replay will be available on our website shortly after today’s call. It is now my pleasure to introduce John Matovina.
John Matovina
Thank you, Julie, and good morning, everyone. Well half way through 2015, we are positioned for a record year at American Equity.
Consistent with our performance over the past several quarters and years, we are performing quiet well on the two key areas that drive our earnings and financial performance, growing our invested assets or policyholder funds under management, and then generating a high level of operating earnings on that growing earning base. Our second quarter sales of 1.8 billion were up 73% from the prior year second quarter and year-to-date sales of 3.1 billion positioned us for that record year of sales in 2015.
The sale outcome fueled a 7.8% increase in policyholder funds under management for the first half of 2015. And as usual, Ron’s remarks will have comments on the sales results and the competitive environment, including the factors that contributed to sales results and our market share gains.
In addition to our sales growth, we also generated a 33% increase in our operating earnings per share, which were $0.64 in the second quarter of 2015 compared to $0.48 per share a year ago. At a trailing 12 months basis, our operating earnings represent a return on average equity of 13.5%.
So let me now turn the call over to Ted for more detailed comments on our second quarter financial results.
Ted Johnson
Thank you, John. Our operating income of 50.9 million for the second quarter was 32% higher than second quarter 2014 operating income of 38.5 million.
As John mentioned, operating income per share growth was even better at 33% due to small reduction in the diluted share count. Our investment spread for the second quarter was 284 basis points compared to 277 basis points last quarter and 270 basis points for the second quarter for 2014.
Spread performance was impacted by average yield on investments, which increased four basis points to 478 from 474 in the first quarter. The increase was due to make-whole consent fees from several bond calls, which together were certain prepayment income added seven basis points to second quarter average yield on invested assets, compared to just one basis point for such items in the first quarter.
Adjusting for the effect of non-trendable items, the average yield on invested assets for the quarter fell by two basis points from the prior quarter, as new premiums and portfolio cash flows were invested at rates below the portfolio rate. The average yield on fixed income securities purchased and commercial mortgage loans funded in the first quarter was 373, compared to 384 in first quarter and average yields ranging from 4.14 to 4.39 in the prior year quarters.
The two basis points of decline was seven basis points better than the nine basis points of decline we experienced in the first quarter. The improvement is generally attributable to two factors interest for commercial mortgage loans and commercial back securities is recognized on the basis of 365 day year whereas most fixed income securities operate off of a 12, 30 day month or at 365 day year.
The second quarter had 91 days of interest for commercial mortgages and CMBS compared to 90 days in the first quarter and 92 days in the fourth quarter in 2014. We also have historically considered 4.5 million of interest from pay downs on residential mortgage backed securities as a baseline amount for measuring excess prepayment income, which we report as non-trendable.
We’ve been below the 4.5 million baseline in each of the last three quarters with the second quarter, 3 million more than the first quarter, and first quarter, 1.1 million less than the fourth quarter 2014. The actual amount for the second quarter was 4.4 million are just high of our 4.5 million baseline.
These two items partially mitigated the impact of investing new premiums and portfolio cash flows at rates below the portfolio rate. The aggregate cost of money for annuity liabilities was 194 in the quarter, compared to 197 in the first quarter.
This decrease reflected continuing reductions in crediting rates. The benefit from over hedging was seven basis points in both second and first quarters of 2015.
We’ve reduced our new money rates by approximately 20 basis points in early March. We have also been actively managing our renewal rates for some time now and most of the renewal rate reductions that were initiated in 2014 were implemented prior to the second quarter.
We initiated additional reductions in 2015 including further adjustments to policies with previous adjustments and initial reductions for policies issued between early October 2011 and early December 2012. A portion of the 2015 rate reductions occurred in the second quarter but the majority will occur on policy anniversary date over the next 12 months.
Our active management of renewal rates will continue should the low investment yields currently available to us persist. We continue to have flexibility in managing our cost of money and could decrease our cost of money by approximately 57 basis points with further reductions and renewal rates to guaranteed minimal rates.
