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AMERICAN EQUITY INVESTMENT LIFE HOLDING CO – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's discussion and analysis reviews our consolidated financial position atDecember 31, 2022 compared withDecember 31, 2021 , and our consolidated results of operations for the years endedDecember 31, 2022 and 2021, and where appropriate, factors that may affect future financial performance. This analysis should be read in conjunction with our audited consolidated financial statements, notes thereto and selected consolidated financial data appearing elsewhere in this report. For information and analysis relating to our financial condition and consolidated results of operations as of and for the year endedDecember 31, 2021 , as well as for the year endedDecember 31, 2021 compared with the year endedDecember 31, 2020 , see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 .
Cautionary Statement Regarding Forward-Looking Information
All statements, trend analysis and other information contained in this report and elsewhere (such as in filings by us with theSEC , press releases, presentations by us or management or oral statements) may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. Forward-looking statements give expectations or forecasts of future events and do not relate strictly to historical or current facts. They may relate to markets for our products, trends in our operations or financial results, strategic alternatives, future operations, strategies, plans, partnerships, investments, share buybacks and other financial developments. They use words and terms such as anticipate, assume, believe, can, continue, could, enable, estimate, expect, forecast, foreseeable, goal, improve, intend, likely, may, model, near, objective, opportunity, outlook, plan, potential, project, probable, remain, risk seek, should, strategy, target, will, would, and other words and terms of similar meaning or that are otherwise tied to future periods or future performance, in each case in all forms of speech and derivative forms, or similar words, as well as any projections of future events or results. Forward-looking statements, by their nature, are subject to a variety of assumptions, risks, and uncertainties that could cause actual results to differ materially from the results projected. Many of these risks and uncertainties cannot be controlled by the Company. Factors that may cause our actual decisions or results to differ materially from those contemplated by these forward-looking statements include, among other things: •results differing from assumptions, estimates, and models. •interest rate condition changes. •investments losses or failures to grow as quickly as expected due to market, credit, liquidity, concentration, default, and other risks. •option costs increases. •counterparty credit risks. •third parties service-provider failures to perform or to comply with legal or regulatory requirements. •poor attraction and retention of customers or distributors due to competitors' greater resources, broader array of products, and higher ratings. •information technology and communication systems failures or security breaches. •credit or financial strength downgrades. •inability to raise additional capital to support our business and sustain our growth on favorable terms. •U.S. and global capital market and economic deterioration due to major public health issues, including the COVID-19 pandemic, political or social developments, or otherwise. •failure to authorize and pay dividends on our preferred stock. •subsidiaries' inability to pay dividends or make other payments to us. •failure at reinsurance, investment management, or third-party capital arrangements. •failure to prevent excessive risk-taking. •failure of policies and procedures to protect from operational risks. •inability to protect intellectual property, or intellectual property infringement claims. •increased litigation, regulatory examinations, and tax audits. •changes to laws, regulations, accounting, and benchmarking standards. •takeover or combination delays or deterrence by laws, corporate governance documents, or change-in-control agreements. •effects of climate changes, or responses to it. •failure of efforts to meet environmental, social, and governance standards and to enhance sustainability.
For a detailed discussion of these and other factors that might affect our
performance, see Item 1A of this report.
Executive Summary
As previously noted, we began to implement an updated strategy, referred to as AEL 2.0, after having undertaken a thorough review of our business in 2020. During 2022, we continued to make significant progress in the execution of the AEL 2.0 strategy in all four key pillars: Go-to-Market, Investment Management, Capital Structure and Foundational Capabilities. See Item 1. Business - Strategy for more information on the AEL 2.0 strategy and progress made during 2022. Excellent customer service teamed with our ability to offer innovative insurance products that provide principal protection and lifetime income continued to result in significant sales of our annuity products. In 2022, our sales were$3.3 billion ; over the last five years our sales have ranged from$3.3 billion to$6.0 billion . 20
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The economic and personal investing environments continue to be conducive to the sale of fixed index and fixed rate annuity products as retirees and others looked to put their money in instruments that will protect their principal and provide them with consistent cash flow sources in their retirement years and a paycheck for life. Sales of fixed index and fixed rate annuity products decreased to$3.3 billion in 2022 compared to$6.0 billion in 2021. The decrease in fixed rate annuity sales was driven by the decision to focus on sales of fixed index annuity products as we believe such products align with the transformation of the Company from a spread based return on equity insurer to more of a fee-based return on asset insurer. The decrease in fixed index annuity sales was driven by the decision to focus on pricing discipline as interest rates fluctuated. With our latest pricing refresh inNovember 2022 , we believe we are well positioned competitively to enter 2023 with strong momentum. During 2022, we saw interest rates rise after an unprecedented period of low interest rates. In response, we have been actively managing policyholder crediting rates for new annuities and existing annuities as we focused on improving our pricing processes to become more nimble, targeted and responsive to market changes. We continue to have flexibility to reduce our crediting rates if necessary and could decrease our cost of money by approximately 82 basis points if we reduce current rates to guaranteed minimums. We expanded our privately sourced assets to include a more diversified portfolio in 2022 covering a variety of sectors, including infrastructure, middle market credit and commercial real estate equity. During 2022, we originated$5 billion of privately sourced assets with expected returns greater than 6%. Total private assets at year-end were nearly$11 billion , bringing our allocation to 22% of the investment portfolio at year-end. OnOctober 18, 2020 , the Company's Board of Directors approved a$500 million share repurchase program (since fully utilized), and onNovember 19 , 2021,the Company's Board of Directors authorized the repurchase of an additional$500 million of Company common stock. The share repurchase program has offset dilution from the issuance of shares to Brookfield, and its purpose remains to institute a regular cash return program for shareholders. OnNovember 11, 2022 , the Company's Board of Directors authorized the repurchase of an additional$400 million of Company common stock. As ofDecember 31, 2022 , we have repurchased approximately 23.9 million shares of our common stock to date at an average price of$34.74 per common share. We specialize in the sale of individual annuities (primarily fixed and fixed index deferred annuities) through IMOs, agents, banks and broker-dealers. Fixed and fixed index annuities are an important product for Americans looking to fund their retirement needs as annuities have the ability to provide retirees a paycheck for life. UnderU.S. GAAP, premium collections for deferred annuities are reported as deposit liabilities instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liabilities for policyholder account balances and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for lifetime income benefit riders, net realized gains (losses) on investments and changes in fair value of derivatives. Components of expenses for products accounted for as deposit liabilities are interest sensitive and index product benefits (primarily interest credited to account balances and changes in the liability for lifetime income benefit riders), changes in fair value of embedded derivatives, amortization of deferred sales inducements and deferred policy acquisition costs, other operating costs and expenses and income taxes.
Our profitability depends in large part upon:
•the amount of assets under our management, •investment spreads we earn on our policyholder account balances, •our ability to manage our investment portfolio to maximize returns and minimize risks such as interest rate changes and defaults or credit losses, •our ability to appropriately price for lifetime income benefit riders offered on certain of our fixed rate and fixed index annuity policies, •our ability to manage interest rates credited to policyholders and costs of the options purchased to fund the annual index credits on our fixed index annuities, •our ability to manage the costs of acquiring new business (principally commissions paid to agents and distribution partners and bonuses credited to policyholders), •our ability to maintain and continue to generate fee based revenue, •our ability to manage our operating expenses, and •income taxes.
Life insurance companies are subject to NAIC RBC requirements and rating
agencies utilize a form of RBC to partially determine capital strength of
insurance companies. Our RBC ratio at
400%, respectively.
We intend to manage our capitalization in normal economic conditions at a level that is consistent with rating agency capital at or above the A-level. It may drift downwards, at times, for reasons including, but not limited to, realized credit losses or temporary increases in required risk capital for ratings migrations. This level is intended to reflect a level that is consistent with the rating agencies expectations for capital adequacy ratios at different points in an economic cycle. This implies operating with a peak to trough swing whereby capital is absorbing risk at the low point of the economic cycle. OnNovember 28, 2022 S&P affirmed its "A-" financial strength rating onAmerican Equity Life and its "BBB-" long-term issuer credit rating onAmerican Equity Investment Life Holding Company with an outlook of "stable" on these ratings. 21
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OnSeptember 9, 2022 ,A.M. Best affirmed its "A-" financial strength rating onAmerican Equity Investment Life Insurance Company and its subsidiaries,American Equity Investment Life Insurance Company of New York andEagle Life Insurance Company , its "bbb-" long-term issuer credit rating ofAmerican Equity Investment Life Holding Company , its "bbb-" senior unsecured debt ratings, and its "bb" perpetual, non-cumulative preferred stock ratings. The outlook for these credit ratings of "stable" was also affirmed byA.M. Best onSeptember 9, 2022 . OnDecember 7, 2022 , Fitch affirmed its "A-" financial strength rating onAmerican Equity Investment Life Insurance Company and its life insurance subsidiaries, its "BBB" issuer default rating onAmerican Equity Investment Life Holding Company and its "BBB-" senior unsecured debt ratings, and revised its outlook to "stable" from "negative" on its financial strength, issuer default and senior unsecured debt ratings.
Earnings from products accounted for as deposit liabilities are primarily
generated from the excess of net investment income earned over the interest
credited or the cost of providing index credits to the policyholder, or the
"investment spread." Our investment spread is summarized as follows:
Year Ended
2022 2021 2020
Average yield on invested assets 4.34% 3.73% 4.12%
Aggregate cost of money 1.71% 1.55% 1.69%
Aggregate investment spread 2.63% 2.18% 2.43%
Impact of:
Investment yield - additional prepayment income 0.03% 0.11% 0.08%
Cost of money benefit from over hedging 0.01% 0.07% 0.02%
The cost of money for fixed index annuities and average crediting rates for
fixed rate annuities are computed based upon policyholder account balances and
do not include the impact of amortization of deferred sales inducements. See
Critical Accounting Policies and Estimates-Deferred Policy Acquisition Costs and
Deferred Sales Inducements. With respect to our fixed index annuities, the cost
of money includes the average crediting rate on amounts allocated to the fixed
rate strategy and expenses we incur to fund the annual index credits. Proceeds
received upon expiration of call options purchased to fund annual index credits
are recorded as part of the change in fair value of derivatives, and are largely
offset by an expense for interest credited to annuity policyholder account
balances. See Critical Accounting Policies and Estimates - Policy Liabilities
for Fixed Index Annuities and Financial Condition - Derivative Instruments.
Average yield on invested assets increased primarily as a result of strong
returns on partnerships and other mark to market assets, the benefit from higher
short-term interest rates, lower average cash balances and the ramp in private
assets partly offset by lower prepayment income. See Net investment income. The
aggregate cost of money increased primarily due to increases in options costs
and a reduction in the benefit from over hedging as compared to the prior year.
We have the flexibility to reduce our crediting rates if necessary and could
decrease our cost of money by approximately 82 basis points if we reduce current
rates to guaranteed minimums.
