Aug 11, 2018
Operator
Welcome to American Equity Investments Life Holding Company’s Second Quarter 2018 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 2018 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.
Non-GAAP financial measures discussed on today’s call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents. Presenting on today’s call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer, and Ron Grensteiner, President of American Equity Investment Life Insurance 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 a 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 made available on our website shortly after today’s call.
It is now my pleasure to introduce John Matovina.
John Matovina
Thanks, Julie. Good morning everyone and thank you for joining us this morning.
American Equity second quarter non-GAAP operating income of $86.6 million, or $0.95 per share, was up 12% sequentially, largely on the strength of an increase in certain non trendable investment spread items. We also initiated an investment realignment program in the quarter that had a modest impact on second quarter results and is expected to have a more meaningful impact on our investment spread in future quarters.
Now as a reminder the three key metrics that drive our financial performance are: growing our invested assets and policyholder funds under management; generating a high level of operating earnings on the growing asset base through investment spread; and then minimizing impairment losses in our investment portfolio. For the second quarter of 2018, we delivered 1.6% sequential growth and 6.4% trailing 12 month growth and policyholder funds under management.
On a trailing 12 month basis, we generated a 14.2% non-GAAP operating return on average equity that excludes the impact of actuarial assumption reviews and loss on extinguishment of debt. And then, excluding the interest rate related losses from the investment realignment program, our investment impairment losses after the effects of DAC and income taxes were just six basis points of average equity.
The growth in policyholder funds under management for the quarter was driven by $1.2 billion of gross sales that is a 17% sequential increase. Fixed index annuity premiums were up 13% sequentially in the second quarter.
The income Shield 10 guaranteed lifetime income product that we launched in March has been well received and we expect to launch new accumulation products in the American Equity and Eagle Life distribution channels later this quarter. You will hear more about the sales environment and competition from Ron.
So while the sequential increase investment spread in the second quarter primarily reflected an increase of eight basis points in the benefit from fee income from bond transactions, prepayment income and over hedging, we also realized some benefit from higher yields on our invested assets and reductions in renewal rates that began in March. We expect to realize additional benefit from the realignment of invested assets and are considering further renewal rate actions.
Ted will have more details of investment spread in his remarks. Substantially, all of the realized losses on investments for the second quarter were interest rate related, losses on securities sold as part of our program to opportunistically replace lower yielding securities with higher yielding securities.
Our low level of investment impairment losses once again reflects our continuing commitment to a high-quality investment portfolio. I will be back at the end of the call for some closing remarks, but now I would like to turn the call over to Ted Johnson for additional comments on second quarter financial results.
Ted Johnson
Thank you, John. As John said, we had non-GAAP operating income of $86.6 million or $0.95 per share for the second quarter of 2018.
This compares quite favorably to non-GAAP operating income of $63.7 million or $0.71 per share for the second quarter of 2017 with much of the increase related to lower statutory federal income tax rate in 2018. On a pretax basis, second quarter 2018 non-GAAP operating income was up 13% over the prior year's second quarter.
Investment spread for the second quarter was 264 basis point up 10 basis points from the first quarter of 2018 as a result of an 11 basis point increase in the average yield on invested assets compared to just a one basis point increase in the cost of money. Average yield on invested assets was 447 in the second quarter compared to 436 in the first quarter.
The increase in the average yield in the quarter reflected a benefit from non-trendable investment income items of 10 basis point - including seven basis points from prepayment and fee income - compared to just three basis points from such items in the first quarter. The average yield on fixed income securities purchased and commercial mortgage loan funded in the second quarter was 477 compared to 443 in the first quarter of 2018.
The yield on investments purchase or funded in July was 489. With the continued increase in the benchmark 10 year U.S.
Treasury rate and rates available on the asset classes we have targeted for purchase we are finally seeing a long trend of declining average yield on invested assets begin to reverse. We continue to benefit from the deployment of money into asset classes not traditionally in our portfolio.
We have continued the higher allocations to asset-backed securities such as collateralized loan obligation, and are looking to increase allocations to commercial mortgage loans. We also began adding infrastructure security loans to the portfolio, and consistent with our past practice when we diversify into an unfamiliar asset class, wecontracted with an experienced manager to assist us with this asset class.
We do not expect to take on material increase in credit risk with this allocation strategy, but there will be a slight increase in investments with an NAIC 3 designation. NAIC 3 investments were 2.8% of fixed maturity securities at June 30, compared to 2.5% at December 31, 2017.
The addition of CLOs in certain commercial mortgage loans to our portfolio has positioned us to have a portion of the portfolio benefit from increases in short-term interest rate. At June 30, we had $3.3 billion or 7% of our investment portfolio in floating-rate investments.