Our operating cost and expenses were 24.9 million in the second quarter compared to 21.1 million in the first quarter and 20.9 million in the second quarter of 2014. First quarter operating expense were lower than the second quarter, due to 1.6 million of refund or reductions in expenses that were nonrecurring.
During the first quarter, we received a reimbursement from our reinsurance counter parties for guaranteed fund assessments and a refund of stay taxes. During the second quarter, we had increase in salaries and benefits of approximately 1 million compared to the first quarter, due to a higher level of expense for incentive plans based on the company’s performance and general increases in salaries.
Our risk-based capital ratio was estimated to be at 349 down from 372 at the end of 2014. However, we continued to remain comfortably above the 300% threshold for our rating from A.
M. Best.
Now, I will turn the call over to Ron to talk about sales and production.
Ronald Grensteiner
Thank you, Ted. Good morning, everyone.
Our policyholders also had a great second quarter and continue to enjoy attractive returns compared to other safe money products such as certificates of deposits. Fixed index annuity policyholders with a policy anniversary in the second quarter earned an average annual index credit of 3.64%.The largest index credit for the quarter was 11.42%.
Approximately 36% of the annual index credits in the first half of this year were 5% or more and approximately 67% of the annual index credits were at least 3%. So this really confirms the value proposition of our products by helping our FIA policyholders prepare or participate in stock market advances with low risk to their fund value, offering upside potential with low risk and guaranteed income for life are really what drives American Equity’s success.
So turning to sales and marketing, as John said earlier, sales for the quarter were 1.8 billion on a consolidated basis and that is a quarterly record for the company and that’s up from 1.04 billion in and second quarter of 2014 or a 73% increase. And our second quarter sales were also up 37% when compared to the first quarter of this year.
As you can probably imagine, we are very pleased with our success in the first half of this year. And when we compare ourselves to our primary competition, our sales are trending up and most competitors our trending down.
And I’m referring to the first quarter statistics the most recent data available when I talk about that. Well our growth and sales was substantial, the ramp up was steady and manageable.
Our monthly sales increased each month this year with June as the best month in our company history. Our average pending business count also increased steadily each month with an average of almost 5,500 cases in June compared to 4,150 in March.
April’s average pending count was 4,872 and May's was 5,130. Looking at the competition for a moment, the competitive landscape has shifted in our favor this year as one competitor known for the highest guaranteed income which drew their product from the market in March.
That product was a top three selling FIA for the last three years. Another significant competitor scaled back their sales appetite for this year giving us yet another opportunity to capture market share.
And while the actions of our competitors certainly helped us, our own doing and philosophy played the major role in our success. I believe we are being rewarded for staying with our product pricing discipline and resisting marketing strategies that were prevalent in 2014.
We do expect sales to be strong going forward, but perhaps not at the same phase as the first half. Some competitors have raised their caps and rates on FIAs, while we have not, plus there is some new resourceful competition entering our space but it’s too early to tell if they will be effective.
We are also making some adjustments to our gender based lifetime income benefit riders starting today and we have had this rider for one year and are simply making adjustments based on experience and the interest rate environment. Some guaranteed payout factors are increasing while others are decreasing.
Regardless we will still be competitive for guaranteed income. One thing that we do know first for certain, while that we are enjoying sales success today.
We are not resting on our laurels. Our market is very competitive and we always need to keep our competitive hedge sharp backed up by our relationship based culture and best-in-class service.
One of the foundations of our agent relationships is our Gold Eagle program. And to refresh your memory, agents who sell at least one million an annuity premium on a calendar year basis are part of our Gold Eagle program.
They get some basic perks such as a special telephone hotline and FedEx shipping discounts at the entry or club level, agent who produce two million or more in annuity premium or the elite level also receive cash compensation and restricted AEL stock with the amount scale higher at various production levels above two million. Through the first half of this year, we have or had or have 664 producers representing 1.5 billion in premium who have qualified compared to 432 during the same time last year.
So that’s a 54% increase in Gold Eagle membership which coincides with the 51% increase in our independent agent production during the same time. Our second quarter recruitment was also very strong for agents.
