American Equity Investment Life Holding Company (NYSE:AEL) Q4 2022 Earnings Call Transcript

American Equity Investment Life Holding Company (NYSE:AEL) Q4 2022 Earnings Call Transcript February 17, 2023

Operator: Welcome to American Equity Investment Life Holding Company’s Fourth Quarter 2022 Conference Call. At this time, for opening remarks and introductions, I would now like to turn the call over to Julie Heidemann, Coordinator of Investor Relations.

Julie Heidemann: Good morning and welcome to American Equity Investment Life Holding Company’s conference call to discuss fourth quarter 2022 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 or elsewhere on our Investor Relations portion of our website. Presenting on today’s call are Anant Bhalla, Chief Executive Officer, and Axel Andre, Chief Financial Officer. Some of our comments will contain forward-looking statements, which refer or relate to future results, many of which we have identified in our earnings release.

Our actual results could significantly differ due to many risks, including the risk factors in our SEC filings. An audio replay will be made available on our website shortly after today’s call. It is now my pleasure to introduce Anant Bhalla.

Anant Bhalla: Thank you, Julie. Good morning and thank you all for your interest in American Equity. The fourth quarter of 2022 capped a successful year for the ongoing advancement of our AEL 2.0 strategy as we continually execute against the four key pillars. In investment management, we originated $5 billion of privately sourced assets at an expected return greater than 6% and expanded our primary focus from residential real estate in 2021 to a more diversified portfolio in 2022 covering a variety of sectors, including infrastructure, middle-market credit, and commercial real estate equity. Across sectors, we are being disciplined and deliberate focusing on underlying assets with a resilient cash flow profile, where the majority of the return is largely delivered by the underlying operating performance and where there is an advantage for an insurance balance sheet to own the assets.

With fixed income spreads widening throughout most of the year, we see this additional optionality to increase exposure in our core fixed income bucket while being more selective in our private asset strategies. In go-to-market, we substantially revamped up pricing procedures, affording us optionality to reprice products quickly as markets change. To put this in perspective, we have historically repriced new products once or twice per year. Thanks to the changes we made to improve these processes. We successfully delivered in excess of 50 product and rate changes in 2022. Our pricing has become more nimble, targeted and responsive to market changes, which is important to generate growing sales, while maintaining attractive double-digit IRRs on total sales volume.

We also refreshed our distribution incentive and loyalty programs and continue to assess ways to further differentiate our service offerings to producers building on our number one ranking for Customer Satisfaction for annuity providers by J.D. Power & Associates. In this area, we will be revamping our new business processes and technology to improve efficiency as we grow. In our capital and reinsurance pillar, we achieved $9.6 billion of fee generating reinsured balances and generated over $50 million in revenues in 2022. This included new business seeded during the year of $1.3 billion to Brookfield and $3.8 billion of in-force to 26North effective October 3. Additionally, the new reinsurance agreement with 26North Re resulted in a capital release of $260 million to fund the growth in excess capital that supports the continued migration to privately sourced assets and capital returned to shareholders.

As a result of these transactions, we are €“ as a result of this transaction, we also reduced the sensitivity of our GAAP financial results to equity index credit. We are also pleased to announce that we started flow reinsurance on traditional fixed rate annuities with 26North Re effective February 8. During the year, we repurchased 14.8 million shares more than offsetting the dilution for the follow-on offering to Brookfield and returned an additional $307 million to shareholders. Combined with dividends paid in the fourth quarters of 2021 and 2022, we have returned $369 million of capital to shareholders in the last five quarters. In 2023, we intend to return at least $380 million to shareholders comprising of the $130 million remaining from our planned return in 2022 and at least $250 million for 2023.

This is well within our remaining authorization of $569 million and a testament to the board and management’s belief in our long-term potential to generate sustainable and growing value for shareholders. While it’s not front and center we continue to invest in enhancing our fourth pillar the foundational capabilities to support a higher trajectory of growth and widening of our liability aperture, while maintaining expense discipline. We have implemented new investment accounting and investment management systems and are implementing a new general ledger system. Turning to the fourth quarter, in the investment area, we saw many unique opportunities in private assets during the fourth quarter as markets continue to reprice across most sectors.

In the quarter, we put $1.4 billion to work in private assets. Total private assets at the end of the year were almost $11 billion, bringing that allocation to 22% of the investment portfolio at year end. Of this amount, approximately $7 billion or close to two-thirds is in real estate loans, comprising of $2.9 billion of residential loans, $3.4 billion of commercial mortgage loans and $0.6 billion of agricultural loans. Beyond mortgage loans, the private asset portfolio consists of middle-market private credit of $1.2 billion or 2% of the portfolio. Middle-market credit consists primarily of senior secured loans to small and medium sized companies with strong lender protections. This portfolio is well diversified across borrower end markets is mostly floating in nature and offers better structure than high yield public credit markets.

