Feb 18, 2021
Operator
Welcome to American Equity Investment Life Holding Company's Fourth Quarter, 2020 Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over, to Julie LaFollette.
Julie LaFollette
Good morning. And welcome to American Equity Investment Life Holding Company's conference call to discuss fourth quarter 2020 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, Anant Bhalla, Chief Executive Officer; Jim Hamalainen, Chief Investment Officer of Insurance; and Ted Johnson, Chief Financial Officer.
Anant Bhalla
Thank you, Julie. Good morning and thank you all for your interest in American Equity.
We enter 2021 focused on being vigilant about realization of shareholder value. 2021 will be a transition year from the AEL 1.0 strategy to the AEL 2.0 business model.
It will be the execution year as we make demonstrable progress with closing of already announced the insurance transaction plan under our capital structure pillar and start our migration to alpha asset with investment management partnerships under our investment management pillar. I'll share more on these partnerships in a few minutes.
In my time with you this morning, I’d like to reference the AEL's 2.0 business model, virtuous flywheel of success that I've spoken up in the past including on December 9 as I shared how we are currently working to build and eventually speed up this flywheel to create superior shareholder value. First, the virtuous flywheel builds on an industry leading at scale annuity funding origination platform.
Second, adding in differentiated investment management capabilities and expertise in aligning the annuity liability funding with cross sector asset allocation now give us a competitive advantage over traditional asset managers as we leverage expertise to both sides of our balance sheet. And third, demonstrable success over time on these first two using our own capital will attract third-party capital to our business and grow fee revenues for AEL.
These fee revenues will be generated by growing third-party asset front of management in our investment management partnerships and from creation of additional side car reinsurance vehicles with new equity investors like the two we've announced to-date with Brookfield and Varde, Agam. These fees will diversify our earnings stream.
Fourth, leveraging third-party capital will transform AEL into a more capital light business. The combination of differentiated investment strategies and increased capital efficiency improves annuity product competitiveness, thereby enhancing new business growth potential and further strengthening the operating platform.
Jim Hamalainen
Thank you, Anant. As part of our AEL 2.0 strategy work, we executed a series of trades designed to raise liquidity to fund the Varde, Agam, and Brookfield block reinsurance transactions and de-risk the investment portfolio.
As part of this de-risking, we sold nearly $2 billion of structured securities and an additional $2.4 billion of corporates where we generally focused on securities that we believed were at risk of future downgrades. The sales occurred before the recent ramp-up in interest rates, so our timing once were two with us.
Ted Johnson
Thank you, Jim. As we reported yesterday afternoon, operating income for the fourth quarter of 2020 was $72 million or $0.70 per share compared to a $126 million or a $1.37 per share for the fourth quarter of 2019.
Fourth quarter 2019 results included a $2 million or $0.02 per share loss from the write off of unamortized debt issue cost for subordinated debentures that were redeemed during the period. Average yield on invested assets was 3.88% in the fourth quarter of 2020 compared to 4.10% in the third quarter of this year.
The decrease was attributable to a 22 basis point reduction from interest forgone due to an increase in the amount of cash held in the quarter. Cash in short-term investments in the investment portfolio averaged $4.4 billion over the fourth quarter up from $1.7 billion in the third quarter.
At year-end, we held $7.3 billion in cash in short-term investments in the life insurance company portfolios yielding roughly 7 basis points. The current point-in-time yield on the portfolio including excess cash is approximately 3.4%.
Operator
Thank you. Our first question will come from the line of Ryan Krueger from KBW.
You may begin.
Ryan Krueger
Hi, good morning. I have a question on the ROE outlook.
I think last quarter you talked about an 11% to 14% intermediate term and below or end of that being likely in 2021. Given the assets liquidity and some of the elevated expenses in 2021, I guess is the reason while we think that you probably come in below the 11% to 14% this year but then migrate back, back into it in 2022 once some of the reinsurance transactions are complete.
Ted Johnson
Hi Ryan, this is Ted. Yes, based upon the liquidity that we're holding right now I would expect is probably will come in a lower than the low end of that.
Now, obviously the determining fact off of where that ends up is going to be depending on whether or not in this part one on the timing of when the reinsurance transactions are executed and whether or not we invest any of that liquidity into securities prior to the execution.
Anant Bhalla
Yes, Ryan. I just have one thing, hi good morning, to what Ted already said which is spot on.
Is that we reel in 2021 or at least the first few quarters of it as a reset year. So, with focusing on '22 is probably the right way to think of matrix for us.
Ryan Krueger
Thanks. And then separately, do you I guess my guess have not been a focused product in the past for -- yes, it seems like they are more borne now.