We contracted almost 2,900 agents compared just under 2,400 agents in the first quarter, and when compared to the second quarter of 2014 that number was 1,600, so recruiting is up very nicely too. Turning to Eagle Life, we had 75 million in sales in the second quarter compared to 122 million in the first quarter.
The second quarter product mix was roughly 89% FIA premium and 11% multiyear guaranteed annuity, whereas the first quarter mix was roughly 50-50. Eagle’s second quarter FIA sales are up 10% over the first quarter and a substantial portion of our FIA sales in the first half of this year came from a broker dealer relationship that was had in place for several years.
As we commented last quarter, we had a multiyear guaranteed annuity rate special for much of the first quarter and old sales have weathered when the rate special ended at the end of February. However our objective was to use our rate special to establish relationship with two financial institutions that we hoped would subsequently begin promoting our FIA products.
And our judgment, this effort was successful and that we began receiving FIA applications in April from one of the financial institutions and sales from that institution have been building momentum since then. And we’re still optimistic that the other relationship will follow with FIA sales as well.
We also began receiving the FIA applications from another financial institution late in the quarter and momentum with that institution is building into the third quarter. We are also in the early stages of forming two new wholesaler relationships that have very good connections with broker dealers and financial institutions that currently don’t have selling agreements with Eagle Life.
We anticipate having more positive news to share with you in the next quarter. Finally, we are holding our 100th client appreciation event next week.
This is a very important and rewarding milestone for us. It’s a program that we’ve been doing for five years now.
It’s an opportunity for us to connect with our policyholders and producers, but our most important mission is to tell our policyholders thank you for in trusting us with their money. It makes our work a whole lot more meaningful when we see and visit with the people who are depending on us to keep the retirement money safe.
Today, we have hosted 20,487 policyholders and 1,244 producers. And with that, I’ll turn the call back over to John.
John Matovina
Thank you, Ron and Ted. That’s kind of bringing the call for conclusion, a few final comments.
One natural question you have when sales are accelerating is, do you have the operational capacity to handle higher volumes? And the answer is as Ron I think commented about is our staff has been up to the task and met the challenge.
They to continue to deliver best-in-class service to our policyholders and independent agents each and every day and we are confident that they will continue to shine in the months and years ahead. However, we do need to acknowledge that the higher volume in second quarter has put a little stress on the operations.
Overtime is up, so we will be planning to add some additional employees perhaps 20 to 25 employees in our key service areas during the next few months to get operations back to a less stressful situation. And of course the second natural question when sales are accelerating, do you have the capital support higher sales.
As Ted said earlier, our estimated risk-based capital ratio at June 30th was 349% than that’s comfortably above the 300% threshold for our A.M. Best rating.
Our current capital projection show that our risk-based capital ratio would be slightly below 300% at end of a third projection year of a three year projection period, if our sales were $6 billion in the first year of that projection period and increase 10% per year in projection years two and three. However, as we've said on previous occasions, we’re looking for our ratings upgrade from Standard and Poor’s, that's likely to move the bar higher in terms of RBC to something in the 325% to 350% range, based upon S&Ps capital model and ratings criteria.
So to the extent that we do have sales levels that cannot be supported by internally generated capital, we would intend to take capital from external sources to facilitate such growth. As Ron commented, we are optimistic about the outlook for the remainder of the year, while though interest rates remain a headwind to our spread management, we’ve remained proactive in managing our liability rages and have much flexibility to continue to do so.
And of course naturally our job would be less challenging if we could get some higher rates. We are expecting a record year for sales but the first year surge may settle down somewhat.
Our product offerings remain competitive and we expect producers to continue to favor us especially in situations where guaranteed lifetime income is important to the consumer’s fixed index annuity purchase. So with that, we’ll open up the call to questions.
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Mark Hughes with SunTrust.
Your line is open, please go ahead.
Mark Hughes
Thank you. Good morning.
John Matovina
Good morning, Mark.