22
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Results of Operations for the Three Years Ended
Annuity deposits by product type collected during 2022, 2021 and 2020, were as
follows:
Year Ended December 31,
Product Type 2022 2021 2020
(Dollars in thousands)
American Equity Life : Fixed index annuities$ 2,692,141 $ 2,753,479 $ 1,992,059 Annual reset fixed rate annuities 5,329 6,133 8,128 Multi-year fixed rate annuities 56,511 855,702 395,982 Single premium immediate annuities 18,935 59,816 33,461 2,772,916 3,675,130 2,429,630 Eagle Life: Fixed index annuities 479,279 697,068 345,519 Annual reset fixed rate annuities 380 350 97 Multi-year fixed rate annuities 82,581 1,597,292 907,151 562,240 2,294,710 1,252,767 Consolidated: Fixed index annuities 3,171,420 3,450,547 2,337,578 Annual reset fixed rate annuities 5,709 6,483 8,225 Multi-year fixed rate annuities 139,092 2,452,994 1,303,133 Single premium immediate annuities 18,935 59,816 33,461 Total before coinsurance ceded 3,335,156 5,969,840 3,682,397 Coinsurance ceded 968,906 424,819 35,667 Net after coinsurance ceded$ 2,366,250 $ 5,545,021 $ 3,646,730 Annuity deposits before coinsurance ceded decreased 44% during 2022 compared to 2021. Annuity deposits after coinsurance ceded decreased 57% during 2022 compared to 2021. The decrease in sales in 2022 compared to 2021 was primarily driven by a reduction in sales of multi-year fixed rate annuity products at bothAmerican Equity Life and Eagle Life which is in line with our 2022 sales strategy of focusing on sales of fixed index annuities. We began ceding 75% of certain fixed index annuities issued afterJuly 1, 2021 to North End Re which caused the increase in coinsurance ceded premiums for the year endedDecember 31, 2022 compared to 2021. Net income available to common stockholders increased 174% to$1.2 billion in 2022 and decreased 33% to$430.3 million in 2021 from$637.9 million in 2020. The increase in net income available to common stockholders for the year endedDecember 31, 2022 was driven primarily by an increase in net investment income, a decrease in the change in fair value of embedded derivatives and a decrease in interest sensitive and index product benefits. These changes were partially offset by a decrease in the change in fair value of derivatives and increases in amortization of deferred sales inducements and deferred policy acquisition costs. Net income available to common stockholders for the year endedDecember 31, 2022 was positively impacted by an increase in the aggregate investment spread as previously noted. Net income, in general, is impacted by the volume of business in force and the investment spread earned on this business. The average amount of annuity account balances outstanding (net of annuity liabilities ceded under coinsurance agreements) decreased 4% to$51.6 billion for the year endedDecember 31, 2022 compared to$53.7 billion in 2021 and increased 1% for the year endedDecember 31, 2021 compared to$53.3 billion in 2020. Our investment spread measured in dollars was$1.4 billion ,$1.2 billion , and$1.3 billion for the years endedDecember 31, 2022 , 2021 and 2020, respectively. Investment income for the year endedDecember 31, 2022 was positively impacted by strong returns on partnerships and other mark to market assets, the benefit from higher short-term interest rates, lower average cash balances and an increase in allocation to higher yielding privately sourced assets (see Net investment income). The volume of cash and cash equivalent holdings decreased in the fourth quarter of 2021 and the first quarter of 2022 with the execution of the reinsurance treaty with North End Re and the investment of cash balances above our target levels. Net income was also impacted by the change in fair value of derivatives and embedded derivatives, which fluctuates from period to period based upon changes in fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in interest rates used to discount the embedded derivative liability. Net income for the year endedDecember 31, 2022 was positively impacted by decreases in expected index credits on the next policy anniversary dates resulting from decreases in the fair value of the call options acquired to fund these index credits and net increases in the discount rates used to estimate the fair value of our embedded derivative liabilities, the impacts of which were partially offset by decreases in the change in fair value of derivatives and increases in amortization of deferred policy acquisition costs and deferred sales inducements related to changes in fair value of derivatives and embedded derivatives. See Change in fair value of derivatives, Change in fair value of embedded derivatives, Amortization of deferred sales inducements and Amortization of deferred policy acquisition costs. 23
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We periodically update the key assumptions used in the calculation of amortization of deferred policy acquisition costs and deferred sales inducements retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of realized investment gains and losses) to be realized from a group of products are revised. In addition, we periodically update the assumptions used in determining the liability for lifetime income benefit riders and the embedded derivative component of our fixed index annuity policy benefit reserves as experience develops that is different from our assumptions.
Net income available to common stockholders for 2022, 2021 and 2020 includes
effects from updates to assumptions as follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Increase (decrease) in amortization of deferred
sales inducements $ 45,682 $ (45,107) $ 428,101
Increase (decrease) in amortization of deferred
policy acquisition costs 56,853 (45,662) 646,785
Increase (decrease) in interest sensitive and index
product benefits
(53,042) 243,658 285,825 Decrease in change in fair value of embedded derivatives (94,770) (122,294) (2,341,279) Effect on net income available to common stockholders 35,543 (24,017) 769,611
We review these assumptions quarterly and as a result of these reviews, we made
updates to assumptions during each year.
The most significant assumption updates made in 2022 were to investment spread
assumptions, including the net investment earned rate and crediting rate on
policies, lapse rate and partial withdrawal assumptions and lifetime income
benefit rider utilization assumptions.
We updated our assumption for net investment spread forAmerican Equity Life to remain steady at 2.60% through an eight-year reversion period. We increased our long-term net investment earned rate assumption by 40 basis points with an assumption of 4.25% in the near term increasing to 5.00% over the eight-year reversion period, and we increased our long-term crediting/discount rate assumption by 30 basis points with an assumption of 1.65% in the near term increasing to 2.40% over the eight year reversion period. In addition, we adjusted the grading of the discount rate assumption in the embedded derivative calculation. These changes resulted in an increase in expected future gross profits and therefore an increase in the deferred policy acquisition costs and deferred sales inducements balances. These changes also resulted in a decrease in the liability for lifetime income benefit riders due to a higher discount rate and a decrease in the fair value of the embedded derivative due to the grading of the crediting rate assumption. We updated lapse rate and partial withdrawal assumptions based on actual historical experience. We refreshed lapse tables based on five years of lapse experience and implemented a 1% lapse floor. For policies with a lifetime income benefit rider that do not charge a fee, we increased the lapse rates. For policies with a lifetime income benefit rider that has been utilized, we decreased the lapse rates. We expanded our partial withdrawal assumptions to include scalars in our assumptions during the surrender charge period, shock period, and post-shock period. This resulted in partial withdrawals extending beyond the surrender charge period. The net impact of the lapse rate and partial withdrawal assumptions resulted in a decrease in expected future gross profits and a decrease in the deferred policy acquisition costs and deferred sales inducements balances. The net impact of these changes resulted in an increase in the liability for lifetime income benefit riders due to higher excess claims and lower gross profits and increased the fair value of the embedded derivative due to lower overall lapses and partial withdrawals. We updated our lifetime income benefit rider utilization assumption structure to capture policyholder characteristics at a more granular level. This resulted in an increase in the number of policies utilizing the benefit and increased the excess claims. The impact of this change resulted in an increase in the liability for lifetime income benefit riders, an increase in the fair value of the embedded derivative, and an increase in the deferred policy acquisition costs and deferred sales inducements balances. The most significant assumption updates made in 2021 were to investment spread assumptions, including the net investment earned rate and crediting rate on policies, lifetime income benefit rider utilization assumptions, mortality assumptions, and lapse rate assumptions as discussed below. In addition, we made assumption updates to change the reinsurance expense assumption associated with the refinancing of statutory redundant reserves effectiveOctober 1, 2021 . Due to the continued low interest rate environment, we updated our assumption for investment spread forAmerican Equity Life to 2.25% in the near term and increasing to 2.50% over an eight-year reversion period and our assumption for crediting/discount rate to 1.55% increasing to 2.10% over an eight-year reversion period. Prior to these assumption updates, our long-term assumption for aggregate investment spread was at 2.60% at the end of an eight-year reversion period, with a near term crediting/discount rate of 1.90% increasing to 2.10% over an eight-year reversion period. The assumption change to decrease aggregate investment spread resulted in lower expected future gross profits as compared to previous estimates and a decrease in the balances of deferred policy acquisition costs and deferred sales inducements. We updated lapse rate and mortality assumptions based on historical experience. For certain annuity products without a lifetime income benefit rider, the lapse rate assumption was increased in more recent cohorts to reflect higher lapses on polices with a market value adjustment ("MVA") feature. For other annuity products with a lifetime income benefit rider, the population was bifurcated based on whether policies had utilized the rider. For those policies which had utilized the rider, the lapse rate assumption was decreased in later durations. The overall mortality assumption was lowered to reflect historical experience. The net impact of the updates to the lapse rate and mortality assumptions resulted in higher expected future gross profits as compared to previous estimates and an increase in the balances of deferred policy 24
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acquisition costs and deferred sales inducements. The net impact of the updates to lapse rate and mortality assumptions resulted in an increase in the liability for lifetime income benefit riders due to a greater amount of expected benefit payments in excess of account values. We updated the lifetime income benefit rider utilization assumption based on historical experience. The ultimate utilization assumption was lowered for policies with a fee rider and certain policies with a no-fee rider. In addition, the utilization assumption was changed to reflect seasonality with higher utilization rates during the first quarter of each year. The net impact of the updates to the utilization assumption resulted in a decrease in the liability for lifetime income benefit riders due to a lower amount of expected benefits payments due to lower expected utilization. The net impact of the updates to the utilization assumption resulted in higher expected future gross profits as compared to previous estimates and an increase in the balances of deferred policy acquisition costs and deferred sales inducements. The most significant assumption update to the calculation of the fair value of the embedded derivative component of our fixed index annuity policy benefit reserve in 2021 was the change in lapse rate assumptions discussed above. The net impact of the updates to the lapse rate assumption resulted in a decrease in the embedded derivative component of our fixed index annuity policy benefit reserves as less funds ultimately qualify for excess benefits. Non-GAAP operating income available to common stockholders, a non-GAAP financial measure increased 25% to$362.9 million in 2022 and increased 320% to$290.5 million in 2021 from$69.1 million in 2020. The increase in non-GAAP operating income available to common stockholders for the year endedDecember 31, 2022 was primarily a result of the impact of assumption updates made during 2022 compared to the impact of assumption updates made during 2021. Non-GAAP operating income available to common stockholders and Non-GAAP operating income available to common stockholders per common share - assuming dilution, excluding the impact of notable items, for the year endedDecember 31, 2022 were$336.4 million and$3.67 per share, respectively. Non-GAAP operating income available to common stockholders and Non-GAAP operating income available to common stockholders per common share - assuming dilution, excluding the impact of notable items, for the year endedDecember 31, 2021 were$368.5 million and$3.90 per share, respectively. Non-GAAP operating income available to common stockholders, excluding the impact of notable items, for the year endedDecember 31, 2022 was negatively impacted by an increase in interest sensitive and index product benefits due to a larger increase in lifetime income benefit rider reserves and increases in amortization of deferred sales inducements and deferred policy acquisition costs compared to 2021. Non-GAAP operating income available to common stockholders for the year endedDecember 31, 2022 was positively impacted by an increase in the aggregate investment spread as previously noted and an increase in other revenue compared to 2021. In addition to net income available to common stockholders, we have consistently utilized non-GAAP operating income available to common stockholders, a non-GAAP financial measure commonly used in the life insurance industry, as an economic measure to evaluate our financial performance. Non-GAAP operating income available to common stockholders equals net income available to common stockholders adjusted to eliminate the impact of items that fluctuate from year to year in a manner unrelated to core operations, and we believe measures excluding their impact are useful in analyzing operating trends. The most significant adjustments to arrive at non-GAAP operating income available to common stockholders eliminate the impact of fair value accounting for our fixed index annuity business and are not economic in nature but rather impact the timing of reported results. We believe the combined presentation and evaluation of non-GAAP operating income available to common stockholders together with net income available to common stockholders provides information that may enhance an investor's understanding of our underlying results and profitability. Non-GAAP operating income available to common stockholders is not a substitute for net income available to common stockholders determined in accordance with GAAP. The adjustments made to derive non-GAAP operating income available to common stockholders are important to understand our overall results from operations and, if evaluated without proper context, non-GAAP operating income available to common stockholders possesses material limitations. As an example, we could produce a low level of net income available to common stockholders or a net loss available to common stockholders in a given period, despite strong operating performance, if in that period we experience significant net realized losses from our investment portfolio. We could also produce a high level of net income available to common stockholders in a given period, despite poor operating performance, if in that period we generate significant net realized gains from our investment portfolio. As an example of another limitation of non-GAAP operating income available to common stockholders, it does not include the decrease in cash flows expected to be collected as a result of credit losses on financial assets. Therefore, our management reviews net realized investment gains (losses) and analyses of our net investment income, including impacts related to credit losses, in connection with their review of our investment portfolio. In addition, our management examines net income available to common stockholders as part of their review of our overall financial results. 25
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The adjustments made to net income available to common stockholders to arrive at
non-GAAP operating income available to common stockholders and non-GAAP
operating income available to common stockholders, excluding notable items for
2022, 2021 and 2020 are set forth in the table that follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Reconciliation from net income available to common
stockholders to non-GAAP operating income available to
common stockholders:
Net income available to common stockholders $ 1,177,269 $ 430,317 $ 637,945
Adjustments to arrive at non-GAAP operating income
available to common stockholders:
Net realized losses on financial assets, including
credit losses 36,428 10,299 59,355
Change in fair value of derivatives and embedded
derivatives (1,080,356) (187,290) (784,005)
Net investment income 664 - -
Other revenue 5,969 - -
Income taxes 222,966 37,184 155,808
Non-GAAP operating income available to common
stockholders 362,940 290,510 69,103
Impact of excluding notable items (26,572) 78,036 310,117
Non-GAAP operating income available to common
stockholders, excluding notable items $ 336,368
Per common share - assuming dilution: Non-GAAP operating income available to common stockholders$ 3.96 $ 3.07 $ 0.75 Impact of excluding notable items (0.29) 0.83 3.36 Non-GAAP operating income available to common stockholders, excluding notable items$ 3.67
Notable items impacting non-GAAP operating income available to common stockholders: Impact of actuarial assumption updates$ (26,572) $ 78,036 $ 340,895 Tax benefit related to the CARES Act - - (30,778) Total notable items$ (26,572)
The amounts disclosed in the reconciliation above are presented net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and accretion of lifetime income benefit rider reserves where applicable. Notable items reflect the after-tax impact to non-GAAP operating income available to common stockholders for certain items that do not reflect the company's expected ongoing operations. Notable items primarily include the impact from actuarial assumption updates. The presentation of notable items is intended to help investors better understand our results and to evaluate and forecast those results.
