American Equity Investment Life Holding Company

Good morning, and welcome to American Equity Investment Life Holding Company's conference call to discuss first quarter 2012 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com.

Presenting on today's call are Wendy Waugaman, President and Chief Executive Officer; John Matovina, Chief Financial Officer and Vice Chairman; 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 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 available on our website shortly after today's call. It is now my pleasure to introduce Wendy Waugaman.

Thank you, Julie. And good morning, welcome to the call.

We were pleased last night to report first quarter operating earnings of $29.8 million, that's $0.46 per diluted share. These results are consistent with our long-term strategy, which is to continue to build assets under management and manage a consistent investment spread on a growing base of assets.

We're very pleased with gross spread results of 2.93%, which is substantially on target despite the fact that over the last year rates at which could put new money to work have dropped by over 100 basis points. The low rate environment continues to be our top challenge as we seek to find assets meeting our quality, duration and yield requirements.

We believe we can continue to maintain spreads at target levels despite the low rates by adjusting rates to policyholders as we have in the past. Industry sales are expected to be muted in 2012 due to the low rate environment.

We believe that consumers making long-term savings decisions may elect to wait for rates to rise. At the same time, we are interested in what's happening with competitors and we may see market shifts, shifts in market share, as certain of our competitors face obstacles such as Solvency II, which may cause them to exit the market.

In contrast, we see others attempting to build market share through aggressive product pricing coupled with riskier asset strategies. As we continue in this unusual market environment, we're committed to several things.

Number 1, we remain committed to quality in our invested assets and we will not compete by adopting a strategy of taking on more risk. Number 2, should we see competitors exit the market we're convinced that we more than sufficient capital to take on additional sales which might result from that occurrence.

Our book value at March 31, x-AOCI was $16.24. This consistent growth in our book value reflects our consistently solid financial results, yet our stock continues to trade at a discount to book.

Why is the #1 question we get from investors. We have limited answers to this question.

We're a small cap company. We're a single focus company, as the rating agencies like to point out.

But neither of these things reflect a flaw in our basic business model. We intend to continue to adhere to our strategy and, of course, we hope to continue to post strong results.

In the meantime, we believe the stock represents a very good value. And with that, I'll turn it over to John.

Thank you, Wendy. As Wendy said, our first quarter operating earnings were $29.8 million or $0.46 per diluted share.

That is a slight decline from a year ago where operating earnings were $30.6 million, $0.47 per diluted share. The results were for Q1 translate into a 14.3% return on average equity based upon a trailing 12-month period, and if you exclude the impact of the favorable unlocking we had in the third quarter of last year, that trailing month -- trailing 12 months ROE would be 13%, still a very high number.

As she commented, our investment spread was 2.93% in the quarter. Total invested assets grew to $24 billion.

We've got about another $1.3 billion in cash that will be invested over the balance of this quarter and next.

Net cash results from calls and prepayments to government agency securities. And we'll talk a little bit more about that a few more comments down the road.

The spread result was slightly below the fourth quarter spread of 2.97% but on an adjusted basis, the first quarter spread was 2.99% compared to 2.98% in the fourth quarter and at the target level of 3% that we're targeting. The average excess cash balance in the quarter was $759 million and that resulted in a -- at a cost to the spread of 14 basis points, offsetting that impact from the foregone investment income would've been some incremental income for prepayments and bond fees, commercial real estate, RMBS securities and corporate bonds that added about 7 basis points to spread and we had a benefit of 1 basis point from the over-hedging.

Our favorable spread results reflect our actions to maintain spreads by adjusting rates to policyholders. So while the average yield on investment assets declined 15 basis points from the fourth quarter, the cost of money although declined by 11 basis points and, of course after adjustments, the numbers were even closer together.

Should the aggregate yield on investments continue to decline, which of course we're investing new money in -- at rates less than the portfolio yield, we have the capacity or ability to take additional actions to adjust rates to maintain that spread. And in terms of the index annuities, we estimate that there's about 75 basis points of room where we could reduce rates before we would run up against our minimum guarantees.

And in our financial supplement for this quarter, we've added some additional information on Page 9 that gives a lot of the details in terms of our index -- the various index strategies and where the money is currently positioned in terms of caps and participation rates versus the minimum rates that are available within those policies. During the quarter, we purchased $1.7 billion of new fixed income securities at an average yield of 4.35% and we also made $59.2 million of new commercial mortgage loans at an average yield of 5.42%.

Thus far in the second quarter, we're continuing to get security investments out at levels that were equal to or better than the first quarter yield. Our mortgage loan rates are slightly lower.

We've been making more new mortgages in the 4.75% to 5% range. So that 5.42% rate for the first quarter is not going to persist throughout the year.

The purchases of fixed income securities in the quarter, largely in the area of corporate bonds and then some reinvestment into government agencies, we purchased $1 billion of corporate bonds at a yield of 4.55%. And we purchased $660 million of agency securities at a yield of 4.05%.