Mark Hughes
Ron, did you give the pending count for July, most recent pending count number?
Ronald Grensteiner
I did not. We - as I mentioned in our comments, we changed the terms to our lifetime income benefit rider and they are effective today.
So the number is inflated perhaps a little bit. I can give you an average for July was 5,585, so that was the average for July.
Today which is the first day of the change, as I said it’s inflated, but at this morning it was 5,733.
Mark Hughes
And then last year if I recall the 2,800 I think was the number, do you agree with that?
Ronald Grensteiner
Yes, just a little bit less than 2,800.
Mark Hughes
Right, okay. The regulatory picture John, if you wouldn’t mind touching on that, anything - we’ve read the comments from the, I guess the group that you can contributed to.
I wonder if you could make any comments or any updates on developments as you see them kind of how you are in the industry efforts are going to try to shape the DOL rule.
John Matovina
Well of course everybody’s comments are now in and at this point in time, I wouldn’t say there’s been any development since the end of the comment period last week. The next thing on the schedule is the hearings that the DOL is going to conduct I think the week after next, so that might provide some insight into their reactions to the comments based upon how those hearings go.
As you saw in our comment letter, we try to make suggestions to help the rule be more workable, since the original proposal was pretty big and often times the question was well, what you have to do to make sure you are compliant with this. So it was framed around that type of thing.
I know there are comment letters out there that were work more vocal in their opposition to the rule. I think it shouldn’t happen at all.
There was one comment letter from a very well established lawyer who question the legal president or legal authority for the DOL to do with a - are proposing to do. So it’s still kind of open as to see where it does head.
Mark Hughes
And just wondering this spending count were on, you doing quite well may be even better on a year-over-year basis than you did in the second quarter and we can adjust for the change in the rate. But it doesn’t seem like the competition has increased.
Is that a fair assessment, I mean are they making noise but not really having an impact on your sales trends, how should we think about that?
Ted Johnson
Well, I think your thinking is probably pretty good. We have seen some of the competition raise caps for example on their indexing strategies, not huge amounts.
I think it’s probably in response to some of the uptick in the tenure treasury and a little bit of relief there. Our big play Mark is the guaranteed income which John spoke about.
We have one of the most competitive guaranteed income options for our index annuities. So when is in the retirement plan, American Equity is one of the first companies that they go to.
And it’s simple strategy that we have compared to some of the competitors out there that are little bit more complicated, so they like us for that too. So other than some interest rate changes from the competition, we really haven’t seen any - anybody really poke their head up that would be a serious threat at this point, but it’s only July.
Mark Hughes
Right. And then final question, any update on your expectations for sales out of Eagle Life for the full year?
John Matovina
Well we finished the first half of the year right a little bit shy of 200 million and that as a result of a pretty good boost for some multiyear guaranteed premium in the first quarter. We are increasing our MIGA rates or multiyear guaranteed annuity rates coming up here in early August, which might spread on a little bit more production in that product for the third quarter.
So we’ll be competitive in that product, but that doesn’t mean that our competition when also increase their MIGA rates as well. So we’re optimistic for Eagle Life, the two new wholesalers that are fairly new in our relationship with them this year.
There we hopefully get some access to some new financial institutions and broker dealers for us. But as we’ve learned through with our Eagle Life project here that things move a lot slower in the broker dealer in a financial institutional channel than they do in independent channel.
But we’ll keep after him.
Mark Hughes
Thank you.
Operator
Thank you. Our next question comes from the line Steven Schwartz with Raymond James.
Your line open, please go ahead.
Steven Schwartz
Thank you. Good morning, everybody.
John Matovina
Hi Steven.
Steven Schwartz
Hey Ron, you know you just pointed out to Mark’s question that you through pending might be inflated because of the LIBR changes which says to me that you got a bunch of agents, a bunch of NMOs who are trying to get their sales and before the change and the reason why they would do that is because they would find the change on attractive. While you are making I guess the question is if you are - you are making a lot of different changes but overall is will the change increase the return on the product to you?
