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Text: 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 Anant Bhalla.
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 reinsurance transaction plan under our capital structure pillar and start our migration to alpha active with investment management partnerships under our investment management pillar.
I'll share more on these partnerships in a few minutes.
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 gives us a competitive advantage over traditional asset managers as we leverage expertise for both sides of our balance sheet.
And third, demonstrable success overtime 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 assets under management in our investment management partnerships and from creation of additional side-cars reinsurance vehicles with new equity investors like the two we've announced to date with Brookfield and Varde-Agam.
These fees will diversify our earning streams.
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.
We believe that in the foreseeable market environment, it is imperative for most asset-intensive insurers, including American Equity, to switch the source of earnings generation from traditional core fixed income investing to a blend of core fixed income and an alpha-generating private credit and real or physical assets, and over the next few years, migrate to a combination of spread and capital-light fee-based businesses.
Regarding American Equity-specific execution.
The fourth quarter was the start of the turnaround of the go-to-market pillar, our strategy to enhance our ability to raise long-term client assets through annuity product sales.
We and our distribution partners consider American Equity's marketing capabilities and franchise to be core competitive strengths.
The liabilities we originate result in stable, long-term attractive funding, which is invested to earn a spread and return on the prudent level of risk capital.
In the fourth quarter, we reintroduced ourselves to our markets.
We used the fourth quarter to tell distribution that we are back and in a big way.
Driven by the introduction of competitive three and five-year single-premium, deferred-annuity products at both American Equity and Eagle Life, we saw a substantial increase in sales, with total deposits of $1.8 billion, doubling from the prior year quarter and up 221% from the third quarter of 2020.
Fixed-rate annuities was a major driver of fourth quarter sales increase, while fixed-indexed annuities also increased, up 23% sequentially.
Total sales at Eagle Life were up over six fold on a sequential basis, and for the first time in its history, Eagle Life surpassed American Equity Life in total sales.
The competitive positioning we took in the fixed-rate annuity market benefited both the fixed-indexed annuity sales and recruiting of new producers.
Our FIA sales in the bank and broker-dealer channel increased 76% sequentially.
New representatives appointed with Eagle Life during the quarter increased by nearly 1,200 to over 9,300 at year-end.
While not as dramatic, we saw growth in sales at American Equity Life as well.
Total sales increased 103% from the third quarter, while fixed-indexed annuity sales climbed 16%.
The momentum that began in the fourth quarter has continued into the new year.
Pending applications when we reported third quarter results stood at 1,625.
For fixed-indexed annuities, we will shortly launch a revamped AssetShield product chassis to appeal to a broader market adding two new proprietary indices, the Credit Suisse Tech Edge Index and the Societe Generale Sentiment Index, in addition to the existing Bank of America Destinations Index, all of which we expect to illustrate extremely well with participation rates that cost well within our pricing budgets to meet our target pricing IRRs.
With the introduction of these multi-asset indices, we will offer clients a compelling single-accumulation annuity product that covers traditional equity indices as well as multi-asset custom indices focused on U.S. risk parity, global risk control asset allocation, and sector-specific allocations.
Following last year's refresh of IncomeShield, we are very well situated for income.
The level of income offered to retail clients dominates the market in almost all the important combinations of age and deferral periods, and where we don't, we are top three, which is key to getting distribution partners' attention.
I want to highlight management changes we've made at Eagle Life to accomplish our goals.
In September, we announced the hiring of Graham Day as President of Eagle Life.
Graham has added quickly to his team from other leading annuity manufacturers, including Greg Alberti as Head of National Accounts and Bryan Albert as Head of Sales.
Eagle Life is a key piece of our expansion into being a scale player in a new channel of distribution.
Pending applications when we reported third quarter results were at 975.
Moving onto the investment management pillar.
In 2021, we intend to focus on ramping up our allocation to alpha assets.
Our first foray in this area includes our partnership with Pretium, announced in the fourth quarter, including an equity investment in the general partner.
With Pretium, we expect to expand our focus as both a lender and a landlord in the residential market.
In each new alpha asset subsector that we enter, we expect to partner with a proven industry manager with aligned economic incentives and risk management culture.
This allows AEL to have an open architecture asset allocation approach versus other insurers that may have a more closed architecture approach to asset allocation.