Non-GAAP operating income available to common stockholders for 2022, 2021 and
2020 includes effects from updates to assumptions as follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Increase (decrease) in amortization of deferred
sales inducements $ 8,670 $ (66,066) $ 57,467
Increase (decrease) in amortization of deferred
policy acquisition costs 10,520 (78,183) 90,970
Increase (decrease) in interest sensitive and index
product benefits
(53,042) 243,658 285,825
Effect on non-GAAP operating income available to
common stockholders 26,572 (78,036) (340,895)
The impact to net income available to common stockholders and non-GAAP operating
income available to common stockholders from assumption updates varies due to
the impact of fair value accounting for our fixed index annuity business as
non-GAAP operating income available to common stockholders eliminates the impact
of fair value accounting for our fixed index annuity business. While the
assumption updates made during 2022, 2021 and 2020 were consistently applied,
the impact to net income available to common stockholders and non-GAAP operating
income available to common stockholders varies due to different amortization
rates being applied to gross profit adjustments included in the valuation.
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Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for lifetime income benefit riders) decreased 5% to$230.4 million in 2022 and decreased 3% to$242.6 million in 2021 from$251.2 million in 2020. The components of annuity product charges are set forth in the table that follows: Year Ended December 31, 2022 2021 2020 (Dollars in thousands) Surrender charges$ 72,699 $ 67,657 $ 72,551 Lifetime income benefit riders (LIBR) fees 157,655 174,974 178,676$ 230,354 $
242,631
Withdrawals from annuity policies subject to surrender charges$ 1,145,415 $ 1,099,098 $ 776,305 Average surrender charge collected on withdrawals subject to surrender charges 6.3 % 6.2 % 9.3 %
Fund values on policies subject to LIBR fees
Weighted average per policy LIBR fee
0.81 % 0.79 % 0.78 % The decrease in annuity product charges during 2022 was attributable to a decrease in fees assessed for lifetime income benefit riders due to a smaller volume of business in force subject to the fees slightly offset by an increase in the average fees being charged and an increase in withdrawals subject to surrender charges compared to 2021. The smaller volume of business subject to the fees is primarily due to the execution of the North End Re reinsurance treaty which was effective onJuly 1, 2021 and the execution of the AeBe reinsurance treaty which was effectiveOctober 3, 2022 . See Interest sensitive and index product benefits below for corresponding expense recognized on lifetime income benefit riders. Net investment income increased 13% to$2.3 billion in 2022 and decreased 7% to$2.0 billion in 2021 from$2.2 billion in 2020. The increase for 2022 compared to 2021 was attributable to an increase in the average yield earned on invested assets during 2022. Average invested assets excluding derivative instruments (on an amortized cost basis) decreased 3% to$53.2 billion in 2022 and increased 3% to$54.8 billion in 2021 compared to$53.1 billion in 2020. The average yield earned on average invested assets was 4.34%, 3.73% and 4.12% for 2022, 2021 and 2020, respectively. The increase in yield earned on average invested assets in 2022 was primarily attributable to strong returns on partnerships and other mark to market assets, the benefit from higher short-term interest rates, lower average cash balances and the ramp in private assets partly offset by lower prepayment income. The expected return on investments purchased during 2022 was 5.01%, net of third-party investment management expenses. Purchases for 2022 included$5.7 billion of fixed maturity securities with an expected return of 4.02% and$5.0 billion of privately sourced assets with an expected return of 6.14%. The privately sourced assets include investments in infrastructure, middle market credit and commercial real estate equity. The expected return on investments purchased during 2021 and 2020 was 3.92% and 3.84%, respectively. Change in fair value of derivatives primarily consists of call options purchased to fund annual index credits on fixed index annuities. The components of change in fair value of derivatives are as follows: Year Ended December 31, 2022 2021 2020 (Dollars in thousands) Call options: Gain (loss) on option expiration$ (287,328) $ 1,368,381 $ 15,042 Change in unrealized gains/losses (831,440) (20,456) 19,562 Warrants 264 810 - Interest rate swaps (19,624) - - Interest rate caps - - 62$ (1,138,128) $ 1,348,735 $ 34,666 27
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The differences between the change in fair value of derivatives between years for call options are primarily due to the performance of the indices upon which our call options are based which impacts the level of gains on call option expirations, the fair values of those call options and changes in the fair values of those call options between years. The changes in gain (loss) on option expiration and in unrealized gains/losses on call options for the year endedDecember 31, 2022 as compared to 2021 are due to equity market performance in 2022 compared to 2021. A substantial portion of our call options are based upon the S&P 500 Index with the remainder based upon other equity and bond market indices. The range of index appreciation (after applicable caps, participation rates and asset fees) for options expiring during these years is as follows: Year Ended December 31, 2022 2021 2020 S&P 500 Index Point-to-point strategy 0.0% - 12.5% 0.0% - 42.6% 0.0% - 17.4% Monthly average strategy 0.0% - 8.6% 0.0% - 29.4% 0.0% - 11.9% Monthly point-to-point strategy 0.0% - 12.9% 0.0% - 21.7% 0.0% - 14.0%
Volatility control index point-to-point strategy 0.0% - 7.3%
0.0% - 9.7% 0.0% - 9.3% Fixed income (bond index) strategies 0.0% - 6.5% 0.0% - 10.0% 0.0% - 13.6% The change in fair value of derivatives is also influenced by the aggregate cost of options purchased. During 2022, the aggregate cost of options were higher than in 2021 as option costs generally increased during 2022. The aggregate cost of options is also influenced by the amount of policyholder funds allocated to the various indices and market volatility which affects option pricing. See Critical Accounting Policies and Estimates - Policy Liabilities for Fixed Index Annuities. Net realized gains (losses) on investments include gains and losses on the sale of securities and other investments and changes in allowances for credit losses on our securities and mortgage loans on real estate. Net realized gains (losses) on investments fluctuate from year to year primarily due to changes in the interest rate and economic environments and the timing of the sale of investments. See Note 3 - Investments and Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements and Financial Condition - Credit Losses for a detailed presentation of the types of investments that generated the gains (losses) as well as discussion of credit losses on our securities recognized during the periods presented and Financial Condition - Investments and Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements for discussion of credit losses recognized on mortgage loans on real estate. Securities sold at losses are generally due to our long-term fundamental concern with the issuers' ability to meet their future financial obligations or to improve our risk or duration profiles as they pertain to our asset liability management. Other revenue increased 180% to$43.9 million in 2022 compared to$15.7 million in 2021. The increase for 2022 compared to 2021 was primarily attributable to the increase in business ceded under the North End Re reinsurance treaty which was effectiveJuly 1, 2021 . See Note 8 - Reinsurance and Policy Provisions to our audited consolidated financial statements for more information. The components of other revenue are summarized as follows: Year Ended December 31, 2022 2021
2020
(Dollars in thousands)
Asset liability management fees
Amortization of deferred gain
31,235 10,200 -
$ 43,921 $ 15,670 $ -
Interest sensitive and index product benefits decreased 67% to $889.7 million in
2022 and increased 74% to $2.7 billion in 2021 from $1.5 billion in 2020. The
components of interest sensitive and index product benefits are summarized as
follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Index credits on index policies $ 305,292 $ 1,977,888 $ 747,489
Interest credited (including changes in minimum
guaranteed interest for fixed index annuities) 249,579 253,725 198,745
Lifetime income benefit riders 334,779 449,793 597,036
$ 889,650 $ 2,681,406 $ 1,543,270
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The changes in index credits were attributable to changes in the level of appreciation of the underlying indices (see discussion above under Change in fair value of derivatives) and the amount of funds allocated by policyholders to the respective index options. Total proceeds received upon expiration of the call options purchased to fund the annual index credits were$0.3 billion ,$2.0 billion and$0.8 billion for the years endedDecember 31, 2022 , 2021 and 2020, respectively. The decrease in interest credited in 2022 was due to a reduction in interest credited to funds allocated to the fixed option strategy within our fixed index annuities due to a decrease in the average balance allocated to the fixed option strategy partially offset by an increase in deferred annuity products that receive a fixed rate of interest. The decrease in benefits recognized for lifetime income benefit riders for 2022 compared to 2021 was due to the impact of assumption updates made during 2022 compared to assumption updates made during 2021 partially offset by the impacts on the calculation of the lifetime income benefit rider reserve of actual results compared to expected results for items such as lifetime income benefit rider election rates and the level of index credits. The net impact of updating expected results with actual results led to an increase in the lifetime income benefit rider reserve for the year endedDecember 31, 2022 . In addition, fund value of policies with lifetime income benefit riders decreased as a result of the North End Re reinsurance treaty executed during 2021 and the execution of the AeBe reinsurance treaty which was effectiveOctober 3, 2022 . See Net income available to common stockholders above for discussion of the changes in the assumptions used in determining reserves for lifetime income benefit riders for the years endedDecember 31, 2022 and 2021. Amortization of deferred sales inducements is based on historical, current and future expected gross profits. The changes in amortization from period to period are the result of differences in actual gross profits compared to expected or modeled gross profits and changes to the underlying business. The increases in amortization before and after gross profit adjustments for 2022 compared to 2021 were due to the impact of assumption updates made during 2022 compared to the impact of assumption updates made during 2021. In addition, amortization of deferred sales inducements for the year endedDecember 31, 2022 increased due to increases in actual gross profits for the year endedDecember 31, 2022 compared to 2021. Amortization of deferred sales inducements for the year endedDecember 31, 2022 also increased as index credits on index policies for the year endedDecember 31, 2022 were less than index credits on index policies for 2021. Bonus products represented 63%, 65% and 75% of our net annuity account values atDecember 31, 2022 , 2021 and 2020, respectively. The amount of amortization is affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business and amortization associated with net realized gains (losses) on investments. Fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our fixed index annuity contracts. The change in fair value of the embedded derivatives will not correspond to the change in fair value of the derivatives (purchased call options), because the purchased call options are one-year options while the options valued in the fair value of embedded derivatives cover the expected lives of the contracts which typically exceed ten years.
Amortization of deferred sales inducements is summarized as follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Amortization of deferred sales inducements before
gross profit adjustments $ 234,778 $ 112,790 $ 243,067
Gross profit adjustments:
Fair value accounting for derivatives and embedded
derivatives 177,131 40,899 202,660
Net realized losses on investments (3,361) (997) (7,563)
Amortization of deferred sales inducements after
gross profit adjustments $ 408,548 $
152,692
See Net income available to common stockholders and Non-GAAP operating income available to common stockholders, a non-GAAP financial measure above for discussion of the impact of assumption updates on amortization of deferred sales inducements for the years endedDecember 31, 2022 and 2021. See Critical Accounting Policies and Estimates - Deferred Policy Acquisition Costs and Deferred Sales Inducements. Change in fair value of embedded derivatives includes changes in the fair value of our fixed index annuity embedded derivatives (see Note 6 - Derivative Instruments to our audited consolidated financial statements). The components of change in fair value of embedded derivatives are as follows: Year Ended December 31, 2022 2021 2020 (Dollars in thousands) Fixed index annuities - embedded derivatives$ (2,561,676) $ (876,803) $ (1,922,085) Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting 648,580 520,863 635,298 Reinsurance related embedded derivative (439,502) (2,362) -$ (2,352,598) $ (358,302) $ (1,286,787) The change in fair value of the fixed index annuity embedded derivatives resulted from (i) changes in the expected index credits on the next policy anniversary dates, which are related to the change in fair value of the call options acquired to fund those index credits discussed above in Change in fair value of derivatives; (ii) changes in the expected annual cost of options we will purchase in the future to fund index credits 29
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beyond the next policy anniversary; (iii) changes in the discount rates used in estimating our embedded derivative liabilities; and (iv) the growth in the host component of the policy liability. The amounts presented as "Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting" represent the total change in the difference between policy benefit reserves for fixed index annuities computed under the derivative accounting standard and the long-duration contracts accounting standard at each balance sheet date, less the change in fair value of our fixed index annuities embedded derivative. See Critical Accounting Policies and Estimates- Policy Liabilities for Fixed Index Annuities. The primary reasons for the decrease in the change in fair value of the fixed index annuity embedded derivatives during 2022 compared to 2021 were due to decreases in expected index credits on the next policy anniversary dates resulting from decreases in the fair value of the call options acquired to fund the index credits during 2022 compared to increases in the expected index credits resulting from increases in the fair value of the call options acquired to fund these index credits during 2021 and larger increases in the net discount rates used in the calculation during 2022 compared to 2021. The discount rates used in estimating our embedded derivative liabilities fluctuate based on the changes in the general level of risk free interest rates and our own credit spread. The reinsurance agreements executed in 2022 with AeBe and 2021 with North End Re to cede certain fixed index annuity product liabilities on a coinsurance funds withheld and modified coinsurance basis contain embedded derivatives. The fair value of these embedded derivatives are based on the unrealized gains and losses of the underlying assets held in the funds withheld and modified coinsurance portfolios and the fair value of the assets decreased during 2022. See Note 6 - Derivative Instruments for discussion on this embedded derivative. Amortization of deferred policy acquisition costs is based on historical, current and future expected gross profits. The changes in amortization from period to period are the result of differences in actual gross profits compared to expected or modeled gross profits and changes to the underlying business. The increases in amortization before and after gross profit adjustments for 2022 compared to 2021 were due to the impact of assumption updates made during 2022 compared to the impact of assumption updates made during 2021. In addition, amortization of deferred policy acquisition costs for the year endedDecember 31, 2022 increased due to increases in actual gross profits for the year endedDecember 31, 2022 as compared to 2021. Amortization of deferred policy acquisition costs for the year endedDecember 31, 2022 also increased as index credits on index policies for the year endedDecember 31, 2022 were less than index credits on index policies for 2021. The amount of amortization is affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business and amortization associated with net realized gains (losses) on investments. As discussed above, fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our fixed index annuity contracts.