Ronald Grensteiner
No. When you say increase the return, do you mean increase production, will the change increase production for us or?
Steven Schwartz
No, IRR on the product, where the return on capital invests in the products, Ted?
Ted Johnson
This is Ted. The changes we’re making to the product is to keep us at the same IRR that we want to be at.
So it’s not increasing the profit or the returns back to us on those products.
Steven Schwartz
Okay, just - for there you get from decreasing, I guess, is the way to look at it?
Ted Johnson
Yes.
Steven Schwartz
Okay, alright. And then, Ted the incentive comp that you noted in the quarter, was there any catch up growth from Q1?
Ted Johnson
There is a little bit of catch up because we - when we look at where the company’s performance is as it push it up. So there is probably about maybe 400,000 of expense in this quarter that’s really catch up from last quarter.
Steven Schwartz
Okay, alright. And then a couple of DOL questions as well.
I guess, Ron, any change in the percentage of sales that went to IRA accounts in the quarter? I think you are somewhere around 70%, 68%, 70% something like that?
Ronald Grensteiner
You know that’s a good question Steve and I didn’t specifically look at that but I don’t - I haven’t heard of any trends that are percentage change from the first quarter. So you are accurate, our qualified money or IRA money would be in the 65% to 70% range.
Steven Schwartz
Okay. And then one more on this if I could.
The IRA - Investor Day, Ron you stated that you believe the product in the company would get treatment under PTE 84.24, do you still think that’s an accurate statement?
Ronald Grensteiner
Yes.
Steven Schwartz
Okay, alright, that’s what I had. Thanks guys.
Operator
Thank you. Our next question comes from the line of John Barnidge from Sandler O'Neill.
Your line is open, please go ahead.
John Barnidge
Good morning. Thanks for the call.
What is your investment strategy for over hedging gains, you had seven basis points of access for two quarters in a row, should that pattern continue accelerate or decelerate?
Ted Johnson
You know, it’s always been the philosophy here to manage to an over hedge. However, what we would like to manage do is more like a two to three basis point return.
Now obviously the amount of over hedging often depends on market performance and we happen to be at a point in time where we are a little bit more over hedged than what we would like and the market is performing. How long that will persist is depended on policyholder behavior but we need as a hedging group on a monthly basis and we have people looking at it on a daily basis.
And when we see trends in over hedging, we made adjustments to the amounts of options that we’re purchasing on a daily basis. And you don’t want to have a kneejerk reaction to that and pullback too much on your decrements of what you are doing, so we try to have a very discipline policy.
But seven is a little high for us and but in the future it really does depend on market performance and policy behavior, but we do make adjustments here to start to reflect that in our decrements when we are making purchases.
John Matovina
And just to - this is John. Just to remind everybody, the over hedging comes from the standpoint of estimates of policyholder behavior as opposed to other actions.
The options that we buy matchup in terms very closely to the obligations to the policyholder, the policyholder has got an opportunity for 4% cap, we buy our 4% cap. But the hedging inefficiency comes in as we have to estimate how many people - how much money is going to be withdrawn over the course of the next 12 months at the time we’re doing the hedging whether it be full lapses, partial withdraws and all that, because any money that’s not there your ladder does not receive the index credit.
And so that group that Ted referred to is regularly looking at where the trends are at in those withdraws and the outcomes and adjusting the amount of options we buy to reflect those trends. But as you could imagine, we’re always and probably a catch up mode on that process, although you try and stay on top of it as much as you can.
John Barnidge
Alright, great. Do you perhaps have some visibility on bond prepayment fee income in the third quarter?
Ted Johnson
We don’t have any comments on that at this point in time.
John Barnidge
Okay.
Ted Johnson
And that’s going to depend on behavior of the holders that are - the issuers themselves.
John Matovina
So yeah there is 30 some billion dollars of investments, who knows what the managements of those corporate entities are thinking a lot of that prepayment or consent fees comes from situations where they or the management teams or companies to the bondholders asking for consent and pay fees to accomplish through whatever they want to get done. And - so you just have no idea when those might happen.