Our focus expansion sectors include middle market credit, real estate, infrastructure debt, and agricultural loans.
Yesterday, we announced plans to enter the middle market credit space with Adams Street Partners.
American Equity and Adams Street will form a management company joint venture for co-developing insurer capital efficient assets with secured first-lien middle market credit.
Our company will initially commit up to $2 billion of invested assets to build the joint venture, and we expect to bring this capital-efficient asset product to other insurers as well.
As this venture and other similar ventures in the future garner third-party assets, American Equity's mix of fee revenues will grow supporting the migration to a more sustainable higher-return business profile.
The capital structure pillar is focused on greater use of reinsurance structuring to both optimize asset allocation for American Equity's balance sheet and to enable American Equity to free up capital and become a capital-light company overtime.
We are working diligently to complete in 2021 the announced reinsurance partnerships with Varde Partners and Agam Capital Management as well as Brookfield Asset Management and the formation of our own offshore reinsurance platform.
These transactions will enable American Equity to generate deployable capital in order to pivot toward a greater free cash flow generative and a capital-light or ROA, return on assets, business model.
Turning to financial results for the fourth quarter and full year.
For the fourth quarter of 2020, we reported non- GAAP operating income of $72 million, or $0.77 per diluted common share.
Financial results were significantly affected by excess cash in the portfolio as we repositioned our investment portfolio by derisking out of almost $2 billion of structured securities and $2.4 billion of corporates in the fourth quarter and build cash we expect to redeploy by transferring to Varde-Agam and Brookfield reinsurance transactions.
Overall, 2021 is a transition year for repositioning a significant portion of our balance sheet and hence a reset year for American Equity.
Over this year, we will explain any transaction execution driven short-term or one-time notable impacts on financial results.
For full year 2020, we reported non-GAAP operating income of $69.1 million or $0.75 per share.
Excluding notable items, specifically the one-time effect of annual actuarial review in the third quarter, a tax benefit from the enactment of CARES Act, and loss on extinguishment of debt, 2020 non-GAAP operating income was $381.4 million or $4.13 per share.
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 derisk the investment portfolio.
As part of this derisking, 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 was fortuitous.
As of the fourth quarter, the fixed maturity securities portfolio had an average rating of A minus with almost 97% rated NAIC 1 or 2.
In addition, almost 80% of our commercial mortgage loan portfolio was rated CM1 at year-end, with 99.7% rated either CM1 or CM2.
All commercial mortgage loans in the portfolio were paid current as of year-end, and in the fourth quarter of 2020, there were no additional forbearances granted.
Back on our first quarter 2020 call, we laid out an estimate of our capital sensitivity to a 12-to-18-month adverse recessionary scenario modeled on the Fed's CCAR stress test.
Through year-end, the portfolio performed better than expectations.
The impact to ratings migrations totaled 23 RBC points compared to the projection of 50 RBC points in that 12-to-18-month economic stress scenario.
The impact of credit losses and impairments was 10 points, which compared to a projection of 25 RBC points in the stress scenario.
Following derisking activities of the fourth quarter, we would expect our capital sensitivity in an adverse economic environment to be truncated relative to our March 2020 estimates.
Looking forward, we expect to reposition the portfolio starting this year.
With the completion of the reinsurance transactions with Varde-Agam and Brookfield, AEL will free up capital and then redeploy part of that capital to support a move into alpha-generating assets.
Going forward, we expect to operate at lower invested asset leverage than in the past.
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 foregone due to an increase in the amount of cash held in the quarter.
Cash and 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 and 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%.
So the pressure on investment spread will continue in the first quarter.
Excluding excess cash and invested assets to be transferred as part of the reinsurance transactions, we estimate the current point-in-time yield on the investment portfolio to be roughly 4%.
As we expect to close the reinsurance transactions in or after the second quarter, starting in March, we may partially pre-invest the assets for the reinsurance transactions, thereby offsetting some cash drag.
We do not expect significant benefit in the first quarter from such pre-investing.
On our future quarterly earnings calls, we will call out the effect of excess cash, if any, related to the reinsurance transactions.
The aggregate cost of money for annuity liabilities was 163 basis points, down three basis points from the third quarter of 2020.
The cost of money in the fourth quarter benefited from one basis point of hedging gain compared to a three basis point gain in the third quarter.