The yields have been achieved and the bond purchases without reducing in -- our credit quality or exposure to investment grade bonds. The level of investment grade continues to be very high at 98% on an NAIC basis.

And 93% on a rating agency basis. There has been a slight shift into more BBB bonds versus the single-A bonds from year end but still, investment-grade purchases and avoiding the below investment-grade category of investments.

Calls of bonds in the quarter were $1.9 billion at a yield of 5.33%. And then thus far in the second quarter, we've had another $405 million called.

We don't have any additional calls on the horizon for this quarter until late June. When the amount that would be callable is at $358 million, and those bonds have a yield or weighted average yield of 5.32%.

So if the rate environment continues as it is today, it's very likely those bonds would be called.

Then for the balance of the year, there is $912 million in August of the third quarter. Those bonds have a blended yield of 5.13%, in the fourth quarter, the number's $669 million at a yield of 4.16%.

So based upon current levels of rates, very likely the third quarter bonds would get called not so sure about the fourth quarter bonds. Operating cost and expenses for the quarter were $21.7 million, that's up from $17.5 million a year ago.

And a majority of that increase is going to be attributable to the prospective adoption of the revised accounting guidance for deferred policy acquisition cost, which resulted in a $3 million additional expense recognition in Q1, 2012. That $3 million largely relates to internal cost of salary and other expenses that we incur for the issuance of policies that were previously deferred under the prior guidance, and are no longer eligible for deferral.

Our RBC at March 31 is estimated at 343%, that's down slightly from year end. Slower sales are benefiting our RBC result and may result in increases in future quarters.

We also, though, have a negative impact from statutory valuation rates, which are used to determine reserves for -- on a statutory basis. The rates for policies issued in 2012 are much lower, lower than what they were in 2011.

So that's having an effect of reducing statutory marketing income 2012. With that, I'll turn the call over to Ron to talk about sales and production.

Thank you, John. Good morning, everyone.

As Wendy mentioned, sales were satisfactory at $979 million for the first quarter. That is lower than the first quarter of 2011 at $1.3 billion.

In 2011, we had significant production in that first quarter due to rate cuts announced in January. Our pending in the first quarter of this year averaged 2,845 cases that did start to increase mid- to late March and it is been just above 3,000 since.

A year ago, our pending count was in the 3,500 range. Lower rates offered to policyholders today may certainly lead to 2012 sales that are lower, but they will have little impact on our overall profitability.

As we visit with our core group of marketing companies, most everyone has had lower production in the first quarter. We have been losing some business to companies with aggressive pricing and investment philosophies.

This is absolutely a strategy we will not employ, especially in today's interest rate environment. It also seems typical that some companies come out aggressive in the first half of the year, then hit their sales targets and then fall back.

We've had a consistent approach to our business. It served us well over the long-term and we plan to stick to it.

As a reward for our consistency American Equity has increased our index annuity market share every year since 2008. Back then, it was 8.4%, and last year it was 13.5%.

Our focus for 2012 is to retain our Gold Eagle members. To refresh your memory, our Gold Eagle member is someone who writes at least $1 million in annual annuity premium for our company.

Benefits include marketing money and American Equity stock options, among other things. In 2011, we had 1,128 Gold Eagle members who produced 58% of our total sales.

So it's a small group of people responsible for a lot of sales. And in 2011, we retained 66% of our 2010 Gold Eagle members, an all-time high.

We feel, going forward, we can be more efficient, more effective by focusing on a smaller group of high-volume producers. We have extraordinary success in retaining significant Gold Eagle members.

For example, we retained 56% of our Gold Eagle members who roped between $1 million and $2 million in 2010. But we retained 92% of our Gold Eagle members that wrote between $4 million and $5 million.

Now granted, that we have a smaller number of $5 million producers then we do $1 million producers, but the numbers are high enough that would make it still very relevant. We feel good about our Gold Eagle percentages.

And retaining Gold Eagle percent -- Gold Eagle agents, obviously it helps to have competitive products and rates, but I think a really big reason for our Gold Eagle retention and for our success is our people.

And we -- and our people, along with our founding principle of providing excellent service. I got an e-mail just yesterday as a matter of fact, from one of our marketing companies telling me about our people.

I'll read it, just a brief snippet that says, commenting on 2 people, they have superior work ethic and always go the extra mile in helping us please our agents. They make us look great and also make it seamless to write business with American Equity.

So we get e-mails and phone calls like that all the time and it's just a tribute to our great people here at American Equity. I'm very proud of all of them, they do an outstanding job.

We had a successful million dollar producer forum in March, and in line with our 2012 goals, we invited only our Gold Eagle members. In the past we would invite producers that could document that they wrote $1 million with, in the previous year regardless of who the company was.