Amortization of deferred policy acquisition costs is summarized as follows:
Year Ended December 31,
2022 2021 2020
(Dollars in thousands)
Amortization of deferred policy acquisition costs
before gross profit adjustments $ 330,290 $ 181,589 $ 368,139
Gross profit adjustments:
Fair value accounting for derivatives and embedded
derivatives 290,905 88,576 293,827
Net realized losses on investments (5,895) (1,837) (12,412)
Amortization of deferred policy acquisition costs
after gross profit adjustments $ 615,300 $
268,328
See Net income available to common stockholders and non-GAAP operating income available to common stockholders, a non-GAAP financial measure, above for discussion of the impact of assumption updates on amortization of deferred policy acquisition costs for the years endedDecember 31, 2022 and 2021. See Critical Accounting Policies and Estimates - Deferred Policy Acquisition Costs and Deferred Sales Inducements. Other operating costs and expenses decreased 2% to$239.6 million in 2022 and increased 33% to$243.7 million in 2021 from$183.6 million in 2020 and are summarized as follows: Year Ended December 31, 2022 2021 2020 (Dollars in thousands) Salary and benefits$ 162,061 $ 139,155 $ 95,815 Other 77,555 104,557 87,821 Total other operating costs and expenses$ 239,616 $ 243,712 $ 183,636 Salary and benefits increased$22.9 million for the year endedDecember 31, 2022 compared to 2021. The increases in salary and benefits were primarily due to an increased number of employees related to our continued growth and implementation of AEL 2.0 as well as increases in the expense recognized under our equity and cash incentive compensation programs ("incentive compensation programs"). The increases in expenses related to our incentive compensation programs were primarily due to new compensation programs and increases in the expected payouts due to a larger number of employees participating in the programs. 30
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Other expenses decreased for the year endedDecember 31, 2022 compared to 2021. The decrease was primarily related to a decrease in risk charges expense due to the recapture of an existing reinsurance agreement which was replaced with a new agreement with a lower risk charge.
We expect the level of other operating costs and expenses to be in the
million
Income tax expense increased in 2022 primarily due to an increase in income
before income taxes. The effective income tax rates were 21.0% and 21.4% for
2022 and 2021, respectively.
Income tax expense and the resulting effective tax rate are based upon two
components of income before income taxes ("pretax income") that are taxed at
different tax rates. Life insurance income is generally taxed at a statutory
rate of approximately 21.5% reflecting the absence of state income taxes for
substantially all of the states that the life insurance subsidiaries do business
in. The income (loss) for the parent company and other non-life insurance
subsidiaries (the "non-life insurance group") is generally taxed at a statutory
tax rate of 28.7% reflecting the combined federal and state income tax rates.
The effective income tax rates resulting from the combination of the income tax
provisions for the life and non-life sources of income (loss) vary from year to
year based primarily on the relative size of pretax income from the two sources.
We did not provide for a valuation allowance for the deferred income tax asset
attributable to unrealized losses on available for sale fixed maturity
securities. Management expects that the passage of time will result in the
reversal of the unrealized losses on available for sale fixed maturity
securities due to the fair value increasing as these securities near maturity.
We have the intent and ability to hold these securities to maturity and do not
believe it would be necessary to liquidate these securities at a loss. In
addition, we have the ability to sell fixed maturity securities in unrealized
gain positions to offset realized deferred income tax assets attributable to
unrealized losses on available for sale fixed maturity securities. To the extent
future changes in facts and circumstances impact our intent and ability to hold
these assets to recovery, this could impact the realization of the deferred tax
asset.
Financial Condition
Investments
Our investment strategy is to maximize current income and total investment
return through active management while maintaining a responsible asset
allocation strategy containing high credit quality investments and providing
adequate liquidity to meet our cash obligations to policyholders and others. Our
investment strategy is also reflective of insurance statutes, which regulate the
type of investments that our life subsidiaries are permitted to make and which
limit the amount of funds that may be used for any one type of investment.
As previously noted, as part of our AEL 2.0 investment pillar, we have increased
our allocation to private assets in part by partnering with proven asset
managers in our focus expansion sectors of commercial real estate, residential
real estate including mortgages and single family rental homes, infrastructure
debt and equity, middle market lending and lending to revenue, technology and
software sector companies.
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The composition of our investment portfolio is summarized as follows:
December 31,
2022 2021
Carrying Carrying
Amount Percent Amount Percent
(Dollars in thousands)
Fixed maturity securities:
U.S. Government and agencies $ 169,071 0.4 % $ 1,078,746 1.9 %
States, municipalities and territories 3,822,943 8.5 % 3,758,761 6.5 %
Foreign corporate securities and foreign
governments 616,938 1.4 % 375,097 0.6 %
Corporate securities 20,201,774 44.8 % 32,631,189 57.0 %
Residential mortgage backed securities 1,366,927 3.0 % 1,125,049 2.0 %
Commercial mortgage backed securities 3,447,075 7.6 % 4,682,900 8.2 %
Other asset backed securities 5,155,254 11.4 % 5,146,567 9.0 %
Total fixed maturity securities 34,779,982 77.1 % 48,798,309 85.2 %
Mortgage loans on real estate 6,778,977 15.0 % 5,650,480 9.9 %
Real estate investments 1,056,063 2.3 % 337,939 0.6 %
Limited partnerships and limited liability
companies 1,266,779 2.8 % 520,120 0.9 %
Derivative instruments 431,727 1.0 % 1,277,480 2.2 %
Other investments 829,900 1.8 % 690,344 1.2 %
45,143,428 100.0 % 57,274,672 100.0 %
Coinsurance investments (1) 6,181,870 3,101,832
$ 51,325,298 $ 60,376,504
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
Our fixed maturity security portfolio is managed to minimize risks such as interest rate changes and defaults or credit losses while earning a sufficient and stable return on our investments. The largest portion of our fixed maturity securities are in investment grade (typically NAIC designation 1 or 2) publicly traded or privately placed corporate securities.
A summary of our fixed maturity securities by NRSRO ratings is as follows:
December 31,
2022 2021
Percent of Percent of
Amortized Carrying Fixed Maturity Amortized Carrying Fixed Maturity
Rating Agency Rating Cost Amount Securities Cost Amount Securities
(Dollars in thousands)
Aaa/Aa/A $ 24,462,459 $ 21,723,282 62.5 % $ 24,943,232 $ 27,496,506 56.4 %
Baa 14,228,490 12,434,302 35.7 % 18,443,171 20,147,369 41.3 %
Total investment grade 38,690,949 34,157,584 98.2 % 43,386,403 47,643,875 97.7 %
Ba 554,605 485,166 1.4 % 899,253 930,321 1.9 %
B 94,185 79,058 0.2 % 104,443 117,989 0.2 %
Caa 20,020 18,540 0.1 % 38,484 39,354 0.1 %
Ca and lower 40,664 39,634 0.1 % 61,352 66,770 0.1 %
Total below investment
grade 709,474 622,398
1.8 % 1,103,532 1,154,434 2.3 %
39,400,423 34,779,982 100.0 % 44,489,935 48,798,309 100.0 %
Coinsurance
investments (1) 5,465,596 5,024,635 2,509,248 2,507,634
$ 44,866,019 $ 39,804,617 $ 46,999,183 $ 51,305,943
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
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The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day
credit quality assessment of securities owned by state regulated insurance
companies. The purpose of such assessment and valuation is for determining
regulatory capital requirements and regulatory reporting. Insurance companies
report ownership to the SVO when such securities are eligible for regulatory
filings. The SVO conducts credit analysis on these securities for the purpose of
assigning a NAIC designation and/or unit price. Typically, if a security has
been rated by an NRSRO, the SVO utilizes that rating and assigns a NAIC
designation based upon the following system:
NAIC Designation NRSRO Equivalent Rating
1 Aaa/Aa/A
2 Baa
3 Ba
4 B
5 Caa
6 Ca and lower
The NAIC introduced 20 NAIC designation modifiers that are applied to each NAIC
designation to determine a security's NAIC designation category. New risk-based
capital charges for each of the 20 designated categories for reporting were
effective beginning December 31, 2021 .
For most of the bonds held in our portfolio the NAIC designation matches the
NRSRO equivalent rating. However, for certain loan-backed and structured
securities, as defined by the NAIC, the NAIC rating is not always equivalent to
the NRSRO rating presented in the previous table. The NAIC has adopted revised
rating methodologies for certain loan-backed and structured securities comprised
of non-agency residential mortgage backed securities ("RMBS") and commercial
mortgage backed securities ("CMBS"). The NAIC's objective with the revised
rating methodologies for these structured securities is to increase the accuracy
in assessing expected losses and use the improved assessment to determine a more
appropriate capital requirement for such structured securities. The revised
methodologies reduce regulatory reliance on rating agencies and allow for
greater regulatory input into the assumptions used to estimate expected losses
from structured securities.
The use of this process by the SVO may result in certain non-agency RMBS and
CMBS being assigned an NAIC designation that is different than the equivalent
NRSRO rating. The NAIC designations for non-agency RMBS and CMBS are based on
security level expected losses as modeled by an independent third party (engaged
by the NAIC) and the statutory carrying value of the security, including any
purchase discounts or impairment charges previously recognized. Evaluation of
non-agency RMBS and CMBS held by insurers using the NAIC rating methodologies is
performed on an annual basis.
Our fixed maturity security portfolio is managed to minimize risks such as
defaults or impairments while earning a sufficient and stable return on our
investments. Our strategy with respect to our fixed maturity securities
portfolio has been to invest primarily in investment grade securities.
Investment grade is NAIC 1 and 2 securities and Baa3/BBB- and better securities
on the NRSRO scale. We expect this strategy to meet the objective of minimizing
risk while also managing asset capital charges on a regulatory capital basis.
A summary of our fixed maturity securities by NAIC designation is as follows:
December 31, 2022 December 31, 2021
Percentage Percentage
of Total of Total
NAIC Amortized Carrying Carrying Amortized Carrying Carrying
Designation Cost Fair Value Amount Amount Cost Fair Value Amount Amount
(Dollars in thousands) (Dollars in thousands)
1 $ 24,466,961 $ 21,752,775 $ 21,752,775 62.5 % $ 25,378,938 $ 28,006,835 $ 28,006,835 57.4 %
2 14,185,506 12,398,001 12,398,001 35.7 % 18,028,077 19,667,529 19,667,529 40.3 %
3 562,190 490,198 490,198 1.4 % 909,173 941,071 941,071 2.0 %
4 109,409 91,495 91,495 0.3 % 133,070 147,160 147,160 0.3 %
5 61,721 36,738 36,738 0.1 % 16,496 15,357 15,357 - %
6 14,636 10,775 10,775 - % 24,181 20,357 20,357 - %
39,400,423 34,779,982 34,779,982 100.0 % 44,489,935 48,798,309 48,798,309 100.0 %
Coinsurance investments (1) 5,465,596 5,024,635 5,024,635 2,509,248 2,507,634 2,507,634
$ 44,866,019 $ 39,804,617 $ 39,804,617 $ 46,999,183 $ 51,305,943 $ 51,305,943
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
The amortized cost and fair value of fixed maturity securities at
2022
audited consolidated financial statements in this Form 10-K, which is
incorporated by reference in this Item 7.