We expect our allocation to floating rate investments to increase to roughly 8% of our investment portfolio by the end of the year. We estimate we realized two basis point of additional investment yield in the second quarter from increases in rates from our floating-rate portfolio.
As mentioned during our first quarter conference call, we are looking to improve our investment yield to opportunistically replace lower yielding security with higher yielding securities. During the second quarter, we sold $1.6.
billion in book value of securities with an average yield of 312. As book yields on the securities sold were less than market yields we incurred a capital loss of approximately $38 million on these sales.
This loss should be recovered from the higher yield on the securities acquired with the proceeds from the sales in less than two years. The substantial sale of lower yielding securities together with the annuity deposit received during the quarter left us with that short-term cash position of $604 million at June 30.
We anticipate we will pick up incremental investment yield from additional portfolio realignment once the June 30 excess cash position is invested. The aggregate cost of money for annuity liabilities was 183 basis points, up one basis point from the first quarter of 2018.
The benefit from over hedging index linked interest obligations was six basis points in the second quarter compared to two basis points in the first quarter. A five basis point increase in the cost of money excluding over hedging benefits primarily reflects the escalation of option costs for certain index strategies in the last several quarters that is recognized in the cost of money ratably over the 12 month option period.
As we stated on our first quarter earnings conference call, to counteract this impact, we began lowering cap for the monthly point-to-point index strategy in March. We are also raising spreads (which lowers option costs) for our volatility controlled index strategy.
Total policyholder funds affected is $11.4 billion and we expect annual savings of nearly 28 basis points on the $11.4 billion once all rate changes are implemented. This is roughly six basis point on the entire in-force.
As John mentioned, we will be considering additional of renewal rate adjustments this quarter. One trend affecting quarterly spread comparisons is a change in the product mix from bonus product to non-bonus product, which includes the American Equity Choice and Eagle Select products.
Non-bonus products have a lower spread requirement than bonus products, which translates into a higher cost of money for non-bonus products. The estimated impact from this change on the second quarter sequential spread income was modest at one basis point, but this is a trend we expect will continue in future quarters.
We continue to have flexibility to reduce our crediting rates if necessary and could decrease our cost of money by approximately 59 basis points if we reduce current rates to guaranteed minimums. This is up from 54 basis points at the end of March.
Our effective income tax rate on non-GAAP operating income in the quarter was 20.5%. Income tax expense in the quarter was reduced by $842,000 from the income tax benefit for share-based compensation.The benefit varies from quarter to quarter based on stock option exercise activity and the vesting of restricted stock and restricted stock units.
The effective income tax rate excluding this item was 21.4%. We continue to expect our non-GAAP operating effective income tax rate to be in a range of 20% to 22%.
Our estimated risk based capital ratio at June 30th was 384, up from 378 at December 31, 2017. Now, I will turn the call over to Ron, to discuss sales, marketing and competition.
Ron Grensteiner Thank you Ted, and good morning everyone. As we reported yesterday gross sales for the second quarter of 2018 were $1.2 billion, up 17% compared to the first quarter of 2018.
This is the third consecutive quarter that we recorded higher sales sequentially. Fixed index annuity sales increased 13% sequentially, reflecting a 14% increase at American Equity Life and an 8% increase at Eagle Life.
The fixed index annuity market remained competitive in the second quarter, with a number of competitors raising caps participation rates and guaranteed income. Reflecting the attractiveness of accumulation products in the current market environment the Choice series continues to be our best-selling product line at American Equity Life with 37% of sales in the second quarter.
This compares to 35% in the first quarter of 2018 and 33% in the fourth quarter of 2017. Choice 10 remained our best-selling product in the second quarter.
Guaranteed lifetime income has been a significant focus for us through the years and we are thrilled with the initial reception of the IncomeShield series by our independent agents. As a reminder, the IncomeShield series was introduced on March 19th to improve our competitive positioning in the guaranteed lifetime income space.
Guaranteed lifetime income on IncomeShield is competitive with levels offered by our most important competitors despite having annual fees which are among the lowest in the industry. The no fee rider option has proven very attractive to distribution as well.
IncomeShield is already our second best-selling product line, accounting for 23% of American Equity Life sales in June. While many of our agents have pivoted from one of our other products to IncomeShield, we believe we have picked up incremental sales from agents who have returned to selling American Equity products after selling products for our competitors.
Later this quarter, we plan to introduce a new series of non-bonus products focused on accumulation and sold without a lifetime income benefit rider. A key feature will be a participation rate above 100% on the S&P 500 Dividend Aristocrats Excess Return index.