Excluding hedging gains, the decline in the adjusted cost of money reflects a year-over-year decrease in option cost due to past renewal rate actions.
Reflecting the decline in the portfolio yield, investment spread fell to 225 basis points from 244 basis points in the third quarter.
Excluding non-trendable items, adjusted spread in the fourth quarter was 213 basis points compared to 231 basis points in the third quarter of 2020.
The average yield on long-term investments acquired in the quarter was 4.46%, gross of fees, compared to 3.59% gross of fees in the third quarter of the year.
We purchased $152 million of fixed income securities at a rate of 3.32%, originated $142 million of commercial mortgage loans at a rate of 3.67%, and purchased $224 million of residential mortgage loans at 5.63% gross of fees.
The cost of options declined slightly to 139 basis points from 142 basis points in the third quarter.
All else equal, we would expect to continue to see the cost of money continue to decline throughout most of 2021, reflecting lower volatility and the actions taken in June of last year to reduce participation rates on $4.3 billion of policyholder funds and S&P annual point-to-point and monthly average strategies.
The cost of options for the hedge week ended February 9th was 143 basis points.
Should the yields available to us decrease or the cost of money rise, we continue to have flexibility to reduce our rates if necessary and could decrease our cost of money by roughly 62 basis points if we reduce current rates to guaranteed minimums.
This is down slightly from the 63 basis points we cited on our third quarter call.
The liability for lifetime income benefit riders increased $79 million this quarter, which included negative experience of $16 million relative to our modeled expectations.
Coming out of the third quarter actuarial assumption review, we said we had expected for that quarter a $63 million increase in the GAAP LIBOR reserve based on our actuarial models, while actuarial and policyholder experience true-ups had added an additional $5 million of reserve increase.
We said that we thought expected plus or minus $10 million would seem reasonable.
So the fourth quarter of 2020 was a little bit above that range.
There were pluses and minuses in the fourth quarter, with the biggest differences due to a $6 million increase from lower-than-expected decrements on policies with lifetime income benefit riders and a $10 million increase as a result of lower caps and par rates due to renewal rate changes and policies having anniversary dates during the quarter.
We will continue to experience the impacts from the renewal rate changes made in the second quarter of 2020 and the first and second quarters of this year.
Deferred acquisition cost and deferred sales inducement amortization totaled $113 million, $16 million less than modeled expectations.
The biggest items driving the positive experience were lower-than-modeled interest and surrender margins, lower-than-expected utilization of lifetime income benefit riders, and the second quarter of 2020 renewal rate changes I spoke about previously.
The benefit on the combined deferred acquisition costs and deferred sales inducement amortization from the second quarter 2020 renewal rate changes was $10 million, effectively offsetting the negative effect on the lifetime income benefit rider reserve.
Other operating costs and expenses increased to $55 million from $43 million in the third quarter.
Notable items not likely to reoccur in the first quarter of 2021, primarily advisory fees related to the unsolicited offer for the company in September totaled, approximately, $3 million with much of the remaining increase associated with the implementation of AEL 2.0.
Post-closing of the announced reinsurance transactions with Varde-Agam and Brookfield and the creation of the affiliated reinsurance platform, we would expect the level of other operating costs and expenses to fall in the mid-to-high $40 million range.
We expect to complete the execution of the already announced accelerated share repurchase program in the first quarter.
Based on current estimates, we expect an additional 520,000 shares to be delivered to us in addition to the initial 3.5 million shares delivered at the initiation.
Combined with the 1.9 million shares we repurchased in the open market prior to the initiation of the ASR program, we will have effectively reduced the share dilution resulting from the November 30th initial equity investment of 9.1 million shares from Brookfield Asset Management by, approximately, two-thirds.
The risk-based capital ratio for American Equity Life was 372%, flat with year-end 2019.
Total debt to total capitalization, excluding accumulated other comprehensive income, was 12.2% compared to 17.7% at year-end 2019.
At year-end, cash and short-term investments at the holding company totaled $484 million.
We expect to have over $300 million of cash at the holding company even after buying back additional shares after completion of the existing ASR to fully offset Brookfield issuance related dilution.
We are strongly capitalized as we look to execute AEL 2.0 with ample liquidity at the holding company, low leverage ratio relative to our industry peers, and robust capitalization at the life company.

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q4 non-gaap operating earnings per share $0.77.

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