I guess generally going forward, would you expect some of the more balanced mix between mig and FIA sales going forward.
Ted Johnson
I can take that and then Jim can add in. The mig is where our single premium deferred annuities were a good way for us to reintroduce into the market.
We think that's compelling its price to our pricing return. We are focused on fixed index annuities and you would see the rest of they are really focusing on the fixed index annuity side.
Now, given the pending numbers I gave earlier, you can see we're pretty robust in the first quarter as well. But second quarter onwards you'd probably see us pivoting much more to a fixed index annuity, there's new product introductions come to market like AssetShield.
Ryan Krueger
Got it. Thank you.
Operator
Our next question will come from the line of Pablo Singzon from JPMorgan.
Pablo Singzon
Hi, good morning. Hi.
My first question is and thinking about the next several years, how much of your portfolio do you intent to allocate to alpha generating assets. I think you know most insurance that all be somewhere between 3% to 5% in an Is you're thinking that you'll end up with a similar allocation longer term?
Anant Bhalla
Hi Pablo, good morning, it's Anant. I think the definition of alpha generating is very important in this case.
We believe yes we are in the markets right now and this is informed by leading partners as well. Actually allocating to traditional private equity hedge funds publicly traded equities is more risky.
And so, our allocation there is basically zero, or near to zero. So, the definition of alpha generating from our point-of-view is stable cash flow like traditional fixed income investing but in private markets.
Hence middle market credit for example is an alpha generating. It’s not equity.
This broader definition of alpha generating there is basically anything that is not queue set in public markets. Because anything that is queue set in public markets is grinding towards in a world of excess supply, excess demand for bonds is driving towards very low yields.
So, if you look at private credit, real-estate with contractual cash flows or infrastructure debt, all those are always going to have the flavor of a more traditional fixed asset which may have a residual equity sleeve as you structure it for capital efficiency. That's one important point.
As we think of that will probably put around 5% to 10% of the portfolio and it progressively each year and ultimately the target asset allocation, these private assets would be between 20% to 30% of the portfolio.
Pablo Singzon
Understood, thanks Anant. And then the follow-up question I had is just regarding your ROE aspirations broader than the team's longer term.
I know surely these but I was wondering if it's possible to give us a rough indication of how much of that expansion will be driven by higher earnings low versus the lower capital days whether through buybacks or leaning to third party capital, thanks.
Anant Bhalla
I'll start, the others can chime in. I think probably bring up a very important point.
They're few drivers of a high ROE overtime. First of all, one thing that we're very proud of this year which may go unnoticed is that the asset leverage of our business has gone down meaningfully.
If you do the math in page 9 and page 1 of the supplement, you'll see that asset leverage is going down on the GAAP basis from like 18 times to 12.5 times. So, it's actually applying to alpha assets which create greater earnings.
So, primary driver will be earnings and I would say that three drivers of that ROE expansion. First, alpha asset investment income growing.
Second, fee income that's non-equity related because its fee income from like the asset management ventures or reinsurance growing. So, those are two on the numerator of ROE.
And then finally, equity will go down as we redeploy more of that cash earnings back in our ongoing share repurchase programs or capital return programs like the outlined. Those items grow the numerator, one item reduces the denominator as we return cash to shareholders.
Pablo Singzon
Okay. Thanks, Anant.
Operator
Thank you. Our next question comes from the line of Randy Binner from B.
Riley. You may begin.
Randy Binner
Hi, it's Randy Binner. So, I have a question just not the pending counts you mentioned currently on the call.
I think it was kind of running something like 3500 at AEL and like about 1200 for Eagle Life. Are those the numbers generally for pending?
Anant Bhalla
Yes, it's this morning, Randy. Hi, Happy New Year and nice to hear your voice again.
That this morning --.
Randy Binner
Hi.
Anant Bhalla
Hi. I would expect that as we pivot from SPDA to more FIA, sorry if everyone .
If you will, it’s somewhat fixed in that annuities, that pending will probably trend down a little bit. It's at a high point is probably the way I put it.
Randy Binner
Yes. So, that's I just wanted to confirm those numbers, so they would be the highest in history.
I guess I'm curious just kind of can you characterize a little bit more where you're sitting kind of from a market competition perspective to get those numbers. And just confirm that from an operational perspective.
You're absorbing all that volume well. Just kind of curious how the sales and operations organization is dealing with that kind of flow.
Anant Bhalla
It's a great question, it's nuancing on the point. It allowed us to actually understand our operations capabilities the strength.
If you recall what the fourth pillar of our foundational capabilities of our strategy was foundational capability. And it's been a great test kit for us to realize how be the operations.