In addition, these products will have a first of its kind crediting strategy based on the S&P 500 index. We expect this new strategy to compare favorably to the monthly point-to-point strategy that has been popular in fixed index annuities for more than 10 years.
These indexing strategies together with our traditional participation rate strategy on the S&P 500 index should compete very well with the hybrid index/multi-term products which certain distributors have focused on. The new product series will be available with five, seven and 10 year surrender charge periods.
While products featuring hybrid strategies remain popular in the marketplace, we continue to have no interest in introducing a new index with no actual performances history created solely for the purpose of being used in a fixed index annuity. We believe such indices add little to no benefit to policyholders compared to traditional S&P 500 index products while adding increased complexity.
Turning to pending. Pending business at American Equity Life average 2640 applications during the second quarter and was 2598 at the end of June compared to 2696 applications when we first reported first-quarter 2018 earnings.
Pending applications stand at 2341 as of this morning. One year ago, pending was 2048.
As I said earlier Eagle Life’s index annuity sales were up 8% sequentially. Keeping our participation rates competitive was certainly a factor.
Also an increase in our multi-year fixed annuity rates opened some doors to promote our fixed index annuities. One of our newly recruited mid major banks gain some traction, and our employee wholesalers are also making a difference in a large financial institution previously serviced by a third-party wholesalers.
Pending Standing at Eagle Life stands at 263 applications today compared to 239 when we reported first-quarter earnings. Participation rates on our Eagle Select series remain attractive.
Fixed index annuities with surrender charge periods shorter than six years have become popular in the bank and broker-dealer channels. To meet this demand, Eagle Life recently introduced a fixed index annuity with a five year surrender charge period - Eagle Select Focus 5.
In addition to the traditional Select Series features, this product uses the same S&P 500 Dividend Aristocrat index strategies that I mentioned while discussing the new accumulation product series at American Equity Life. The Select Focus 5 features an annual participation rate of 120% on this index with the market value adjustment rider added.
A seven year product - the Eagle Select 7 or Focus 7 - will be introduce later this quarter with the same index strategies as the Select Focus 5. We will retain 100% of all Select Focus 5 and 7 sales.
With Eagle Select 6, 8 and 10 and now with Select Focus 5 and 7, Eagle Life will have a robust product portfolio incorporating varying surrender charge periods, indexing strategies and compensation structures. Finally later this month, Eagle Life anticipates beginning a new sales effort through one of the country’s 15 largest banks based on assets.
Our products are competitive and we will, at least at the time of introduction, have the only participation rate strategy in its system. And with that, I will turn the call back over to John.
John Matovina
Thank you, Ted and Ron. We are certainly pleased with our second quarter results and the outlook for the next several quarters.
The first quarter sales momentum at American Equity Life did continue well into the second quarter, our IncomeShield series has been well received by our independent agent distribution and we have several new products we expect to rollout this quarter. On the spread side, the prospect for higher investment yield is quite good, and the trend of declining investment yields that has persisted for more than eight years has likely abated.
Option cost still remain a challenge, but as always, we will take the necessary actions to protect our spread and we have ample room to lower caps, participation rates and crediting rates on or in-force business. With the Department of Labor's Fiduciary Rule now formerly vacated by the Fifth Circuit Court of Appeals, we continue to participate in the National Association of Insurance Commissioner’s review of the Model Suitability Law and to monitor the Securities and Exchange Commission’s work on its best interest standard.
The SEC comment period ends today and the NAIC working group met last week to continue work on possible changes to the Model Suitability Law. Our long-term outlook remains the favorable as the aging American population need products like fixed index annuities that build retirement savings with low volatility of returns, while offering options for guaranteed lifetime income.
American Equity has been a significant participant in the fixed index annuity market and we are fully prepared to participate in the growth that we see ahead for our market. The value proposition we have always offered our distribution partners, transparent products attractive renewal crediting history and unparalleled service remains as attractive as ever.
Now before we move to Q&A, I want to advise everyone that we will not be commenting on or answering any questions about market rumors or a potential transaction. So on behalf of the entire American Equity team, thank you for your time and attention this morning.
We will now turn the call back to the operator for questions.
Operator
[Operator Instructions] Our first question is from Randy Binner of B. Riley.
Your line is open.
Randy Binner
On the investment strategy I have a couple. One, was that you mentioned that you are going to try to allocate 8% of the portfolio to floating rate securities by year-end 2018.
I just want to confirm if that is the case and then beyond that if that would continue to be a higher proportion of the portfolio and what proportion that would be? And then you mentioned CDO series loans and the structured securities, I guess these are privately negotiated generally maybe with the exception of some CDOs.