John Barnidge
Alright, great. My last question.
If there was one thing you change about the DOL rule, what would it be and why?
Ted Johnson
John, we haven’t condensed that down.
John Barnidge
Too much to note?
Ted Johnson
Yeah.
Operator
Thank you. Our next question comes from the line of Randy Binner with FBR Capital Markets.
Your line is open, please go ahead.
Unidentified Analyst
Hi good morning. This Alex comes on for Randy Binner.
My first question is on your sales growth with ten counts above 5,000 seems sales of 6 billion to 7 billion for 2015, what level of sales can you support this year and next year with your current capital base in order to meet the - I see in S&P requirements in that 325% range? And can you provide some more color on your thoughts on sources of additional capital?
Ted Johnson
Well the comments I made earlier Alex that the high projection scenario we have is a $6 billion this year, $6.6 billion next year and $7.2 billion the year after and that takes us down to a 300% RBC at the end of the third year. And you can actually look at those in the level of aggregate they don’t necessarily have to emerge in that pattern, so that - that’s an average of 6.6 billion over the next three years would take us down to that level.
And pulling 300% three years out up to 325 is - I am trying to do the math in my head, it’s - no it have to look at the required capital obviously and ratio would up. And may it seem like we’re working off of 2.3 or 2.4 billion to get the 349.
So …
Unidentified Analyst
Okay.
Ted Johnson
I don’t want - maybe we call you and give you the number after that as we know where the 300% comes out at, but I don’t know, it’s not on top of my head here what the - how much it would take to go from 300 to 325 three years out.
Unidentified Analyst
Okay.
Ted Johnson
And in terms of capital options, the things that naturally come to our mind are equity capital, reinsurance which we haven’t done for a while but have experience in doing coinsurance arrangements with we have two counterparty relationships there. There has been over the last several years, several parties have contacted us about the interest in coinsurance, so we think there is - there is people out there that wanted to coinsurance and that we would be able to create a relationship.
And then in terms of debt capital, at the moment that’s not an option because one of the criteria in our S&P process is to take our adjusted debt-to-capital to below 20% which we’ve now have achieved. Capital charges from S&P kick in if you exceed the 20%.
But as equity capital continues to build, and that ratio goes down that puts debt capital as an option out in the future at some point in time.
Unidentified Analyst
Okay, great. Are you in open talks with any coinsurers at the moment?
Ted Johnson
No.
Unidentified Analyst
Okay, alright, great, that’s all I have. Thanks.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of Steven Schwartz with Raymond James.
Your line is open.
Steven Schwartz
Hey guys, couple of follow-ups. One a DOL question again, Ron even though you are going to be end of the peak 84.24, do you know will UBS reduce sharing under the new rule.
Ronald Grensteiner
We don’t believe so.
Steven Schwartz
.
Ronald Grensteiner
We don’t think the NMOs would be either.
Steven Schwartz
Okay, we made of a different understanding about PTA for 24 works in, we would fix that later. And then I guess just a theoretical question maybe there is no way to do this, but I mean does it make sense, I don’t know to maybe be a little less competitive and get more return on product.
Then I understand that you got to keep the agents happy, but does it make any sense to be a little less competitive?
John Matovina
Theoretically year, but I think your point was you got to keep the agents happy and you know if all of the sudden, we change our competitive pasture in the marketplace, the agents are going to recognize that and then you are going to start here in the stories about American Equity doesn’t want business and that. So yeah, I think overtime, we can alter the profile a little but I don’t see this been able to do something in a fairly quick matter that’s not going to create confusion in the marketplace and sent the wrong signals.
Steven Schwartz
Okay, alright, thanks.
Operator
Thank you. I am showing no further questions at this time.
I would now like to turn the call back to Julie LaFollette for any further remarks.
Julie LaFollette
Thank you for your interest in American Equity and for participating in today call. Should you have any follow-up questions, please feel free to contact us.
Operator
Ladies and gentlemen, that does conclude the program and you may all disconnect. Everyone have a great day.