It's doing great. Do you get pushed?
It did. It'll make us realize where will you make investments in our business, three year, two years from now, yes.
So, we will be bolstering what we do in operations but it's done well, it's held up well to answer your question. And it's been a great test kit for us to see both how we reengage with the market, bring in new producer, Eagle hits new highs and it's obviously the rate.
So that we can actually do which very few companies do. Dominate two channels, and then figure out other avenues for growth.
Randy Binner
And then just can you characterize kind of where you're fitting in versus other competitors in the market. You obviously were very competitive at the end of last year.
Can you give us any color of kind of where you're fitting in against key competitors so far in 2021?
Anant Bhalla
We probably fit in to in the first core tile is the way to think about it. It'll be probably within the first half by the end of this year, at the end of this quarter.
We're going to take some rate action on the SPDA side. We have this accumulation product coming out you know this early next week actually launches Monday.
So, we're gone from first core tile to middle of the pack by the end of the quarter. We're still pricing to meet a in a turn and we got the assets on the balance sheet and the returns on the balance sheet to make that work.
So, as long as your asset returns the mid threes, we're meeting a product price in return hurdles which are like in the 10% area unlevered. Now to assume Jim then.
But that if you have any more questions, I'm sure Jim can add in.
Randy Binner
I'll leave it there on the product side. Thanks so much for the answers.
Anant Bhalla
Thank you, Randy.
Operator
Your next question comes from the line of Erik Bass from Autonomous Research. You may begin.
Erik Bass
Hi, good morning. Thank you.
Anant, your comments on focusing on 2022 I think make a lot of sense given all the moving keys is the near term. Is your expectation that you'll be a call it normalized level of cash and expenses by the end of 2021.
And then probably also executed some meaningful capital management by that time so that you'll enter '22 more of a normal run rate for earnings?
Ted Johnson
Hi Erik. Yes.
You got it spot on right.
Erik Bass
Great and then you also commented obviously part of the longer term strategy is to increase the level of the fee income for AEL and we've got good line of sight into the seating commissions you'll be getting from Brookfield but can you help us think about maybe the initial level of the income you expect from Varde and Agam in the asset management partnerships you've announced and how you see that building over time?
Anant Bhalla
It's a fair question. I'd probably sequence it this way early to give you any exact views on that other than the fact that like the answer is giving Pablo earlier about ROE improvement over time right and how earnings change.
The first driver of earnings growth will be actual spread income on Alpha assets because of higher yield. So sustaining 4 and growing from 4% yields that's one.
The second part will be actually constantly returning capital to shareholders from the earnings that are cash generated and some of the capital that's freed up which will then impact the denominator of all these calculations. And then, the third part of it will be the ramping up of fee income as you mentioned reinsurance fee income will be greater than asset management fee income as it takes time to ramp it up so like in the case of a Brookfield transaction you can see we have 90 basis points between ALM fees and insurance fees.
Those kind of transactions like we did with Brookfield obviously are more substantial you get 90 basis points of assets transfers and then when we do asset management deals I think it is fair to say you should expect us to earn from that asset management stream which is the third driver here around double-digit basis points on other people's money as we make insurance capital efficient products available for them and grow that. So that's a slower ramp.
I think that's a multi-year ramp, but it's a demonstrable ramp with these differentiated asset classes. Let me pause there because that was a mouthful.
Does those three drivers make sense and then sort of my sequencing it out and if not I'm happy to add on to it because I didn't do about throw a mouthful there.
Erik Bass
No. I think that makes sense.
It's the one to clarify on the asset management deal you talked about earning double digit basis points on other people's money. So to clarify does that mean you're not earning any investment fee on the capital you're putting in, but it's if the platform grows and takes on other kind of third party money then that's where you're going to fee income?
Anant Bhalla
No. It's a great question.
I'm glad you have to clarify. We make it on our own too but that's all you could look at returns on a gross or net basis so yes we earn rev share or we earn economics in the ventures on our own money too but it really is additive to us.
If I go through the construct because it comes with high yield net of fees in the first driver. You return capital the second driver but when you have other people's assets which was not in AEL 1.0 now you have third-party assets and we're making fees on that I think that's additive.
Erik Bass
Got it. That's helpful and I can just sneak in one other.
I think the Pretium acquisition is done in the general account is that where you expect most of the asset management partners to sit or would you hold any of them at the holding company so you don't have to kind of go through a dividend process to get fee income out?
Anant Bhalla
We'll probably do more of the latter and we don't have to own equity in all the partnerships. The Pretium partnership and the partnership which we haven't talked too much in great deal about are very different constructs.