So the attraction there is its higher yield, so there is greater risk. So could you kind of dimension out if structure and privately placed stuff is mitigating some of that risk of just taking higher yields.
Jeffrey Lorenzen
It’s Jeff Lorenzen. On the topic of the CLOs, not CDOs but CLOs, most of ours are going to be publicly generated securities, so we are not going necessarily to the private market.
These are transactions that have plenty of liquidity and offer very good attractive values in terms of market comparisons. In terms of the floating rate component of the portfolio, we initially targeted 8%, we will see where the market opportunities go.
It depends on what Fed policy continues to look like as we move through our strategy. If we get to the point where we still believe that there is potential upside for more Fed action then we may continue to move that a little bit higher.
If we like we are capping out and we don’t see we are going to get a lot of incremental benefit from the floating rate component of it, it may be something that we cap out and we maintain our position.
Randy Binner
And then I guess follow up just kind of the RBC ratio impact of all of that activity you mentioned there are being more level III investments. Is there some new proposed rules for how to [MESS] (Ph) assets are classified within the RBC construct.
So I guess a net of it is, is there kind of a tolerances of RBC you would be willing to lose on a percentage basis to kind of gain the advantage of a better place portfolio?
Ted Johnson
Well, what we have seen so far for the portfolio realignment, is the impact from RBC has been fairly minimal. So that isn't overly restrictive for us.
Jumping to the other topic changing of factors and what the NAIC is looking at, when we run and look at what their interim factors that they put at we are at 384 now. We would see maybe our RBC go to maybe 357, but again from that is purely an NAIC calculation and doesn’t necessarily affect how the rating agencies look at that.
So we are not necessarily overly concerned on that. But so far in regards to the realignment and what we have done, the impact to RBC has been fairly minimal.
Randy Binner
Okay and still managing 3%0 will be the floor - with the new standard.
Ted Johnson
No. Our target is we are trying to manage between 375 and 400.
John Matovina
Under the current frame work.
Ted Johnson
Under the current frame work of the what the NAIC I,s we are managing between 375 and 400 and remember Randy why we are targeting that too is looking at where our ratings at with the various rating agencies and one of the rating agencies that we would like to obtain an upgrade is Fitch and they have referenced that they would like us to have a 375 RBC and maintain that or higher.
Randy Binner
Okay. So the net of it is, you don’t have a lot of wiggle room on RBC ratio to accommodate kind of significant net risk increase in the portfolio should these…
Ted Johnson
We are at 384 and I think we said before, that if you look at what our capacity would be for sales, we could produce up to $6 billion and our RBC ratio should stay fairly level. So we are in a situation where while we are doing some of this realignment we are also building up RBC because we are putting less of that capital to work through sales.
So we do have some flexibility here in what we are doing right now. Jeff LorenzenIn addition Randy, we haven't seen a credit quality decrease in our portfolio as part of this realignment.
It’s just an asset class shifts what we are going in, we are going out of the very high-quality or maybe a triple B rated corporate that has rolled down the curve that have a lower yielding and going out the curve a little bit and going into a different asset class that has higher yield. Overall, our credit quality of our portfolio has actually remained the same.
It’s A-rated.
Randy Binner
Understood. Thank you.
Operator
Thank you. Our next question is from Ryan Kreuger of KBW.
Your line is now open.
Ryan Krueger
I had a follow-up on the asset realignment and can you give us a broad sense of how much additional assets you might consider for realignment from here.
Jeff Lorenzen
At this point in time we have some capacity left within the framework of what we’re working with two continue, you know our target is to get a couple hundred million more done in the near-term, then we will reevaluate as we get into the fourth quarter and determine where we are positioned longer term for how we want to shift the portfolio in and add incremental yield, but we do have some shelf space left to do some for the realignment.
Ryan Krueger
Thank. Operating expenses has increased on this year to 26 basis points of account value that can be typically run around 24 basis point is that something you would expect to continue at a similar level as the first half going forward.
Ted Johnson
I think our operating expenses that we have is pretty close to probably what our run rate would be and we certainly incremental increases mostly in salaries and benefits just due to adding additional employees to the workforce because of the growth we have here at the Company.
Ryan Krueger
Thanks and then just last one I may have missed this. But did you provide the American Equity average pending count for the second quarter and if no, could you provide that?
John Matovina
Yes, the 2640 was the average for Q2.
Ryan Krueger
Great. Thank you.
Operator
Our next question comes from John Barnidge of Sandler O'Neill.