Majority of this portfolio is managed by Adam Street Partners and some more details on this were presented in our Investor Symposium in December. Additionally, outside of credit, the single largest sector in our private asset portfolio is our approximate $1 billion portfolio of single-family residential rental homes. We have been a big believer in this asset class and over the past 2 years, have built a portfolio of home that is geographically diversified in locations, seeing both strong growth in population and associated wage income growth. We look to benefit from both long-term appreciation of housing stock and rental growth. The macro dynamics for rental housing are strong and partnering with the nation’s leading platforms operated by our asset management partner, Pretium is a compelling differentiator for AEL.

Photo by Jason Dent on Unsplash

Finally, our private assets portfolio comprises of a 1% allocation each to infrastructure debt and specialty credit and a smaller allocation to commercial real estate equity, which along with infrastructure equity should grow over time. We have negligible exposure to traditional private equity and no exposure to hedge funds. During the quarter, we put over $800 billion to work in the real estate sector, primarily residential non-qualified mortgages, residential transitional loans and single-family real estate at an average expected return of over 6.4%. We remain bullish on rental housing as demand continues to significantly outpace supply. Residential real estate loans remain attractive and with underwriting standards tightening still produce expected returns north of 6%.

In addition, we see attractive risk adjusted yields in directly originated middle-market credit as well as in directly sourced opportunistic specialty credit and real assets. One of the real estate investments made in the quarter was our first equity investment in the ultra luxury hospitality sector, partnering with a world class hotel owner and operator. This is part of the hospitality sector that is proving to be more resilient through economic cycles though it is still a newer and growing segment within the United States. Earlier this week, American Equity Life Insurance Company co-invested alongside an I Squared Capital Fund in the Whistler Pipeline. The Whistler Pipeline is a leading U.S core energy infrastructure system connecting the Permian Basin growing natural gas supply to LNG Mexico and Gulf Coast demand.

Whistler will have direct connections into LNG facilities in the Corpus Christi area. Nearly all current capacity is contracted under long-term fixed fee minimum volume commitments, primarily with investment grade counterparties. We see increasing long-term demand for natural gas across the U.S Gulf Coast due to the growth in LNG liquification capacity being constructed in the region as well as growing demand from Mexico. I share this detail, because it is an example of an asset that offers a rare combination of strong free cash flow, high quality contracts and operating rights on highly strategic natural gas infrastructure. The management team of the asset will retain a significant portion of equity in the business, has established a reputation for growing contracted cash flows through developing and operating greenfield projects, and have identified several initiatives to further grow this platform.

We are also strategic and purposeful in seizing the opportunities arising from broader public market dislocation. For example, during the fourth quarter, we added over $1 billion of high-quality almost entirely AAA and AA rated structured securities with expected return above 6%. All of this points to the value we have delivered to our investment management area where we are balanced from a risk return point of view between public markets and private assets. In the go-to-market area, we saw a fourth quarter increase in sales of fixed index annuities of 7% compared to the third quarter. We saw very strong sales gains at Eagle Life in both accumulation and income products, which would be expected given the rapid response nature of the bank and broker dealer channels to pricing change.

At American Equity Life, we continue to see growing momentum for sales of IncomeShield, which was up 8% from the third quarter and increased 29% from the comparable period a year ago. Accumulation product sales in the independent agents channel saw decline due to relative attractiveness of more commoditized S&P cap rates. With our latest pricing refresh effective November 30, we are well positioned competitively and entered 2023 with strong momentum. Through February 15, we have sold approximately $460 million of fixed indexed annuities and over $160 million of traditional fixed rate annuities for total annuity sales of approximately $620 million. We are very well positioned to continue to seize opportunities and be competitive in the marketplace and are confident in and energized about plan to deliver superior value in the long-term.

Now, I will turn the call over to Axel to go over earnings results. Axel?

Axel Andre: Thank you, Anant. Let me extend my appreciation to all of you attending this call. For the fourth quarter of 2022, we reported non-GAAP operating income of $67.9 million or $0.79 per diluted common share compared to non-GAAP operating income of $75.8 million or $0.81 per diluted common share for the fourth quarter of 2021. Excluding notable items, operating income for the fourth quarter of 2021 was $97.1 million or $1.04 per diluted common share. There were no notable items in the fourth quarter of 2022. The quarter included $21 million of revenues from reinsurance agreements, up from $11 million in the third quarter of 2022. You notice that we changed the presentation in our financial supplement to show account values rather than cash spend values as we had previously done.