One's an equity investment the Pretium one, the one is building something together maybe equity in the future but right now it’s more P&L l oriented. So that does not need equity.
We expect the blueprint to be that we're not really making that many equity investments only. A lot of them are going to be forms of revenue shares or P&L sharing arrangements.
Erik Bass
Got it. Thank you.
Appreciate the comments.
Operator
And our own next question come from the line of Wilma Burdis from Credit Susie. You may begin.
Wilma Burdis
Hi, good morning. Do you still feel comfortable with targeted capital return of 250 million to 300 million in 2021 and I think that was above the buybacks required to offset the Brookfield deal?
Anant Bhalla
Yes. Hi Wilma, good morning.
Wilma Burdis
Hey good morning.
Ted Johnson
I mean Wilma, with the reinsurance transactions that we're executing and along with where we want to hold capital and remember in normal times we wouldn't want to hold capital around a 400% RBC or an excess of that. So when we look at that and the reinsurance transactions certainly we believe that this year potentially we should be able to return that 250 to 300 above of the buybacks and then as we go forward and as Anant talked about the creation of the AEL 2.0 model and the fee revenue generation, etc.
we believe that's going to increase our cash generation profile to be able to hit those targets as we go forward.
Anant Bhalla
Yes. If you think of it the cash we have the holding company is plentiful for us to offset the Brookfield valuation as well as meet the target we had for the year.
So we only have the cash we need to put to work.
Wilma Burdis
Got it. That makes sense.
And then could you guys talk about the expected AEL 2.0 implementation cost especially in 2021? I mean, I know the costs were a little bit higher in 4Q.
Just if you could give us maybe some idea what it would look like this year?
Ted Johnson
On the nature of the cost I mean the nature of the cost or _
Wilma Burdis
No. The level.
The outlook for 2021.
Anant Bhalla
Certainly as we go through 2021 here we're going to see potentially elevated expenses. We were at 55 million of operating expenses.
What we indicated is on a go forward basis post the transactions we probably would be somewhere in that mid 40s range, the high 40s range but I would say we're going to see expenses we called out 3 million in this quarter. So you're still in the low 50s for operating expenses as we go forward through 2021, which really represents additional expenses that we're incurring for advisory fees related to the transactions and the other work that's been doing.
Now the other part when we talk about run rate the reason why the run rate we're quoting that 45 or higher 40s is certainly staffing and creating the infrastructure for AEL 2.0 is different than what was there for AEL 1.0, but we have factored that into our modeling and our expense structure when we're quoting what ROEs we think we're going to be able to hit in the future.
Wilma Burdis
Got it and then if there's just one more could you just provide any outlook for kind of 2021/2022 sales? I know the sales were very strong in the fourth quarter just and you talked about some of the trends for this early this year but just any thoughts on the outlook?
Ted Johnson
Well historically, we don't give any outlook on sales but beyond quoting the pending numbers that we currently have and I think Anant touched on those pending numbers and also talked about potentially how we would over the year move away from maybe to higher levels of sales to SPDA multi-year products to more of the fixed indexed annuity products.
Wilma Burdis
Got it. Thank you.
Operator
And our next question will come from the line of Mark Hughes from Truist. You may begin.
Mark Hughes
Yes. Can you hear me?
Ted Johnson
Yes Mark we can hear you.
Mark Hughes
On the independent agent channel can you talk about how they are operating with still presumably some COVID related restrictions? What you might say capacity utilization on that channel just in general?
Are they back up and going or still at reduced capacity?
Anant Bhalla
Hi Mark its Anant. The channel is fairly active.
I mean we've all adapted to this new way of working which is largely remote. We're not actively in the market face-to-face we're putting help first in that point of view in that channel but it's functional.
It's doing well. It's easier to sell SPDA also as a product when you don't have face-to-face interaction with a client when you're not doing the way they go to market a lot of them have seminars, dinners but I would say the channel activity is good.
The IMO partners are helping the producers of the agents figure out how to sell and more importantly I think the kind of products we have with the product refresh we are launching income shield for example got refreshed that's doing well and actually income shield is one of the products that's reinsured to Brookfield so it's good we've got that working well. AssetShield with the revamp will make it a very simple compelling composition where flying for accumulation can grow that then we have some additional product ideas in mind working with distribution that we think are going to pivot things forward, but no one knows what the new normal is working but it's working fine.
Mark Hughes
On future deals, you've got the other asset managers or potential reinsurance deals is there anything unique about these transactions that contributes to the cash drag? The future deals also have kind of periods where you've got this buildup of capital?