John Barnidge
[Indiscernible]MYGA activity picked up the highest since early 2016. Are you trying to get more in a bank and brokers dealers now obviously, but is because of DOL headwinds going away and thus broker dealers are looking to expand their products again.
Ron Grensteiner
It's more of the former. We felt that we needed to raise our MYGA rates a bit at Eagle Life, just so we could be in the conversation with the different financial institutions and have more conversations about our fixed index annuities in the process.
Ryan Krueger
Okay, and then another question. What are your thoughts on New York State recently proposing the best interest regulation.
Do you think other states will pick-up and what can the industry do to push back because it was successful in the DOL pushing back? Thanks for the answers.
John Matovina
Relative to New York, it's going to have pretty much no impact on us, we are not active in the state of New York. I know for instance on the cyber security, the playbook seemed to be that New York did something and the NAIC fell in-line.
I think we would be surprised if we saw the same playbook this time around that the rest of the states and the NAIC gravitate to do what New York has already adopted. And I know that the Model Suitability working group was meeting over the weekend.
I guess the NAIC had its quarterly meeting I think starting Saturday through yesterday, but I don't think there is any momentum for the NAIC to pick up on what New York has already adopted.
Ryan Krueger
Great. Thank you.
Operator
Our next question comes from Dan Bergman of Citi. Your line is open.
Dan Bergman
Actions increased nicely this quarter, and came in most higher than I had expected. So I was hoping if you could provide a little color on what you saw in the quarter and what drove the sequential increase.
And just given the recent rise in interest rates, any thoughts on how we should expect prepayments to trend ahead?
Ted Johnson
Dan, can you restate that question. You didn’t come through in the very beginning,.
Dan Bergman
So just in terms of prepayments and bond transactions, kind of with the sequential increase we saw this quarter. I just wanted to see if you can give a little bit more color on what you saw in the quarter and what drove that increase.
And then just going forward given the rise in the interest rates how we would expect we should expect prepayments to trend going forward?
Ted Johnson
Again, I will give a little bit of breakout and Jeff can talk about trends which I would right away say are very hard to predict on what the trend will be on prepayments and other types of non-trendable investment income. So we talked about 10 basis points this quarter of untrendable related to investment income.
Seven of that is additional prepayment income related to bond calls or prepayment on mortgage loan. And then there is three basis points that is related to primarily the RMBS security pay downs and some other non-trendable items.
So with that I will let Jeff try to answer the trend question.
Jeffrey Lorenzen
As we look at the RMBS side of it, we haven't purchased any new RMBS for quite some time. We have a lot of old seasoned paper in the portfolio, that probably still has fairly high coupons back from 08, 09 and before then.
So even modest rises or increases in interest rates really probably aren’t going to have a dramatic impact on slowing those down. I think we are going to see quarters where maybe you have a little bit higher prepayment, maybe the quarter prior was a little bit softer, but now on an average we are going to probably continue to see that trend move forward even if we see interest rates move up a little bit more from here.
Dan Bergman
Got it. It’s very helpful thank you.
And then maybe just one on the cost of crediting. Excluding the over-hedging the cost of money moved up due to the elevated option costs.
I know you have taken some renewal rate adjustments earlier in the year, but I just wanted to see if you could give some guidance in terms of the timing or how soon those actions will begin to impact the cost of money, and just generally how we might expect that the trend going forward?
Ted Johnson
Well, we have the decisions that have been made or in place on the $11.4 billion which has started in March and overall that should affect the cost of money in total by six basis points. It isn’t necessarily going to trend in ratably over that 12 to 15 months period of time, but it will come through a bp to two bps a quarter.
Now the remaining piece, as we have stated we are looking that renewal rate and we will be deciding on whether or not we will make adjustments to those here in the near-term, but we have not made those decisions yet. And again any decision we would make on any renewal rate adjustments down would then start flowing in over a 12 to 15 month period of time.
So there would be a lag of the decrease in what we would see in our cost of money compared to the increases that we have already experienced and are experiencing.
Dan Bergman
That was very helpful. Thank you.
Operator
Our next question comes from Erik Bass of Autonomous Research. Your line is open.
Erik Bass
I appreciate that you are unable to talk about any potential transactions. Just can you discuss why you chose to put out a release confirming preliminary discussions.
John Matovina
So it was so long ago, I forgot all the discussions that we were having as to why.
Ted Johnson
That was in response to a market rumor and an article that had been published.
Erik Bass
Okay. So just responding specifically to that market rumor.
Ted Johnson
Yes.
Erik Bass
And then Jeff or Ted if you could comment just make sure I have moving pieces on the investment realignment correct. You talked about initially there being some cash drag, would you see that as something that could negatively affect the spread in the third quarter and then you would certainly benefit from reinvesting at higher yields beyond that?