We wanted to really focus on that group of people who are moving the needle for American Equity. We had 552 attendees that was including marketing companies that was down from 800 attendees the last, the year before.

As I mentioned, we wanted to tailor the program to producers already familiar with our company, and we wanted to strengthen those relationships and increase our market share within their business. And while it's still a little bit early, so far, we've seen good results from our new strategy.

We are also continuing our producer forums in our office. Here again, we want to focus on our Gold Eagle members and specifically, those Gold Eagle members who have not been to our office yet, this will give us an opportunity to reinforce our value proposition and also give them an opportunity to meet our great people.

As a matter of fact, today, we have 45 Gold Eagle members in our office and next week we'll have another 45. Finally, we're continuing our policyholder appreciation events.

So far, since we started our program, we've had 41 events across the country with over 8,000 policyholders attending and 550 Gold Eagle members. And we believe our policyholders are entitled to hear directly from us that their money is safe and that American Equity is financially rock-solid.

And based on the cards and e-mails and phone calls we receive after each event, we feel these events are absolutely the right thing to do. We also think the popularity of the event is spreading as our attendance has been going up on a consistent basis.

We are, at almost every event now, well over 200 people. Also, we recently won a Stevie Award for our policyholder appreciation event idea.

This is an international award for excellence in customer service. And we also had a real nice article in the February issue of Best's Review, if you'd like to take a look at a third party's perspective of this event.

So with that, that concludes my report, and I'd like to turn it back over to the operator.

This is Dan Altscher on for Randy. Regarding the sales, Ron, I guess in the first quarter, it's obviously a seasonally weaker quarter, but you think there were some sales activity that was pushed forward in both third quarter and fourth quarter as a result of the repricing initiatives that maybe, would've, have come through normally in the first quarter?

I'm not sure I understand the basis of your question.

To deliver rate -- deliver changes in December. Pull some sales back.

No, I don't think so. I, we've made some changes to the lifetime income benefit rider and that had maybe a small impact, but I don't think that it has pushed anything into the first quarter?

Okay. And maybe a little bit more generally on the sales outlook.

And I guess there were some indication that this year could be down a little bit but, I guess anything that you could quantify or think about as we go forward, I mean, it looks like 2Q should be sequentially better than the first quarter.

Well, our pending count is up so far compared to where it was in the first quarter. So we hope that's a good indication.

We continue to be optimistic for 2012, with some of the things that Wendy and I both mentioned, while interest rates are down, we still promote our products as a great safe money alternative compared to other safe money alternatives. The rates are down, but what they can get in bank CDs, in money markets and those types of things, and combine that with our lifetime income benefit riders for guaranteed income, still think we're great alternative and we got the other companies with their, perhaps Solvency II issues and those types of things.

So we're poised to take the business and we're optimistic.

Okay, great. And then just a question for John.

On the RBC, you mentioned kind of puts and takes this quarter with lower sales driving down, or I guess, less contribution for a required capital and then the take being, or the negative being the higher valuation rates on the reserves. Can you kind of give a little bit more color around those specifically, and I guess how much the statutory earnings was reduced by the higher reserve -- the higher evaluation rates on the reserves?

Dan, I don't have a specific number on the quantification of that. Dan, I think it might exist within some information we have.

But I didn't focus in on quantifying how much the valuation rate was taken away from the growth in capital. And the lower sales is going to have a small effect, not much.

I mean, our approach to doing RBC on quarterly basis is to do a trailing 12 months. So we replaced first quarter a year ago with first quarter this year.

So that's got, that's taken us from about $5.1 billion C4 risk consideration to 4.7%, 4.6% consideration, so that's a reasonably small effect.

Okay. And I guess that the thinking, or the logic behind that is, if the sales pace does slow down a little bit, we'll continue to see some, I guess, boost in the required capital over the less growth in required capital going forward, which would be a, I guess a positive for the RBC [indiscernible] ?

Right.

Given where interest rates are and the tighter corporate spreads, can you just talk about how much spread you currently are getting on new business? If you're contemplating any additional changes to new money rates?

We think we're making our spread at 3 points or right at 3 points on the new business, Erik. We haven't had any consideration or discussion of lowering rates beyond what was done in the fourth quarter of last year.

We -- the yields have been the 4 30 so, 5 a bond yield was a little bit higher than what the expectation was when we made the rate adjustment back in the fourth quarter. Our cost of money on new business, we were -- with fixed rates set at 160 and 175.

That would've been a blended option budget for us of 168. In recent weeks we've been coming in at about 155 as the overall cost.

So we're comfortable that were making our 3-point spread on the new business, and at this time, don't see any need to change any rates.

And then on, just wondering if you've updated your capital model for 2012 yet? And if you have, if you could just talk a little bit about the outcome?