Ted Johnson
Related to the cash drag the asset managers those are not those transactions aren't going to create cash drag for us. The cash drag is much more related to reinsurance transactions and if we would do another reinsurance transaction outside of the ones we said and it wasn't a transfer of securities or it was a transfer of cash yes we could see cash built up but really our current cash that we have on the balance sheet is specifically related to the couple reinsurance transactions that we're currently working on.
Anant Bhalla
Yes and I just add in Mark is that we feel very good about actually the strengthening of the balance sheet as we did in the, which we did last year and the fact that the asset leverage is down, financial leverage is down from 17.7% to 12.2% asset averages down from 18 times around 12 times, 12 to 13 times and so the cash drag is actually a part of implementing a new business model that's actually less risky and with the balance sheet being strong and capitalizations being at the highest levels in our history and staying in those levels as on a go forward basis allows us to execute. So we really do the cash impacts of holding liquidity to being a transitionary nature related to the two insurance transactions because we are transforming 20 of the balance sheet with these reinsurance transactions and the rest of the balance sheet moving to where they're going.
Having de-risked out of it's good to be smart if you can be smart and lucky we'll take it and I think our timing was really good. The team did a good job.
Jeff, Jim -- on de-risking some of the structured securities and frankly it's better because it worked out. It's the part of being lucky.
Rates are up 40 basis points in the last one month. So it's actually been good to be in cash but it will be a short term impact on results and we expect first quarter to be impacted by that because we have more cash in first quarter than we had on average in the fourth quarter.
Another long answer to a very simple question. I apologize for that but happy to take any further follow up on it.
Mark Hughes
Thank you.
Operator
Next question comes from the line of John Barnidge from Piper Sandler. You may begin.
John Barnidge
Thank you and good morning. AEL.
Apologies if I missed it in your prepared remarks but what was the yield on securities purchased during the quarter?
Ted Johnson
Hi, Mark its Ted. I said those in my remarks.
The average yield on investments acquired this quarter was 446 gross of fees. Now it's compared to, was compared to 359 last quarter.
John Barnidge
Thank you very much and then maybe as part of AEL 2.0 have you looked into building maybe like a third-party claims and policy administration platform that could generate additional servicing revenue?
Anant Bhalla
You hang out in our strategy sessions.
John Barnidge
No. I guess I am asking the right questions though.
Anant Bhalla
You're asking exactly the right questions. I think it's an element of that foundational capability pillar the fourth pillar of, this year we are really focused on investment management and capital structure and you're spot on right, but it's too early to talk about that fourth pillar and what that could be but as I said I think you hang out in our strategy sessions.
So jokes apart. That's a stretch it's doable but it'll require some more investments.
That's not reflected in anything we've shared with you it's sort of upside over the long term.
Ted Johnson
You certainly recognize that there's an opportunity in the marketplace out there to do that but it's an onset that's not on our near term plan but certainly it is something we are looking at long term.
John Barnidge
Great. Thank you for your answers and best of luck.
Operator
Thank you and our last question will be from Pablo Singzon from JPMorgan. You may begin.
Pablo Singzon
Hi, thanks for checking my follow-up. So Anant and Ted I just wanted to follow up under capital deployment comments but to your point if you consider the next maybe two to three years your capital appointment is already covered by the insurance transactions and available capital in the balance sheet.
At what point though would you need to start allowing more earnings to support capital deployment and I guess to relate to that how should we think about the context of operating needs to support fields and buybacks and the context of that question is that I think in the past most of the capital was used to fund sales. Thanks.
A – Anant Bhalla
Hi Pablo happy to take to follow on. Yes so your spot on right.
We expect to free up capital. If I go back to my the three building blocks that I started our articulatory earlier question earnings will go up as investment income goes up with Alpha assets being a greater portion of the investment portfolio.
If it goes up from 10% this year to 15% to 20% next year 25% to 30% the following year that's how earnings will grow. Those earnings including our reinsurance platform that's created so that in our a lot of those earnings are coming out of the reinsurance platform will be able to be returned to shareholders as will capital freed up as we'll then fee income from investment management partnerships or transactions that we talk about but it will be, we will not need capital to fund growth.
We will be more than self-sufficient to fund growth. The devil will be in the details as we work through all the execution but I think the priority order that I just gave you with the existing capital we free up that goes back to shareholders and then with the growth of the earnings that sustainable earnings including out of the reinsurance platform and the investment management partnerships will be free cash flow up to shareholders.
Pablo Singzon
Thanks Anant.
Operator
Thank you. I'm not showing any further questions.
I'd like to turn the call back over to the speakers 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 concludes today’s conference call. Thank you for your participating.