Or would you expect the reinvestment to fully offset in the third quarter?
Ted Johnson
There is going to be a slight amount of drag that we will see in the quarter. But we expect that based upon forward purchases that we have out there for August that we should be able to absorb that excess cash balance.
Erik Bass
Got it. Thank you.
Finally for Ron, if you could just talk a little bit more about the competitive environment and the different distribution channels and how you expect the new product introductions you talked about to improve your market position.
Ron Grensteiner
I would say the competition has been more intense than usual, particularly in the guaranteed income market kind of seeing almost a one [indiscernible] upmanship by some of our competitors, where they’ll raise guaranteed income and then another competitor will leapfrog over them and so it's really been fierce. Again, particularly in the guaranteed income.
We think our guaranteed income is competitive, and we can match up fairly well against them. We are not the highest, but you know our value proposition has always been lets be competitive and lets fill the gap with our excellent customer service.
So answering the phone in 60 seconds and issuing policies in 24 hours and those types of things. On the bank side, everybody is competitive.
In particular, the cap rates onthe S&P 500 are, you know, there is a lot of them that are over 6% now. Actually 21 carriers with 74 different products that offer 6% or higher.
We are very competitive in the participation rate strategy. We have on your pure S&P annual point-to-point strategy, we have about the highest if not the highest, and that tends to be our lane.
So we are optimistic for sales, but it is very, very competitive.
Erik Bass
Thank you. That is a helpful color.
Operator
Thank you. Our next question comes from Pablo Singzon of JP Morgan.
Your line is now open.
Pablo Singzon
Can you just talk about your most recent option costs on policy renewals. I think in 1Q you were slightly north of 190 bps and is that still the case?
And your current cost of money is under 190 bps and it seems like the gap for the cost of optional renewal is narrowed at least to 2017 when the cost was about 180 bps.
Ted Johnson
In regards to option costs of money we’re still experiencing option costs low 190s.
Pablo Singzon
Okay. But just given where adjusted cost is right now which is 189, I guess the [indiscernible] is not to be as steep as what we saw from 2017 to this year, correct?
Ted Johnson
I got to think about that Pablo more to really be able to answer that. It’s going to dependent to replacing option cost, back in the beginning, four quarters ago we were quite a bit lower.
They were in maybe the 170 range. You’re replacing option costs four quarters ago that were 170 now with options that are costing on average 192, 190.
Pablo Singzon
Okay. And then my next question was as you are reshaping the investment portfolio, would you ever consider investing in alternative type assets that generate closer to high single-digit projected returns like some of your PE-backed peers are doing.
So why or why not is capital a constraint if you’re thinking about doing something like that potentially.
Jeff Lorenzen
It’s definitely something that we are considering, historically, when we have had lower RBC, it hasn't been something where we wanted to allocate to capital at risk to the portfolio, but as we accumulate more capital it gives us more flexibility to maneuver the portfolio into asset classes maybe we traditionally have a looked at. We are clearly looking at alternative strategies for the portfolio that align with our philosophy of high-quality portfolio and protecting the downside, and we have several things that we think are interesting that we think could fit in the portfolio over the long-term.
John Matovina
Pablo excuse me. It would be a big stretch for us to get allocations in alternatives that get anywhere near what some of our competitors have.
Pablo Singzon
Sure. But do you sense of immediate what capital level when you saw the finger toes in those kinds of assets?
John Matovina
Yes, I think at any point in time we can dip our toes, we only have about a 150 million at this point in time that we would consider to be alternatives. So we have got plenty of flexibility in terms of capital at risk.
Finding the right partner is not stuff that we would - it’s not investments we would do in house so finding the right partners and the right types of assets that help diversify the portfolio that are non-correlated to our credit risk in our portfolio and allow us to reduce overall risk in the portfolio as we look at it from a macro standpoint.
Pablo Singzon
Okay. Thanks.
Operator
Our next question comes from Greg Peters of Raymond James. Your line is open.
Gregory Peters
Obviously the market rumor or press release is off the table for questions, and so I thought I would focus on the sales and if you look at your market share since 2015, I think it's been trending down and I think Ron you provided some color around products, et cetera, and how you think your positioned for the second quarter. But to tie this up with the market rumor, do you think that is having any effect on sales results when you talk to your agents?
John Matovina
Greg this is John Matovina. Yes.
Sales outcomes are always difficult to pinpoint to the reasons or expectations, but certainly, and as Ron has talk about, the competitive dynamic has been there throughout the year. But yes, there is feedback coming from our distribution that says the market rumors are influencing their activities.