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Unrealized Losses
The amortized cost and fair value of fixed maturity securities that were in an
unrealized loss position were as follows:
Unrealized
Number of Amortized Losses, Net of Allowance for
Securities Cost Allowance Credit Losses Fair Value
(Dollars in thousands)
December 31, 2022
Fixed maturity securities, available
for sale:
U.S. Government and agencies 27 $ 165,746 $ (4,637) $ - $ 161,109
States, municipalities and
territories 514 3,265,080 (574,814) - 2,690,266
Foreign corporate securities and
foreign governments 43 590,944 (74,151) - 516,793
Corporate securities 2,103 21,393,656 (3,224,609) (3,214) 18,165,833
Residential mortgage backed
securities 219 1,235,672 (126,368) (133) 1,109,171
Commercial mortgage backed securities 339 3,750,331 (391,966) - 3,358,365
Other asset backed securities 567 4,579,149 (382,563) - 4,196,586
3,812 34,980,578 (4,779,108) (3,347) 30,198,123
Coinsurance investments (1) 698 3,085,834 (504,739) - 2,581,095
4,510 $ 38,066,412 $ (5,283,847) $ (3,347) $ 32,779,218
December 31, 2021
Fixed maturity securities, available
for sale:
U.S. Government and agencies 8 $ 761,102 $ (124) $ - $ 760,978
States, municipalities and
territories 42 173,106 (2,485) (2,776) 167,845
Foreign corporate securities and
foreign governments 3 34,673 (801) - 33,872
Corporate securities 176 1,433,317 (26,035) - 1,407,282
Residential mortgage backed
securities 74 280,044 (2,093) (70) 277,881
Commercial mortgage backed securities 89 795,405 (16,553) - 778,852
Other asset backed securities 577 3,118,385 (50,018) - 3,068,367
969 6,596,032 (98,109) (2,846) 6,495,077
Coinsurance investments (1) 458 1,327,173 (14,261) - 1,312,912
1,427 $ 7,923,205 $ (112,370) $ (2,846) $ 7,807,989
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
The unrealized losses at December 31, 2022 are principally related to the timing
of the purchases of certain securities, which carry less yield than those
available at December 31, 2022 . Approximately 98% and 83% of the unrealized
losses on fixed maturity securities shown in the above table for December 31,
2022 and 2021, respectively, are on securities that are rated investment grade,
defined as being the highest two NAIC designations.
The increase in unrealized losses from December 31, 2021 to December 31, 2022
was primarily related to an increase in treasury yields during the twelve months
ended December 31, 2022 . The 10-year U.S. Treasury yields at December 31, 2022
and December 31, 2021 were 3.88% and 1.52%, respectively. The 30-year U.S.
Treasury yields at December 31, 2022 and December 31, 2021 were 3.97% and 1.90%,
respectively.
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The following table sets forth the composition by credit quality (NAIC
designation) of fixed maturity securities with gross unrealized losses:
Carrying Value of
Securities with Gross
Gross Unrealized Percent of Unrealized Percent of
NAIC Designation Losses Total Losses (1) Total
(Dollars in thousands)
December 31, 2022
1 $ 18,396,691 60.9 % $ (2,836,027) 59.4 %
2 11,207,008 37.1 % (1,825,520) 38.2 %
3 465,867 1.6 % (72,976) 1.5 %
4 89,686 0.3 % (17,922) 0.4 %
5 29,075 0.1 % (25,037) 0.5 %
6 9,796 - % (1,626) - %
30,198,123 100.0 % (4,779,108) 100.0 %
Coinsurance investments (2) 2,581,095 (504,739)
$ 32,779,218 $ (5,283,847)
December 31, 2021
1 $ 3,825,403 58.9 % $ (33,823) 34.4 %
2 2,233,761 34.4 % (47,154) 48.1 %
3 376,933 5.8 % (13,723) 14.0 %
4 33,229 0.5 % (1,083) 1.1 %
5 9,506 0.1 % (1,140) 1.2 %
6 16,244 0.3 % (1,186) 1.2 %
6,495,076 100.0 % (98,109) 100.0 %
Coinsurance investments (2) 1,312,912 (14,261)
$ 7,807,988 $ (112,370)
(1)Gross unrealized losses have been adjusted to reflect the allowance for
credit loss of
respectively.
(2)Investments held byAmerican Equity Life in a segregated account to support liabilities reinsured under both coinsurance with funds withheld and modified coinsurance reinsurance agreements. Our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position atDecember 31, 2022 and 2021, along with a description of the factors causing the unrealized losses is presented in Note 3 - Investments to our audited consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7. 35
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The amortized cost and fair value of fixed maturity securities in an unrealized
loss position and the number of months in a continuous unrealized loss position
(fixed maturity securities that carry an NRSRO rating of BBB/Baa or higher are
considered investment grade) were as follows:
Gross
Amortized Unrealized
Number of Cost, Net of Losses, Net of
Securities Allowance (1) Fair Value Allowance (1)
(Dollars in thousands)
December 31, 2022
Fixed maturity securities, available for
sale:
Investment grade:
Less than six months 984 $
6,296,895
Six months or more and less than twelve
months
2,308 24,207,057 20,481,666 (3,725,391)
Twelve months or greater 427 3,761,294 3,153,240 (608,054)
Total investment grade 3,719 34,265,246 29,603,699 (4,661,547)
Below investment grade:
Less than six months 12 51,711 47,494 (4,217)
Six months or more and less than twelve
months 34 319,964 265,726 (54,238)
Twelve months or greater 47 340,310 281,204 (59,106)
Total below investment grade 93 711,985 594,424 (117,561)
3,812 34,977,231 30,198,123 (4,779,108)
Coinsurance investments (2) 698 3,085,834 2,581,095 (504,739)
4,510 $ 38,063,065 $ 32,779,218 $ (5,283,847)
December 31, 2021
Fixed maturity securities, available for
sale:
Investment grade:
Less than six months 567 $
4,255,321
Six months or more and less than twelve
months
39 132,110 130,156 (1,954)
Twelve months or greater 281 1,752,779 1,705,640 (47,139)
Total investment grade 887 6,140,210 6,059,164 (81,046)
Below investment grade:
Less than six months 11 43,745 42,994 (751)
Six months or more and less than twelve
months 7 28,544 25,706 (2,838)
Twelve months or greater 64 380,686 367,213 (13,473)
Total below investment grade 82 452,975 435,913 (17,062)
969 6,593,185 6,495,077 (98,108)
Coinsurance investments (2) 458 1,327,173 1,312,912 (14,261)
1,427 $ 7,920,358 $ 7,807,989 $ (112,369)
(1)Amortized cost and gross unrealized losses have been adjusted to reflect the
allowance for credit loss of $3.3 million and $2.8 million as of December 31,
2022 and 2021, respectively.
(2)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
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The amortized cost and fair value of fixed maturity securities (excludingU.S. Government and agencies) segregated by investment grade (NRSRO rating of BBB/Baa or higher) and below investment grade that had unrealized losses greater than 20%, when comparing fair value to amortized cost, and the number of months in a continuous unrealized loss position were as follows: Gross Amortized Unrealized Number of Cost, Net of Fair Losses, Net of Securities Allowance (1) Value Allowance (1) (Dollars in thousands)December 31, 2022 Investment grade: Less than six months 333 $
3,955,378
Six months or more and less than twelve
months
299 4,496,559 3,146,868 (1,349,691)
Twelve months or greater 1 40,351 26,854 (13,497)
Total investment grade 633 8,492,288 6,235,797 (2,256,491)
Below investment grade:
Less than six months 8 61,481 47,057 (14,424)
Six months or more and less than twelve
months 7 111,990 71,271 (40,719)
Twelve months or greater - - - -
Total below investment grade 15 173,471 118,328 (55,143)
648 8,665,759 6,354,125 (2,311,634)
Coinsurance investments (2) 423 1,250,509 859,395 (391,114)
1,071 $ 9,916,268 $ 7,213,520 $ (2,702,748)
December 31, 2021
Investment grade:
Less than six months - $ - $ - $ -
Six months or more and less than twelve
months - - - -
Twelve months or greater - - - -
Total investment grade - - - -
Below investment grade:
Less than six months - - - -
Six months or more and less than twelve
months - - - -
Twelve months or greater - - - -
Total below investment grade - - - -
- - - -
Coinsurance investments (2) - - - -
- $ - $ - $ -
(1)Amortized cost and gross unrealized losses have been adjusted to reflect the
allowance for credit loss of $3.3 million and $2.8 million as of December 31,
2022 and 2021, respectively.
(2)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
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The amortized cost and fair value of fixed maturity securities, by contractual
maturity, that were in an unrealized loss position are shown below. Actual
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties. All of our mortgage and other asset backed securities provide for
periodic payments throughout their lives, and are shown below as a separate
line.
Available for sale
Amortized
Cost Fair Value
(Dollars in thousands)
December 31, 2022
Due in one year or less $ 567,599 $ 563,298
Due after one year through five years 3,591,040 3,377,197
Due after five years through ten years 4,844,271 4,280,762
Due after ten years through twenty years 7,443,657 6,377,081
Due after twenty years
8,968,858 6,935,663
25,415,425 21,534,001
Residential mortgage backed securities 1,235,672 1,109,171
Commercial mortgage backed securities 3,750,331 3,358,365
Other asset backed securities 4,579,149 4,196,586
34,980,577 30,198,123
Coinsurance investments (1) 3,085,834 2,581,095
$ 38,066,411 $ 32,779,218
December 31, 2021
Due in one year or less $ 762,035 $ 761,590
Due after one year through five years 49,668 46,687
Due after five years through ten years 476,811 467,284
Due after ten years through twenty years 443,909 435,589
Due after twenty years 669,775 658,827
2,402,198 2,369,977
Residential mortgage backed securities 280,044 277,881
Commercial mortgage backed securities 795,405 778,852
Other asset backed securities 3,118,385 3,068,367
6,596,032 6,495,077
Coinsurance investments (1) 1,327,173 1,312,912
$ 7,923,205 $ 7,807,989
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
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International Exposure
We hold fixed maturity securities with international exposure. As ofDecember 31, 2022 , 14.7% of the carrying value of our fixed maturity securities was comprised of corporate debt securities of issuers based outside ofthe United States and debt securities of foreign governments. Our fixed maturity securities with international exposure are primarily denominated inU.S. dollars. Our investment professionals analyze each holding for credit risk by economic and other factors of each country and industry. The following table presents our international exposure in our fixed maturity portfolio by country or region: December 31, 2022 Percent of Total Amortized Carrying Amount/ Carrying Cost Fair Value Amount (Dollars in thousands) Europe$ 2,285,608 $ 1,994,351 5.7 % Asia/Pacific 383,900 324,205 0.9 % Latin America 313,097 272,291 0.8 % Non-U.S. North America 1,178,177 1,045,695 3.0 % Australia & New Zealand 927,819 815,440 2.3 % Other 795,657 696,191 2.0 % 5,884,258 5,148,173 14.7 % Coinsurance investments (1) 1,036,513 909,094$ 6,920,771 $ 6,057,267 (1)Investments held byAmerican Equity Life in a segregated account to support liabilities reinsured under both coinsurance with funds withheld and modified coinsurance reinsurance agreements.
All of the securities presented in the table above are investment grade (NAIC
designation of either 1 or 2), except for the following:
December 31, 2022
Carrying Amount/
Amortized Cost Fair Value
(Dollars in thousands)
Europe $ 96,525 $ 82,618
Asia/Pacific 62 52
Latin America 45,570 37,194
Non-U.S. North America 23,209 19,911
Australia & New Zealand 219 182
Other 91,588 62,509
257,173 202,466
Coinsurance investments (1) 32,889 20,123
$ 290,062 $ 222,589
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
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At each balance sheet date, we identify invested assets which have characteristics (i.e., significant unrealized losses compared to amortized cost and industry trends) creating uncertainty as to our future assessment of credit losses. As part of this assessment, we review not only a change in current price relative to amortized cost but the issuer's current credit rating and the probability of full recovery of principal based upon the issuer's financial strength. For corporate issuers, we evaluate the financial stability and quality of asset coverage for the securities relative to the term to maturity for the issues we own. For structured securities, we evaluate changes in factors such as collateral performance, default rates, loss severity and expected cash flows. AtDecember 31, 2022 , the amortized cost and fair value of securities on the watch list (all fixed maturity securities) are as follows: Net Unrealized Amortized Cost, Losses, Number of Amortized Allowance for Net of Net of Fair General Description Securities Cost Credit Losses Allowance Allowance Value (Dollars in thousands) States, municipalities and territories 1$ 20,657
$ -
Corporate securities - Public
securities
6 20,860 - 20,860 (1,050) 19,810
Corporate securities - Private
placement securities 1 10,646 (3,214) 7,432 - 7,432
Residential mortgage backed
securities 22 25,095 (133) 24,962 (2,954) 22,008
Commercial mortgage backed
securities 8 41,899 - 41,899 (2,752) 39,147
Other asset backed securities 1 2,314 - 2,314 - 2,314
Collateralized loan obligations 16 103,907 - 103,907 (21,239) 82,668
55 $ 225,378 $ (3,347) $ 222,031 $ (31,339) $ 190,692
We expect to recover the unrealized losses, net of allowances, as we did not
have the intent to sell and it was not more likely than not that we would be
required to sell these securities prior to recovery of the amortized cost basis,
net of allowances. Our analysis of these securities and their credit performance
at December 31, 2022 is as follows:
States municipalities and territories: The decline in value of this security is
primarily due to the security being recently restructured as part of bankruptcy
proceedings and uncertainty around the impact of the restructure.