Yes, Erik, we did update our model and the outcome reflects, as suspected, that if in an aggressive growth mode that we continue to have very adequate capital to support in excess of $16 billion of new business over the next 3 years. In a lower sales environment, the RBC ratios remain relatively level over the next 3 years.

We had expected to see them move up in a lower sales scenario, but with the change in the valuation rate that John discussed, it's having a little bit of a drag on that so the base case scenario showed essentially a level RBC.

Got you. So level RBC in kind of a lower flat sales environment, but you wouldn't see as much pressure on the RBC if sales were to grow a little bit from here as you had historically, is that the right way of looking at it?

That's correct. We have a -- we have more of a cushion that we had in the past to support excess sales.

Wendy, you said 16, that was 1, 6?

Yes, a little bit in excess of that.

John, on the question of the valuation rate, and the strain out, just so I'm clear, the strain is only on 2012, right? It's not retroactive?

That is correct. Valuation rates are set per year of issue and then remain with the policy over the policy life.

Okay, yes, all right, that's what I thought. So, I guess my question is did, I guess my question is why is this strain here, given the fact that you have reduced rates as much as you have?

I think because you expected this, this was easily predictable, given what was going on, no? So I guess I'm a little bit confused.

The strain from new business and statutory, the rate of -- rate adjustment is not going to cover that. And our base policies, just we got the same spread requirements 2011 to 2012, but the 2012 issues are going to have slightly higher statutory reserves than 2011, in the first year.

Now over time, that -- it's all a timing issue for statutory, it eventually evaporates because the surrender charges runoff you get to account values. And within the base product, adjusting, if we could raise spread to 310 or 320, we could offset, perhaps the impact of the lower valuation rates.

But the only other options are to the modify products somehow say change surrender charge or adjust commissions, which is really not things you can -- they're not realistically on the table, so to speak. And neither is a spread adjustment moving up to 10, 15, 20 basis points.

So we -- I don't want to say our hands are tied, but on the base product, we don't necessarily have a lot of flexibility to deal with the impact of the lower valuation rates. We do -- those valuation rates can have a bigger effect on the lifetime income benefit rider aspect of policy reserves, and that was something we did adjust in December to lower the terms of the accumulation rates and the payout factors to be responsive to the fact that reserve valuations per statutory were going to be a tougher challenge or rates were going to be lower, reserves were going to be higher.

So we've mitigated some of that effect through adjusting the terms of the lifetime income benefit writer.

And another piece of that too, that would be the index credits in the first quarter were below what we would call par threshold, I guess. And the way statutory accounting works on the index side in particular, is in periods of robust index credits, you have better statutory earnings because your full value of the option comes through as revenue when you put up say, 85% or whatever the number might be of the increase in the account value is the increase in reserve.

But the opposite holds true in periods of lower index credits and that's the period we had in the first quarter, we had $58 million or $59 million, which I think blended out to 1.5 or 1.6 index credit, which would be below 275 to 3, with -- where baseline was at. So that results in lower quarterly statutory earnings or lower statutory earnings when you have shortfalls in index credits from the baseline.

Okay got it. And then, on the -- well, 2 questions, I guess, Wendy, anything legal going on?

I still think we've got a case in Los Angeles?

We do. And in terms of actual litigation, there's nothing going on.

There continue to be mediation discussions around a possible settlement.

Okay. And then Ron, any fallout among the agents, with regards to the Neasham case?

There's certainly been a lot of talk of surrounding it. I think some agents are a little nervous about the prospects of an outcome like that case.

I don't think we've had any fallout, though. There's certainly been a lot of chatter about it.

You had mentioned that the competitors -- certain competitors have gotten more aggressive with their sales strategies and their investment strategy. Were those any insights as that were those existing players, were those new entrants that were being more aggressive?

I would say some of both, Mark. There are some new entrants that are coming out-of-the-box with some very aggressive income riders and some of the companies that we've been competing with for years that come out historically and the first 2 quarters with caps higher than everybody else's and they steal some market share and then they get what they want and then they pull back.

I call those guys in and outers.

Right. What in -- the new players, when they're aggressive like that, is it usually a 2 quarter phenomenon?

Or is that a little more extended?

Well, it depends on the player. But it can sometimes be extended depending on who's supporting them behind the scenes, or if they're a brand-new start-up, it maybe a shorter period of time.

I just have one quick question and that is, are you seeing any movement in policy holder outflows from the quarter?

I haven't looked at the actual rates of surrenders and withdrawals. But the trend over the last year has been that surrenders are at very low levels.

If you look at 2011, surrenders would've been about 1/4 of what we would've expected based on pricing. I think that's a reflection of the slow rate environment that people, particularly who have older policies, with higher guarantees, are very happy to hang onto those policies and there's very little incentive to surrender.

Penalty-free withdrawals run pretty consistently at between 3%, and say, 3.3%, 3.4%.

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.