And so putting a number on that is very impractical to do, but certainly we are catching that feedback from agents and in some cases, most recently, there was a pretty substantiall agent - a guy that has been in the Top 10 - who shared with us that his business for the time being, was off with us because he was concerned about the outcome.
Gregory Peters
So, okay, thank you for that answer John. Switching gears, one of your competitors reported and I think I mentioned this to you earlier that there was one of your competitors reported unlocking charge in the second quarter and due to higher option costs and interest rates and I'm curious.
Your review I believe it's in the third quarter, but may you could provide some color on your perspective with the higher cost that you have discuss in this call?
Ted Johnson
Certainly from an unlocking perspective, you know part of the reason I mean, what we are looking at, what we think expected spread will be out into the future and that would be obviously one of the reasons why we are currently looking at renewal rates. We certainly have made progress on investment yield as we have talked about today and we expect to be hopefully make further progress on that, but we are also considering being able to manage our spread and where we would like to be through renewal rate actions.
John Matovina
Greg, one addition to that I mean their observation was seem to be focused on cost only and Ted’s comments to you were our focus is on the spread. So because to us just an increase in option costs is not automatic that there is going to be an unlocking, because obviously it’s the spread number that fit the EGP.
Ted Johnson
So there is obviously many assumptions that go in - everything from surrenders to what we are going to get investment yield plus option costs.
Gregory Peters
Great. Thanks for that color.
I can't help myself, but I just had a follow up on your CLO commentary and your new investments in CLO. So I was wondering, Jeff if you could provide us.
I know you have made a lot of comments about it provide a more color about exactly what you are investing in? Are you starting in new issues?
Or are you just going in some market and buy an existing? Is it middle market?
Is it syndicated large syndicate loans? Just give us up some perspective of what you are looking at that?
And thank you very much for your answers.
Jeffrey Lorenzen
Yes. For the most part it is a large syndicated new issue flow, we haven’t gone into the secondary market to pick up flow at this point in time.
So it’s been a lot of the new flow, new structures coming out. Investment grade, BBB, Single A-type credit quality.
Most of them are floating rate, we have gone into an allocation of some BB. We tier our managers and their CLOs by Tier 1, Tier 2 based on a track record, their ability to manage through difficult periods of time.
We have got fairly extensive process our team goes through to evaluate managers and determine whether we would consider them a Top Tier. Our Top Tier managers would get allocated to the lower credit quality because they have done a better job a managing through crisis than some of our Tier 2 which might be more of an investment grade quality type manager that we would invest in.
Gregory Peters
Great. Thanks Jeff.
Operator
Thank you. [Operator Instructions] Our next question comes from Alex Scott of Goldman Sachs.
Your line is open.
Gregory Peters
First question I had was just on the DAC and DSI amortization. I know like the absolute number for amortization came in a bit higher quarter-to-quarter and year-over-year, but I guess relative to higher EGPs anyway like the K factor it looked like you came in a bit lower than it has recently.
So I was just wondering if there is anything that you would call out just in terms of market impacts things like that they may have influenced it.
Ted Johnson
So what influenced on DAC and deferred sales inducement amortization for this quarter was the effect we had from non-trendable investment income. This quarter we saw our actual gross profit exceed our estimated gross profits that were in the model.
That was different than last quarter that trend was in reversed last quarter. So that is the main impact that you see going on, if you are trying to compare to last quarter to this quarter or just looking at DAC and DSI amortization as a percentage of gross profit was the fact that our actual gross profits were in excess of our estimated gross profit.
Alex Scott
Okay that’s helpful. And then maybe just on the - when I think about the realignment and some of the cap rate action you guys are taking, can you just provide some commentary around the goal of using these two levers?.
Is it to get spreads back to that high 250s sort of range? Or will the combination of these two items eventually lead to improvement even beyond where we were on 2017 levels.
John Matovina
Well the real objective on spreads is to get them back to target levels which are even well above 2017. That would have to take place overtime, this action and of itself may not get that done.
But certainly as if rates were to continue to rise. That is always been our expectations that we would let our spread escalate to the pricing target levels.
And then at that point in time, make an evaluation as to renewal rate increases versus decreases, which has been the trend for the last number of years, given the investment environment.
Alex Scott
Got it. Maybe one more quick follow-up if I could.
Could you provide any commentary on surrenders, how you’d anticipate those to play out maybe as a percentage of account value or some kind of metric that we can think about there and if there is any impact the you would expect from some of the cap rate actions you are taking.