Corporate securities: The corporate securities included on the watch list
primarily include a security in the utilities industry that is under financial
stress due to the impact of power outages and a security in the retail market
which is in an unrealized loss position and for which we have the intent to sell
as part of our risk reduction effort.
Structured securities: The structured securities included on the watch list have
generally experienced higher levels of stress due to the impact COVID-19 had on
the economy. In addition, certain securities are included on the watch list as
they are in an unrealized loss position and we have the intent to sell as part
of our risk reduction effort.
Credit Losses
We have a policy and process to identify securities in our investment portfolio for which we recognize credit loss. See Critical Accounting Policies and Estimates-Evaluation of Allowance for Credit Losses on Available forSale Fixed Maturity Securities and Mortgage Loan Portfolios and Note 3 - Investments to our audited consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7. During 2022, we recognized$15.0 million of credit losses which includes$10.0 million of credit losses on structured securities primarily due to our intent to sell such securities and$7.1 million of credit losses on corporate securities due to a$3.3 million credit loss on a security and$3.8 million of credit losses on securities due to our intent to sell such securities which were partially offset by a$2.1 million reduction in credit losses primarily due to revised financial outlook on securities related to senior living facilities in the Southeastern region ofthe United States driven in part by a restructuring of its debt facilities. During 2021, we recognized credit losses of$6.2 million related to our fixed maturity securities which consisted of$6.9 million of credit losses on commercial mortgage backed securities due to our intent to sell the securities, partially offset by net recoveries on corporate securities, municipal securities and residential mortgage backed securities. 40
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Mortgage Loans on Real Estate
Our financing receivables consist of three mortgage loan portfolio segments: commercial mortgage loans, agricultural mortgage loans and residential mortgage loans. Our commercial mortgage loan portfolio consists of loans with an outstanding principal balance of$3.6 billion as ofDecember 31, 2022 and 2021. This portfolio consists of mortgage loans collateralized by the related properties and is diversified as to property type, location and loan size. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and other criteria to attempt to reduce the risk of default. Our agricultural mortgage loan portfolio consists of loans with an outstanding principal balance of$567.6 million and$408.1 million as ofDecember 31, 2022 and 2021, respectively. These loans are collateralized by agricultural land and are diversified as to location withinthe United States . Our residential mortgage loan portfolio consists of loans with an outstanding principal balance of$2.8 billion and$1.7 billion as ofDecember 31, 2022 and 2021, respectively. These loans are collateralized by the related properties and are diversified as to location withinthe United States . Mortgage loans on real estate are generally reported at cost adjusted for amortization of premiums and accrual of discounts, computed using the interest method and net of valuation allowances. AtDecember 31, 2022 and 2021, the largest principal amount outstanding for any single commercial mortgage loan was$83.3 million and$81.5 million , respectively, and the average loan size was$5.8 million and$5.3 million , respectively. In addition, the average loan-to-value ratio for commercial and agricultural mortgage loans combined was 51.4% and 52.3% atDecember 31, 2022 and 2021, respectively, based upon the underwriting and appraisal at the time the loan was made. This loan-to-value ratio is indicative of our conservative underwriting policies and practices for originating mortgage loans and may not be indicative of collateral values at the current reporting date. Our current practice is to only obtain market value appraisals of the underlying collateral at the inception of the loan unless we identify indicators of impairment in our ongoing analysis of the portfolio, in which case, we either calculate a value of the collateral using a capitalization method or obtain a third party appraisal of the underlying collateral. The commercial mortgage loan portfolio is summarized by geographic region and property type in Note 4 - Mortgage Loans on Real Estate of our audited consolidated financial statements of this Form 10-K, which is incorporated by reference in this Item 7. In the normal course of business, we commit to fund mortgage loans up to 90 days in advance. AtDecember 31, 2022 , we had commitments to fund commercial mortgage loans totaling$112.8 million , with interest rates ranging from 6.9% to 8.2%. During 2022 and 2021, the commercial mortgage loan industry has been very competitive due to relatively attractive returns that can be realized on mortgage loans. For the year endedDecember 31, 2022 , we received$403.6 million in cash for loans being paid in full compared to$350.6 million for the year endedDecember 31, 2021 . Some of the loans being paid off have either reached their maturity or are nearing maturity. AtDecember 31, 2022 , we had commitments to fund agricultural mortgage loans totaling$18.5 million with interest rates ranging from 6.4% to 6.7%, and had commitments to fund residential mortgage loans totaling$288.8 million with interest rates ranging from 7.00% to 12.0%. See Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements, incorporated by reference, for a presentation of our valuation allowance, foreclosure activity and troubled debt restructure analysis. We have a process by which we evaluate the credit quality of each of our mortgage loans. This process utilizes each loan's loan-to-value and debt service coverage ratios as primary metrics. See Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements, incorporated by reference, for a summary of our portfolio by loan-to-value and debt service coverage ratios. We closely monitor loan performance for our commercial, agricultural and residential mortgage loan portfolios. Commercial, agricultural and residential loans are considered nonperforming when they are 90 days or more past due. Aging of financing receivables is summarized in the following table: 30-59 days 60-89 days Over 90 days Current past due past due past due Total As of December 31, 2022: (Dollars in thousands) Commercial mortgage loans$ 3,554,558 $ - $ - $ -$ 3,554,558 Agricultural mortgage loans 562,828 - - 3,135 565,963 Residential mortgage loans 2,751,261 62,450 16,924 34,843 2,865,478 Total mortgage loans$ 6,868,647 $ 62,450 $ 16,924 $ 37,978 $ 6,985,999 As ofDecember 31, 2021 : Commercial mortgage loans$ 3,628,502 $ - $ - $ -$ 3,628,502 Agricultural mortgage loans 406,999 - - - 406,999 Residential mortgage loans 1,631,999 34,447 3,030 7,045 1,676,521 Total mortgage loans$ 5,667,500 $ 34,447 $ 3,030 $ 7,045 $ 5,712,022 41
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Private Assets
The following table is a breakout of our private asset investments as ofDecember 31, 2022 and 2021. December 31, 2022 December 31, 2021 Private Asset Class Amount Percent Amount Percent (Dollars in thousands) Real estate loans Commercial $ 3,385 6.8 % $ 3,591 6.6 % Residential 3,002 6.0 % 1,772 3.2 % Agricultural 566 1.2 % 407 0.8 % Total real estate loans 6,953 14.0 % 5,770 10.6 % Private credit Middle market 1,493 3.0 % 1,062 2.0 % Specialty finance 443 0.9 % - - % Infrastructure debt 555 1.1 % 508 0.9 % Total private credit 2,491 5.0 % 1,570 2.9 % Equity Residential real estate 961 1.9 % 344 0.6 % Commercial real estate 117 0.2 % 5 - % Infrastructure 91 0.2 % 73 0.1 % Core private equity 364 0.7 % 253 0.5 % Total equity 1,533 3.0 % 675 1.2 % Total private assets $ 10,977 22.0 % $ 8,015 14.7 % The investment balances within the table above include fixed maturity securities and mortgage loans at amortized cost and real estate and other investments at carrying values as reflected in the consolidated balance sheets.
Derivative Instruments
Our derivative instruments consist of call options purchased to provide the income needed to fund the annual index credits on our fixed index annuity products and interest rate swaps used to hedge against changes in fair value due to changes in interest rates. The fair value of the call options is based upon the amount of cash that would be required to settle the call options obtained from the counterparties adjusted for the nonperformance risk of the counterparty. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options. The fair value of the pay fixed/receive float interest rate swaps are determined using internal valuation models that generate discounted expected future cash flows by constructing a projected Secure Overnight Financing Rate (SOFR) curve over the term of the swap. Our interest rate swaps qualify for hedge accounting and our call options do not qualify for hedge accounting. Any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations. A presentation of our derivative instruments along with a discussion of the business strategy involved with our derivatives for both our derivatives designated as hedging instruments and our derivatives not designated as hedging instruments is included in Note 6 - Derivative Instruments to our audited consolidated financial statements in this Form 10-K, which is incorporated by reference in this Item 7. Liabilities Our liability for policy benefit reserves decreased to$61.1 billion atDecember 31, 2022 compared to$65.5 billion atDecember 31, 2021 . The decrease in policy benefit reserves is due to additional in-force policy reserves being ceded to third party reinsurers during 2022 as well as funds returned to policyholders being in excess of net deposits and interest and index credits credited to policyholders during 2022. Substantially all of our annuity products have a surrender charge feature designed to reduce the risk of early withdrawal or surrender of the policies and to compensate us for our costs if policies are withdrawn early. Our lifetime income benefit rider also reduces the risk of early withdrawal or surrender of the policies as it provides an additional liquidity option to policyholders as the policyholder can elect to receive guaranteed payments for life from their contract without requiring them to annuitize their contract value and the rider is not transferable to other contracts. Notwithstanding these policy features, the withdrawal rates of policyholder funds may be affected by changes in interest rates and other factors.
See Note 10 - Notes and Loan Payable to our audited consolidated financial
statements in this Form 10-K, which is incorporated by reference in this Item 7
for discussion of our notes and loan payable.
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See Note 11 - Subordinated Debentures to our audited consolidated financial
statements for additional information concerning our subordinated debentures
payable to, and the preferred securities issued by, our subsidiary trusts.
Liquidity and Capital Resources
Liquidity for Insurance Operations
Our insurance subsidiaries' primary sources of cash flow are annuity deposits, investment income, and proceeds from the sale, maturity and calls of investments. The primary uses of funds are investment purchases, payments to policyholders in connection with surrenders and withdrawals, policy acquisition costs and other operating expenses. Liquidity requirements are met primarily by funds provided from operations. Our life subsidiaries generally receive adequate cash flow from annuity deposits and investment income to meet their obligations. Annuity liabilities are generally long-term in nature. However, a primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our annuity policies, such as surrender charges and bonus vesting, which help limit and discourage early withdrawals. Our lifetime income benefit rider also limits the risk of early withdrawals as it provides an additional liquidity option to policyholders as the policyholder can elect to receive guaranteed payments for life from their contract without requiring them to annuitize their contract value and the rider is not transferable to other contracts. AtDecember 31, 2022 , approximately 90% or$43.0 billion of our annuity liabilities were subject to penalty upon surrender, with a weighted average remaining surrender charge period of 4.6 years and a weighted average surrender charge percentage of 7.9%. Our insurance subsidiaries generally have adequate cash flows from annuity deposits and investment income to meet their policyholder and other obligations. Net cash flows from annuity deposits and funds returned to policyholders as surrenders, withdrawals and death claims were$(1.9) billion for the year endedDecember 31, 2022 compared to$1.3 billion for the year endedDecember 31, 2021 with the decrease attributable to a$3.1 billion decrease in net annuity deposits after coinsurance and a$66.9 million (after coinsurance) increase in funds returned to policyholders. We continue to invest the net proceeds from policyholder transactions and investment activities in high quality fixed maturity securities, mortgage loans, and other high quality private assets. We have a highly liquid investment portfolio that can be used to meet policyholder and other obligations as needed. In addition, we intend to hold approximately 1% to 3% of our investment portfolio in cash and cash equivalents. Scheduled principal repayments, calls and tenders of available for sale fixed maturity securities and net investment income were$2.8 billion and$2.3 billion , respectively, during the year endedDecember 31, 2022 .