As cash surrender value is no longer a common metric for the calculation of fees on all account value ceded. Going forward, the change in account value line will include new business ceded offset by decrements in certain business ceded. Average yield on invested assets was 4.3% in the fourth quarter of 2022 compared to 4.48% in the third quarter. The sequential decrease was primarily attributable to returns on partnerships and other mark-to-market assets which returned 9 basis points less than expected returns in the fourth quarter compared to 22 basis points over expected returns in the third quarter, partly offset by a 15 basis point benefit on the portfolio from the increase in short-term rates on our floating rate assets. The average adjusted yield, excluding non-trendable prepayments was 4.29% in the fourth quarter of 2022 compared to 4.45% in the third quarter of 2022.

While partnerships and other mark-to-market assets, which are reported primarily on a one-quarter lag basis had a positive contribution to investment income well within the expected range of variance, the contribution was $11 million or 9 basis points of yield less than the assumed rate of returns used in our investment process for the fourth quarter of 2022. As broader context, the contribution of partnerships and mark-to-market assets to net investment income for 2022 was $200 million, which is $87 million or 16 basis points more than the assumed rate of return in our investment process. In-force reinsurance reduced investments by $3.8 billion and reported net investment income by $45 million for the fourth quarter in 2022. We invested $2.5 billion at a yield of 6.81% included €“ including $1.4 billion of privately sourced assets at an expected return of 7.02% in the fourth quarter.

Our allocation to privately sourced assets was 22% of invested assets as of quarter end compared to 18.4% as of September 30. Since quarter end, we have continued to put money to work in privately sourced asset sectors where we have conviction as well as in core sectors where we have seen attractive opportunities to support our strategic initiatives. As of December 31, the point-in-time yield on our investment portfolio was 4.44% compared to 4.22% as of September 30, reflecting the benefit from the increase in floating rate indices, an increase in yield on our public asset portfolio, reflecting portfolio management trades and a further increase in our allocation to privately sourced assets. For the first quarter of 2023, we expect an additional benefit of roughly 7 basis points in yield, reflecting the increase in short-term rates on our $6 billion of floating rate assets.

The aggregate cost of money for annuity liabilities was 1.76% in the fourth quarter, up from 1.75% in the third quarter. The cost of money in both quarter reflected near-zero hedge gains. The increase in the cost of money primarily reflects the higher cost of options purchased in the fourth quarter of 2022 compared to the runoff of the lower cost options purchased in the third quarter of 2021 and higher renewal rates on annual resets, traditional fixed annuity, offset in part by the slightly higher cost of money on account value seeded to 26North. Cost of options in the fourth quarter of 2022 averaged 1.61% compared to 1.58% in the third quarter. Investment spread in the fourth quarter was 2.54% compared to 2.73% in the prior quarter. Excluding prepayment income and hedging gains, adjusted spread was 2.53% compared to 2.70% in the third quarter, reflecting the sequentially lower returns on partnerships and mark-to-market assets and a slight increase in customer.

Deferred acquisition costs and deferred sales inducement amortization totaled $139 million in the fourth quarter compared to $145 million in the third quarter, excluding the effect of actual assumption changes. Fourth quarter amortization was $8 million greater than modeled expectation post the in-force reinsurance transaction, primarily due to lower than modeled index credits and higher surrenders than expected, offset in part by lower than modeled option budget and crediting rates. The change in the liability for guaranteed lifetime income benefit payments decreased $5 million this quarter compared to the third quarter, excluding the effect of actual assumption changes. The fourth quarter increase in the liability for guaranteed lifetime income payments were $37 million more than modeled post the in-force reinsurance transaction.

due primarily to the near zero level of index credits, which increased the reserve by $18 million. Lower than model’s cost of money and other experience true-ups each added $8 million to expense above expectations. For the first quarter, we would expect amortization of the deferred acquisition costs and sales inducement assets under FAS 97 of $126 million and an increase in the SOP 03-1 reserves for guaranteed lifetime income benefit payments of $60 million on current in-force before adjusting for actual experience. As a reminder, the lack of index credits could add up to an additional $10 million to that amortization and another $20 million to the SOP business. Outflows in the quarter totaled $1.2 billion, up from $1.1 billion in the third quarter, driven by increased surrenders.