Ted Johnson
In regards to any renewal rate adjustments that we would be doing or considering, we wouldn't necessarily be expecting to see surrenders increase significantly because those blocks of policies are still at rates that are quite attractive compared to what current rates are at. And we been commenting for many quarters, now our surrender experience has been quite a bit below what our model.
have had in it for both DAC amortization and amortization of deferred sales inducements and we have been having to adjust our estimate down in the model in the near term, and then have them grade up as we expect that rates will go up and surrenders will go to a more normalized level. So at this point in time based upon where current rates are at on current products and you know, the general level of and maybe a general expectation of what renewal rate reductions we would be making, we are not expecting to see any significant increase in surrenders.
Alex Scott
Okay. Thank you.
Operator
Thank you. Our next question comes from Mark Hughes of SunTrust.
Your line is now open.
Mark Hughes
Ron you gave a number and talking about the pending counts of 2048, was that at this day last year or was that different comparison.
Ron Grensteiner
That was one year ago.
Mark Hughes
And was that both Eagle Life and American Equity?
Ron Grensteiner
No just American Equity.
Mark Hughes
Very good. Thank you.
Operator
Thank you. Our next question comes from John Nadel of UBS.
Your line is now open.
John Nadel
Thank you and good morning everybody. First question is about the pace of sales, Ted you’ve spoken in the past that risk-based capital ratio would be relatively stable, all else equal, assuming about $1.5 billion of net production per quarter or $6 billion for the year.
At the current level of sales, give or take $4.5 billion annualized pace, how much should we expect again, all else equal, that RBC can increase on a year-over-year basis.
Ted Johnson
Well I think you probably should really just be looking at the increase we have had for the first six months and annualizing that out.
John Nadel
Okay. So there is no other real moving parts in that.
Ted Johnson
Yes. Plus or minus couple points.
John Nadel
Okay. And then second question is just on sales mix there is a lot of commentary about competitive environment and it seems to me based on your commentary and maybe that I'm reading too much into this, but it sounds like it's increasingly competitive relative to first quarter relative to the fourth quarter of last year, et cetera.
So sales mix and the nature or the increasing competitiveness in the market, how should we think about targeted spread on new sales relative to the overall targeted spread on your portfolio.
Ted Johnson
I mean as we have said like even right now we are seeing - well I guess on our Investor Financial Overview we talked about targeted spread split between premium bonus products and non-premium bonus products. On a bonus product maybe the average spread we are targeting is 300 basis points, on a non-premium bonus products its somewhere between 165 and 220 somewhere in there, so midpoint between those.
I think we saw this quarter when we look at spread and we talked about the cost of money or adjusted cost of money going up about five bps about, one bp of that is really related to just the change in allocation of what we are selling in our in-force, ultimately, how that changes overtime if spread is going to be dependent on, you know, what the shift in production is and how much we are going to be selling of it accumulation versus guaranteed income products.
John Nadel
Yes, understood. I guess what I'm getting at is - I’m sorry go ahead.
Ted Johnson
But again the ROEs, we are pricing the ROEs on both of those products to be relatively the same. And then to remember that the non-premium bonus products even though we have a lower spread target on those, we have an offset to that and why our ROEs are relatively same as the others is because we have less acquisition costs but we don't have a bonus which means we have less amortization.
John Nadel
Yes, that is kind of what I'm getting at it. And I know these things can ebb and flow but it sounds like there is a much larger proportion of yourselves at least currently is non-premium bonus type of sales and so optically if that remained consistent over the next several quarters.
Optically it seems like your spread may be “pressured’ yet your returns wouldn't be. Am I thinking about that the right way.
Ted Johnson
Yes, you are. You are going to see spread contraction, but ROEs are going to stay the same.
John Matovina
John here. What Ted was answering I realize they had a sheet of paper in my pant or with me, that shows up a blended spread requirement of about 250 for the premium for the first six months of this year.
That is new business, mix of bonus to and non-bonus products. Obviously that number will then vary as the premium mix goes, which is what your question went to.
But 250 was a proxy for the first six months premium. And the Eagle Life number, of course Eagle Life is a much smaller percentage of overall premium, but Eagle Life is below that so on the enterprise the number would even be a little bit smaller than the 250.
The 250 was the independent agent American Equity Life distribution.
John Nadel
Got you. Thank you so much.
Operator
Thank you. I'm showing no questions at this time.
I would like to turn the call back over to Julie LaFollette for any closing remarks.
Julie LaFollette
Thank you for your interest in American Equity and for participating in today’s call. Should you have any follow-up questions, please feel free to contact us.
Operator
Ladies and gentlemen, this does conclude today’s conference. Thank you for your participation and have a wonderful day.
You may all disconnect.