Liquidity of Parent Company
We, as the parent company, are a legal entity separate and distinct from our subsidiaries, and have no business operations. We need liquidity primarily to service our debt (senior notes, term loan and subordinated debentures issued to a subsidiary trust), pay operating expenses and pay dividends to common and preferred stockholders. Our assets consist primarily of the capital stock and surplus notes of our subsidiaries. Accordingly, our future cash flows depend upon the availability of dividends, surplus note interest payments and other statutorily permissible payments from our subsidiaries, such as payments under our investment advisory agreements and tax allocation agreement with our subsidiaries. These sources provide adequate cash flow for us to meet our current and reasonably foreseeable future obligations and we expect they will be adequate to fund our parent company cash flow requirements in 2023. The ability of our life insurance subsidiaries to pay dividends or distributions, including surplus note payments, will be limited by applicable laws and regulations of the states in which our life insurance subsidiaries are domiciled, which subject our life insurance subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay. Currently,American Equity Life may pay dividends or make other distributions without the prior approval of the Iowa Insurance Commissioner, unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1)American Equity Life's net gain from operations for the preceding calendar year, or (2) 10% ofAmerican Equity Life's statutory capital and surplus at the precedingDecember 31 . For 2023, up to$369.3 million can be distributed as dividends byAmerican Equity Life without prior approval of the Iowa Insurance Commissioner. In addition, dividends and surplus note payments may be made only out of statutory earned surplus, and all surplus note payments are subject to prior approval by regulatory authorities in the life subsidiary's state of domicile.American Equity Life had$2.0 billion of statutory earned surplus atDecember 31, 2022 . The maximum distribution permitted by law or contract is not necessarily indicative of an insurer's actual ability to pay such distributions, which may be constrained by business and regulatory considerations, such as the impact of such distributions on surplus, which could affect the insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends or make other distributions. Further, state insurance laws and regulations require that the statutory surplus of our life subsidiaries following any dividend or distribution must be reasonable in relation to their outstanding liabilities and adequate for their financial needs. Along with solvency regulations, the primary driver in determining the amount of capital used for dividends is the level of capital needed to maintain desired financial strength ratings from rating agencies. Both regulators and rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could negatively affect the cash available to us from insurance subsidiaries. As ofDecember 31, 2022 , we estimateAmerican Equity Life has sufficient statutory capital and surplus, combined with capital available to the holding company, to maintain its insurer financial strength rating objective. However, this capital may not be sufficient if significant future losses are incurred or a rating agency modifies its rating criteria and access to additional capital could be limited. 43
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OnNovember 30, 2020 we issued 9,106,042 common shares to Brookfield at a value of$37.00 per share for net proceeds of$333.6 million . OnJanuary 7, 2022 , we issued an additional 6,775,000 shares to Brookfield at a value of$37.33 per share for net proceeds of$252.9 million . From the 2020 inception of the share repurchase program throughDecember 31, 2022 , we have repurchased approximately 23.9 million shares of our common stock at an average price of$34.74 per common share, including 14.8 million shares repurchased during the year endedDecember 31, 2022 . As ofDecember 31, 2022 , we had$569 million remaining under our share repurchase program. Cash and cash equivalents of the parent holding company atDecember 31, 2022 , were$531.3 million . We also have the ability to issue equity, debt or other types of securities through one or more methods of distribution. The terms of any offering would be established at the time of the offering, subject to market conditions. OnFebruary 15, 2022 , we established a new five-year credit agreement for$300 million in unsecured delayed draw term loan commitments. OnJuly 6, 2022 , we borrowed$300 million under this agreement which matures onFebruary 15, 2027 . InJanuary 2022 ,American Equity Life became a member of theFederal Home Loan Bank of Des Moines ("FHLB") which provides access to collateralized borrowings and other FHLB products. We may also issue funding agreements to the FHLB. Both the collateralized borrowings and funding agreements require us to pledge qualified assets as collateral. Obligations arising from funding agreements, which totaled$300.0 million as ofDecember 31, 2022 are used in investment spread activities. Statutory accounting practices prescribed or permitted for our life subsidiaries differ in many respects from those governing the preparation of financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. Information as to statutory capital and surplus and statutory net income (loss) for our life subsidiaries as ofDecember 31, 2022 and 2021 and for the years endedDecember 31, 2022 , 2021 and 2020 is included in Note 13 - Statutory Financial Information and Dividend Restrictions to our audited consolidated financial statements. In the normal course of business, we enter into financing transactions, lease agreements, or other commitments. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations as ofDecember 31, 2022 . Payments Due by Period Less Than After Total 1 year 1-3 Years 4-5 Years 5 Years (Dollars in thousands) Annuity and single premium universal life products (1)$ 63,211,336 $ 4,022,156
Notes and loan payable, including
interest payments (2)
1,028,981 50,714 154,288 823,979 - Subordinated debentures, including interest payments (3) 215,825 4,850 9,700 9,700 191,575 Operating leases 28,503 3,792 8,097 5,601 11,013 Mortgage loan funding and other investments 2,390,862 2,390,862 - - - Total$ 66,875,507 $ 6,472,374 $ 15,256,005 $ 8,237,431 $ 36,909,697 (1)Amounts shown in this table are projected payments through the year 2073 which we are contractually obligated to pay to our annuity policyholders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency, when applicable. These assumptions are based on our historical experience.
(2)Period that principal amounts are due is determined by the earliest of the
call/put date or the maturity date of each note payable.
(3)Amount shown is net of equity investments in the capital trusts due to the
contractual right of offset upon repayment of the notes.
Critical Accounting Policies & Estimates
The increasing complexity of the business environment and applicable authoritative accounting guidance require us to closely monitor our accounting policies. We have identified six critical accounting policies and estimates that are complex and require significant judgment. The following summary of our critical accounting policies and estimates is intended to enhance your ability to assess our financial condition and results of operations and the potential volatility due to changes in estimates.
Valuation of Investments
Our fixed maturity securities classified as available for sale are reported at
fair value. Unrealized gains and losses, if any, on these securities are
included directly in stockholders' equity as a component of accumulated other
comprehensive income (loss), net of income taxes and certain adjustments for
assumed changes in amortization of deferred policy acquisition costs, deferred
sales inducements and policy benefit reserves. Unrealized gains and losses
represent the difference between the amortized cost or cost basis and the fair
value of these investments. We use significant judgment within the process used
to determine fair value of these investments.
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GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument.
We categorize financial instruments recorded at fair value in the consolidated
balance sheets as follows:
Level 1 -Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price. Level 2 -Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable. Level 3 -Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
The following table presents the fair value of fixed maturity securities,
available for sale, by pricing source and hierarchy level as of
2022
Quoted Prices
in Active Significant Significant
Markets for Observable Unobservable
Identical Assets Inputs Inputs
(Level 1) (Level 2) (Level 3) Total
(Dollars in thousands)
December 31, 2022
Priced via third party pricing services $ 26,184 $ 30,061,381 $ - $ 30,087,565
Priced via independent broker quotations - - - -
Priced via other methods - 4,034,863 657,554 4,692,417
$ 26,184 $ 34,096,244 $ 657,554 $ 34,779,982
% of Total 0.1 % 98.0 % 1.9 % 100.0 %
Coinsurance investments (1) - 4,836,923 187,712 5,024,635
$ 26,184 $ 38,933,167 $ 845,266 $ 39,804,617
Priced via third party pricing services
Priced via independent broker quotations
- - - -
Priced via other methods - 2,005,747 - 2,005,747
$ 32,742 $ 48,936,577 $ - $ 48,969,319
% of Total 0.1 % 99.9 % - % 100.0 %
Coinsurance investments (1) 32,695 2,303,929 - 2,336,624
$ 65,437 $ 51,240,506 $ - $ 51,305,943
(1)Investments held by American Equity Life in a segregated account to support
liabilities reinsured under both coinsurance with funds withheld and modified
coinsurance reinsurance agreements.
Management's assessment of all available data when determining fair value of our
investments is necessary to appropriately apply fair value accounting.
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We utilize independent pricing services in estimating the fair values of
investment securities. The independent pricing services incorporate a variety of
observable market data in their valuation techniques, including:
•reported trading prices, •benchmark yields, •broker-dealer quotes, •benchmark securities, •bids and offers, •credit ratings, •relative credit information, and •other reference data. The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary. The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain quotes or prices from additional parties as needed. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets. We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, comparison of the prices to a secondary pricing source, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis using inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as ofDecember 31, 2022 and 2021.
Evaluation of Allowance for Credit Losses on Available for
Securities
The process to identify available for sale fixed maturity securities that could
potentially require an allowance for credit loss involves significant judgment
and estimates by management. We review and analyze all fixed maturity securities
on an ongoing basis for changes in market interest rates and credit
deterioration. This review process includes analyzing our ability to recover the
amortized cost or cost basis of each fixed maturity security that has a fair
value that is materially lower than its amortized cost and requires a high
degree of management judgment and involves uncertainty. The evaluation of fixed
maturity securities for credit loss is a quantitative and qualitative process,
which is subject to risks and uncertainties.
We have a policy and process to identify fixed maturity securities that could
potentially have a credit loss. This process involves monitoring market events
and other items that could impact issuers. The evaluation includes but is not
limited to such factors as:
•the extent to which fair value is less than amortized cost or cost;
•whether the issuer is current on all payments and all contractual payments have
been made as agreed;
•the remaining payment terms and the financial condition and near-term prospects
of the issuer;
•the lack of ability to refinance due to liquidity problems in the credit
market;
•the fair value of any underlying collateral;
•the existence of any credit protection available;
•our intent to sell and whether it is more likely than not we would be required
to sell prior to recovery for debt securities;
•consideration of rating agency actions; and
•changes in estimated cash flows of mortgage and asset backed securities.
We determine whether an allowance for credit loss should be established for
fixed maturity securities by assessing all facts and circumstances surrounding
each security. Where the decline in fair value of fixed maturity securities is
attributable to changes in market interest rates or to factors such as market
volatility, liquidity and spread widening, and we anticipate recovery of all
contractual or expected cash flows, we do not consider these securities to have
credit loss because we do not intend to sell these securities and it is not more
likely than not we will be required to sell these securities before a recovery
of amortized cost, which may be maturity.
If we intend to sell a fixed maturity security or if it is more likely than not
that we will be required to sell a security before recovery of its amortized
cost basis, credit loss has occurred and the difference between amortized cost
and fair value will be recognized as a loss in operations.
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If we do not intend to sell and it is not more likely than not we will be
required to sell the fixed maturity security but also do not expect to recover
the entire amortized cost basis of the security, a credit loss would be
recognized in operations in the amount of the expected credit loss. We determine
the amount of expected credit loss by calculating the present value of the cash
flows expected to be collected discounted at each security's acquisition yield
based on our consideration of whether the security was of high credit quality at
the time of acquisition. The difference between the present value of expected
future cash flows and the amortized cost basis of the security is the amount of
credit loss recognized in operations. The recognized credit loss is limited to
the unrealized loss on the security.
The determination of the credit loss component of a mortgage backed security is
based on a number of factors. The primary consideration in this evaluation
process is the issuer's ability to meet current and future interest and
principal payments as contractually stated at time of purchase. Our review of
these securities includes an analysis of the cash flow modeling under various
default scenarios considering independent third party benchmarks, the seniority
of the specific tranche within the structure of the security, the composition of
the collateral and the actual default, loss severity and prepayment experience
exhibited. With the input of third party assumptions for default projections,
loss severity and prepayment expectations, we evaluate the cash flow projections
to determine whether the security is performing in accordance with its
contractual obligation.
We utilize the models from a leading structured product software specialist
serving institutional investors. These models incorporate each security's
seniority and cash flow structure. In circumstances where the analysis implies a
potential for principal loss at some point in the future, we use our "best
estimate" cash flow projection discounted at the security's effective yield at
acquisition to determine the amount of our potential credit loss associated with
this security. The discounted expected future cash flows equates to our expected
recovery value. Any shortfall of the expected recovery when compared to the
amortized cost of the security will be recorded as credit loss.
The cash flow modeling is performed on a security-by-security basis and
incorporates actual cash flows on the residential mortgage backed securities
through the current period, as well as the projection of remaining cash flows
using a number of assumptions including default rates, prepayment rates and loss
severity rates. The default curves we use are tailored to the Prime or Alt-A
residential mortgage backed securities that we own, which assume lower default
rates and loss severity for Prime securities versus Alt-A securities. These
default curves are scaled higher or lower depending on factors such as current
underlying mortgage loan performance, rating agency loss projections, loan to
value ratios, geographic diversity, as well as other appropriate considerations.
The determination of the credit loss component of a corporate bond is based on
the underlying financial performance of the issuer and their ability to meet
their contractual obligations. Considerations in our evaluation include, but are
not limited to, credit rating changes, financial statement and ratio analysis,
changes in management, significant changes in credit spreads, breaches of
financial covenants and a review of the economic outlook for the industry and
markets in which they trade. In circumstances where an issuer appears unlikely
to meet its future obligation, an estimate of credit loss is determined. Credit
loss is calculated using default probabilities as derived from the credit
default swaps markets in conjunction with recovery rates derived from
independent third party analysis or a best estimate of credit loss. This credit
loss rate is then incorporated into a present value calculation based on an
expected principal loss in the future discounted at the yield at the date of
purchase and compared to amortized cost to determine the amount of credit loss
associated with the security.