What we have only limited information on how such disbursements are used, we have seen an increase in Section 1035 exchanges to other carriers of in-force pots, mostly out of and near the end of surrender charge periods. Other operating costs and expenses were $62 million in the fourth quarter, up to $2.5 million from the third quarter, bringing the full year right in line with expectations. For 2023, we expect other operating costs and expenses to be in the $250 million range for the full year. At December 31, cash and equivalents at the holding company were $531 million, reflecting a $325 million dividend from American Equity Life to the holding company. As of year-end, the estimated risk-based capital ratio for American Equity Life was 413% compared to 400% at the end of 2021.

Our internal estimates show that we have excess capital at year-end relative to rating agency models of approximately $650 million. Book value ex AOCI at year-end 2022 was $54.52 per share on a pre LDTI basis. Consistent with our prior messaging on the impact of LDTI, we would estimate book value ex AOCI at year-end 2022 to be north of $60 per share on a post LDTI basis. We will report our first quarter results in early May on a post LDTI basis, and expect to publish a restated financial supplement prior to the call, presenting our results on a post LDTI basis. Directionally, we expect our run rate operating income to be favorably impacted by the change to LDTI, primarily reflecting lower reserve accretion for living benefits or lifetime income benefits under the market risk benefit framework then under the SOP3-1 framework as well as more predictable pattern of back amortization going forward due to it becoming not sensitive to actual to expected variance in investment spread under the new LDTI framework.

With that, thank you for your attention, and I’ll turn it over to the operator to begin Q&A.

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Q&A Session

Operator: And our first question comes from Dan Bergman from Jefferies. Your line is now open

Dan Bergman: Thanks, good morning. I guess first, I just wanted to see if there was any update you can give around the outlook for fixed index annuity sales in 2023. I think in the past, you used an assumption of about $4 billion for the 2023 sales. And if I heard the numbers in the prepared remarks correctly, it sounded like the first 6 weeks production would imply a run rate near that $4 billion level, but given that would be a big step up from the $3.2 billion you did this past year, I just wanted to get a sense of if you thought that $4 billion range is achievable for €˜23 or just how you’re thinking about it? Thanks.

Anant Bhalla: I think you’re thinking about the right way, Dan. We’ve had a strong start to the year, and we feel good about what we said earlier.

Dan Bergman: Got it. That’s helpful. Thanks. And then it looked like surrenders and withdrawals saw another sequential increase, I think, to about $1.2 billion to $1.3 billion versus the closer to $1 billion quarterly range that have been traveling in earlier in the year, even though, I guess, the in-force book was down somewhat due to the reinsurance. I just wanted to see if you can give an update on what you’re seeing €“ seeing there and whether those higher withdrawals have been concentrated in any particular product types or vintages? And if it is just driven by the higher interest rate environment, should we expect this higher level of surrenders to remain in place for the foreseeable future?

Axel Andre: Yes. Thank you for your question. This is Axel. Yes, so we saw higher surrenders in the fourth quarter, so $1.2 billion above versus the $1.1 million in Q3. We see that those surrenders primarily across vintages that are essentially reaching the end of the surrender charge period or that are either out of surrender or just reaching that end of cementer that period. We expect that with the stabilization of the interest rate environment that the increase in surrenders is probably going to stabilize. But of course, this is one of the behavior that we observed closely. And from a rate setting perspective, we look at that on a regular basis, and we take appropriate action as we see fit.

Anant Bhalla: And the thing I’ll add to that, thanks, Axel, is having a big book really helps. We are focused on in-force management to see how they stay around this area. They probably we expect it to stay in this area. But we also have a very liquid asset portfolio. And that’s one of the reasons I provide that extra detail on the private assets. Our private assets are very high quality, some short-term in nature, very liquidfiable. If you think about $7 billion of those are loans, real estate loans, we have access to liquidity facilities. So we feel very good about the liquidity profile of the portfolio. I want to make sure you all understood that because people don’t always understand what private assets are. And we are going to grow our IEOF not have a shrink, which is why our efforts are not just on sales, primarily sales but also in-force actions, as Axel mentioned.

Dan Bergman: Got it. That’s really helpful. Thank you.

Operator: And, thank you. And our next question comes from Ryan Krueger from KBW. Your line is now open.

Ryan Krueger: Hi, thanks. Good morning. Looks like you’ve seen some higher volume from traditional fixed annuities in both the fourth quarter and what you commented on in the early part of the year. Are you €“ do you expect MIGAs start to be €“ I know you’re more focused on FIA, but would you anticipate MIGAs to be a more regular contributor to sales going forward?