For fixed maturity securities which we do not intend to sell and it is not more
likely than not we will be required to sell, but our intent changes due to
changes or events that could not have been reasonably anticipated, a credit loss
may be recognized in operations. Unrealized losses may be recognized in future
periods in operations should we later conclude that the decline in fair value
below amortized cost represents a credit loss pursuant to our accounting policy
described above. The use of different methodologies and assumptions to determine
the fair value of investments and the timing and amount of impairments may have
a material effect on the amounts presented in our consolidated financial
statements.
We establish a valuation allowance to provide for the risk of credit losses
inherent in our mortgage loan portfolios. The valuation allowance is maintained
at a level believed adequate by management to absorb estimated expected credit
losses.
The valuation allowances for each of our mortgage loan portfolios are estimated
by deriving probability of default and recovery rate assumptions based on the
characteristics of the loans in each portfolio, historical economic data and
loss information, and current and forecasted economic conditions. Key loan
characteristics impacting the estimate for our commercial mortgage loan
portfolio include the current state of the borrower's credit quality, which
considers factors such as loan-to-value ("LTV") and debt service coverage
("DSC") ratios, loan performance, underlying collateral type, delinquency
status, time to maturity, and original credit scores. Key loan characteristics
impacting the estimate for our agricultural and residential mortgage loan
portfolios include the current state of the borrowers' credit quality,
delinquency status, time to maturity and original credit scores.
Policy Liabilities for Fixed Index Annuities
We offer a variety of fixed index annuities with crediting strategies linked to
the S&P 500 Index and other equity and bond market indices. We purchase call
options on the applicable indices as an investment to provide the income needed
to fund the annual index credits on the index products. See Financial
Condition-Derivative Instruments. Certain derivative instruments embedded in the
fixed index annuity contracts are recognized in the consolidated balance sheets
at their fair values and changes in fair value are recognized immediately in our
consolidated statements of operations in accordance with accounting standards
for derivative instruments and hedging activities.
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Accounting for derivatives prescribes that the contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. Policy liabilities for fixed index annuities are equal to the sum of the "host" (or guaranteed) component and the embedded derivative component for each fixed index annuity policy. The host value is established at inception of the contract and accreted over the policy's life at a constant rate of interest. We estimate the fair value of the embedded derivative component at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk-free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements including lapse, partial withdrawal and mortality rates. Our best estimate assumptions for future policy growth include assumptions for the expected index credits on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values. The amounts reported in the consolidated statements of operations as "Interest sensitive and index product benefits" represent amounts credited to policy liabilities pursuant to accounting by insurance companies for certain long-duration contracts which include index credits through the most recent policy anniversary. The amounts reported in the consolidated statements of operations as "Change in fair value of embedded derivatives" equal the change in the difference between policy benefit reserves for fixed index annuities computed under the derivative accounting standard and the long-duration contracts accounting standard at each balance sheet date. In general, the change in the fair value of the embedded derivatives will not correspond to the change in fair value of the purchased call options because the purchased call options are generally one year options while the options valued in the embedded derivatives represent the rights of the contract holder to receive index credits over the entire period the fixed index annuities are expected to be in force, which typically exceeds 10 years. The most sensitive assumptions in determining policy liabilities for fixed index annuities are 1) the rates used to discount the excess projected contract values, 2) the expected cost of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary date and 3) our best estimate for future policy decrements specific to lapse rates. As indicated above, the discount rates used to discount excess projected contract value are based on applicable risk-free interest rates adjusted for our nonperformance risk related to those liabilities. If the discount rates used to discount the excess projected contract values atDecember 31, 2022 were to increase by 100 basis points, our reserves for fixed index annuities would decrease by$336.2 million . A decrease by 100 basis points in the discount rates used to discount the excess projected contract values would increase our reserves for fixed index annuities by$386.4 million . As ofDecember 31, 2022 , we utilized an estimate of 2.40% for the expected cost of annual call options, which is based on estimated long-term account value growth and a historical review of our actual options costs. If the expected cost of annual call options we purchase in the future to fund index credits beyond the next policy anniversary date were to increase by 25 basis points, our reserves for fixed index annuities would increase by$334.2 million . A decrease of 25 basis points in the expected cost of annual call options would decrease our reserves for fixed index annuities by$298.1 million . Our lapse rate assumptions are based on actual experience and our outlook as to future expectations for lapse rates. If lapse rates were to increase 10%, our reserves for fixed index annuities would decrease by$4.2 million . A decrease in lapse rates of 10% would increase our reserves for fixed index annuities by$3.3million .
Liability for Lifetime Income Benefit Riders
The liability for lifetime income benefit riders is based on the actual and present value of expected benefit payments to be paid in excess of projected policy values recognizing the excess over the expected lives of the underlying policies based on the actual and present value of expected assessments including investment spreads, product charges and fees. The inputs used in the calculation of the liability for lifetime income benefit riders include actual policy values, actual income account values, actual payout factors, actual roll-up rates and our best estimate assumptions for future policy growth, expected utilization of lifetime income benefit riders, which includes the ages at which policyholders are expected to elect to begin to receive lifetime income benefit payments and the percentage of policyholders who elect to receive lifetime income benefit payments, the type of income benefit payments selected upon election and future assumptions for lapse, partial withdrawal and mortality rates. The assumptions are reviewed quarterly and updates to the assumptions are made based on historical results and our best estimates of future experience. The liability for lifetime income benefit riders is included in policy benefit reserves in the consolidated balance sheets and the change in the liability is included in interest sensitive and index product benefits in the consolidated statements of operations. See Results of Operations for the Three Years EndedDecember 31, 2022 in this Item 7 for a discussion and presentation of the effects of assumption revisions. The most sensitive assumptions in the calculation of the liability for lifetime income benefit riders are 1) the expected cost of annual call options we will purchase in the future, 2) the percentage of policyholders who elect to receive lifetime income benefit payments, 3) our best estimate for future policy decrements specific to lapse rates and 4) the net investment earned rate. We utilize the expected cost of annual call options we will purchase in the future to project policy values and to discount future cash flows. In addition, it is a key component in the calculation of expected assessments in the projection period. As ofDecember 31, 2022 , we utilized an estimate of 2.40% for the long-term expected cost of annual call options, which is based on estimated long-term account value growth and a historical review of the cost of our actual call options. If the expected cost of annual call options and fixed crediting rates were to increase by 48
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25 basis points, our liability for lifetime income benefit riders would decrease by$128.8 million . A decrease of 25 basis points in the expected cost of annual call options and fixed crediting rates would increase our liability for lifetime income benefit riders by$111.7 million . Our assumptions related to the percentage of policyholders who elect to receive lifetime income benefit payments is based on actual experience and our outlook as to future expectations for utilization rates. If the ultimate floor assumption on the percentage of policyholders who elect to receive lifetime income benefit payments was increased by 30% atDecember 31, 2022 , our liability for lifetime income benefit riders would increase by$205.2 million . A decrease by 30% in the ultimate floor assumption on the percentage of policyholders who elect to receive lifetime income benefit payments would decrease our liability for lifetime income benefit riders by$260.6 million . Our lapse rate assumptions are based on actual experience and our outlook as to future expectations for lapse rates. If lapse rates were to increase 10%, our liability for lifetime income benefit riders would decrease by$6.2 million . A decrease in lapse rates of 10% would increase our liability for lifetime income benefit riders by$2.3 million . The net investment earned rate is a key component in the calculation of expected assessments in the projection period. The net investment earned rate is based on current yields being earned in our invested assets portfolio, future expectations for earned yields and the expected mean reversion period. If the net investment earned rate were to increase 10 basis points, our liability for lifetime income benefit riders would decrease by$23.5 million . A decrease in the net investment earned rate of 10 basis points would increase our liability for lifetime income benefit riders by$24.1 million .
Deferred Policy Acquisition Costs and Deferred Sales Inducements
Costs relating to the successful production of new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs or deferred sales inducements. Only costs which are expected to be recovered from future policy revenues and gross profits may be deferred. Deferred policy acquisition costs and deferred sales inducements are subject to loss recognition testing on a quarterly basis or when an event occurs that may warrant loss recognition. Deferred policy acquisition costs consist principally of commissions and certain costs of policy issuance. Deferred sales inducements consist of premium and interest bonuses credited to policyholder account balances. For annuity products, these costs are being amortized in proportion to actual and expected gross profits. Actual and expected gross profits include the the excess of net investment income earned over the interest credited or the cost of providing index credits to the policyholders, or the "investment spread"; and to a lesser extent, product charges and fees net of expected excess payments for lifetime income benefit riders and certain policy expenses. Actual and expected gross profits for fixed index annuities also include the impact of amounts recorded for the change in fair value of derivatives and the change in fair value of embedded derivatives. Current period amortization is adjusted retrospectively through an unlocking process when estimates of actual and expected gross profits (including the impact of net realized gains (losses) on investments and credit losses recognized in operations) to be realized from a group of products are updated. Our estimates of future gross profits are based on actuarial assumptions related to the underlying policies terms, lives of the policies, yield on investments supporting the liabilities and level of expenses necessary to maintain the polices over their entire lives. Revisions are made based on historical results and our best estimates of future experience. See Results of Operations for the Three Years EndedDecember 31, 2022 in this Item 7 for a discussion and presentation of the effects of assumption revisions. The most sensitive assumptions used to calculate amortization of deferred policy acquisition costs and deferred sales inducements are 1) the net investment earned rate, 2) our best estimate for future policy decrements specific to lapse rates and 3) the expected cost of annual call options we will purchase in the future. The net investment earned rate is a key component in the calculation of estimated gross profits. The net investment earned rate is based on current yields being earned in our invested assets portfolio, future expectations for earned yields and the expected mean reversion period. If the net investment earned rate were to increase 10 basis points, our combined balance for deferred policy acquisition costs and deferred sales inducements atDecember 31, 2022 would increase by$99.7 million . A decrease in the net investment earned rate of 10 basis points would decrease our combined balance for deferred policy acquisition costs and deferred sales inducements atDecember 31, 2022 by$101.6 million . Our lapse rate assumptions are based on actual experience and our outlook as to future expectations for lapse rates. If lapse rates were to increase 10%, our combined balance of deferred policy acquisition costs and deferred sales inducements would decrease by$75.8 million . A decrease in lapse rates of 10% would increase our combined balance of deferred policy acquisition costs and deferred sales inducements by$77.0 million . We utilize the expected cost of annual call options we will purchase in the future to project policy values and to discount future cash flows. In addition, it is a key component in the calculation of expected gross profits in the projection period. As ofDecember 31, 2022 , we utilized an estimate of 2.40% for the expected long-term cost of annual call options, which is based on estimated long-term account value growth and a historical review of the cost of our actual call options. If the expected cost of annual call options and fixed crediting rates were to increase by 25 basis points, our combined balance of deferred policy acquisition costs and deferred sales inducements would decrease by$104.4 million . A decrease of 25 basis points in the expected cost of annual call options and fixed crediting rates would decrease our combined balance of deferred policy acquisition costs and deferred sales inducements by$98.9 million . 49
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Deferred Income Taxes
We account for income taxes using the liability method. This method provides for the tax effects of transactions reported in the audited consolidated financial statements for both taxes currently due and deferred. Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. A temporary difference is a transaction, or amount of a transaction, that is recognized currently for financial reporting purposes but will not be recognized for tax purposes until a future tax period, or is recognized currently for tax purposes but will not be recognized for financial reporting purposes until a future reporting period. Deferred income taxes are measured by applying enacted tax rates for the years in which the temporary differences are expected to be recovered or settled to the amount of each temporary difference. The realization of deferred income tax assets is primarily based upon management's estimates of future taxable income. Valuation allowances are established when management estimates, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. When making such determination, consideration is given to, among other things, the following:
•future taxable income of the necessary character exclusive of reversing
temporary differences and carryforwards;
•future reversals of existing taxable temporary differences;
•taxable capital income in prior carryback years; and
•tax planning strategies.
Actual realization of deferred income tax assets and liabilities may materially
differ from these estimates as a result of changes in tax laws as well as
unanticipated future transactions impacting related income tax balances.
The realization of deferred income tax assets related to unrealized losses on our available for sale fixed maturity securities is also based upon our intent to hold these securities for a period of time sufficient to allow for a recovery in fair value and not realize the unrealized loss.
New Accounting Pronouncements
See Note 1 - Significant Accounting Policies to our audited consolidated
financial statements in this Form 10-K beginning on page F-12, which is
incorporated by reference in this Item 7, for new accounting pronouncement
disclosures.
ENACT HOLDINGS, INC. – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
Skyward Specialty Insurance Group Reports Fourth Quarter 2022 Results
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