AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY Management's discussion and analysis reviews our consolidated financial position atDecember 31, 2020 compared withDecember 31, 2019 , and our consolidated results of operations for the years endedDecember 31, 2020 and 2019, 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, 2019 , as well as for the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 , 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, 2019 . 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 Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements 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, and are subject to assumptions, risks and uncertainties. Statements such as "guidance", "expect", "anticipate", "strong", "believe", "intend", "goal", "objective", "target", "position", "potential", "will", "may", "would", "should", "can", "deliver", "accelerate", "enable", "estimate", "projects", "outlook", "opportunity" or similar words, as well as specific projections of future events or results qualify as forward-looking statements. Forward-looking statements, by their nature, are subject to a variety of inherent 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: •general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the fair value of our investments, which could result in credit losses, and certain liabilities, and the lapse rate and profitability of policies; •major public health issues, and specifically the COVID-19 pandemic and the resulting impacts on economic conditions and financial markets; •customer response to new products and marketing initiatives; •changes in Federal income tax laws and regulations which may affect the relative income tax advantages of our products; •increasing competition in the sale of fixed annuities; •regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products and regulation of the sale, underwriting and pricing of products; and •the risk factors or uncertainties listed from time to time in our filings with theSEC . For a detailed discussion of these and other factors that might affect our performance, see Item 1A of this report. Executive Summary 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 2020, our sales were$3.7 billion which has resulted in cash and investments in excess of$62 billion atDecember 31, 2020 . Our sales for the last five years have ranged from$3.7 billion to$7.1 billion . The economic and personal investing environments continued 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. While our sales decreased in 2020 compared to 2019, the fourth quarter of 2020 was the start of our turnaround in the Go-to-Market pillar. Driven by the introduction of competitive three and five-year single premium deferred annuity products at bothAmerican Equity Life andEagle Life , we saw a substantial increase in sales with total deposits of$1.8 billion during the fourth quarter of 2020, doubling from the fourth quarter of 2019 and up 221% from the third quarter of 2020. Fixed rate annuities were the major driver of the fourth quarter sales increase, while fixed index annuity sales were also up 23% as compared to the third quarter of 2020. We continue to be in the midst of an unprecedented period of low interest rates and low yields for investments with the credit quality we prefer which presents a strong headwind to achieving our target rate for investment spread. In response, we have been reducing policyholder crediting rates for new annuities and existing annuities. Active management of policyholder crediting rates resulted in a lower aggregate cost of money during 2020. We continue to have flexibility to reduce our crediting rates if necessary and could decrease our cost of money by approximately 62 basis points if we reduce current rates to guaranteed minimums. Investment yields on fixed income securities purchased and commercial mortgage loans funded in 2020 decreased compared to 2019 due to a general decline in interest rates. As previously noted, as part of the Investment Management pillar, we intend to ramp up our allocation to alpha assets by partnering with proven asset managers in our focus expansion sectors of middle market credit, real estate, infrastructure debt and agricultural loans. 21 -------------------------------------------------------------------------------- Table of Conten t s During June of 2020, we strengthened our balance sheet by raising$300 million in preferred equity through the issuance of 12,000 shares of 6.625% Fixed-Rate Reset Non-Cumulative Preferred Stock with a liquidation preference of$25,000 per share, for aggregate net proceeds of approximately$290.3 million which is currently held atAmerican Equity Investment Life Holding Company . As ofDecember 31, 2020 , excess cash atAmerican Equity Investment Life Holding Company , including net proceeds from the preferred offering, was approximately$330 million . This provides us a strong capital cushion to weather turbulence from potential ratings migration and credit losses and would provide an additional 30 points of RBC if such proceeds were contributed toAmerican Equity Life .. OnOctober 18, 2020 , we announced an agreement with Brookfield under which Brookfield will acquire up to a 19.9% ownership interest in the Company. The equity investment by Brookfield will occur in two stages: an initial purchase of a 9.9% equity interest at$37.00 per share which closed onNovember 30, 2020 with Brookfield purchasing 9,106,042 shares, and a second purchase of up to an incremental 10.0% equity interest, at the greater value of$37.00 per share or adjusted book value per share (excluding AOCI and the net impact of fair value accounting for derivatives and embedded derivatives). The second equity investment is subject to finalization of the terms of a proposed reinsurance transaction that has been agreed to in principle, receipt of applicable regulatory approvals and other closing conditions. Brookfield also received one seat on the Company's Board of Directors following the initial equity investment. OnOctober 18, 2020 , the Company's Board of Directors approved a$500 million share repurchase program. The purpose of the share repurchase program is to both offset dilution from the issuance of shares to Brookfield and to institute a regular cash return program for shareholders. We started the buyback program onOctober 30, 2020 and repurchased 1.9 million shares of our common stock for$50 million in the open market. OnNovember 30, 2020 we entered into an accelerated share repurchase ("ASR") agreement withCitibank, N.A . to repurchase an aggregate of$115 million of our common stock. Under the ASR agreement, we received an initial share delivery of approximately 3.5 million shares. The final settlement of 0.5 million shares, which was based on the volume-weighted average price of our common stock during the term of the transaction, less a discount and subject to customary adjustments, was delivered onFebruary 25, 2021 . The average price paid for shares repurchased under the ASR was$28.45 per common share. Our Business and Profitability 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 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 bothDecember 31, 2020 andDecember 31, 2019 was 372%. We intend to manage our capitalization in normal economic conditions at a level that is consistent with a 400% RBC ratio; and allow it to drift downwards if necessary to approximately 320% RBC 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. As economic activity recovers, we would expect to grow capital adequacy back to or near the 400% RBC ratio level through a combination of earnings and balance sheet optimization actions while continuing to execute on our core business strategy. 22 -------------------------------------------------------------------------------- Table of Conten t s OnAugust 21, 2020 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 , and revised its outlook to "stable" from "negative" primarily due to capital management actions taken throughout the year, including a$200 million contribution fromAmerican Equity Investment Life Holding Company toAmerican Equity Life and the issuance of Fixed-Rate Reset Non-Cumulative Stock, Series B for aggregate net proceeds of$290.3 million . OnJune 26, 2020 ,A.M. Best affirmed its "A-" financial strength rating ofAmerican Equity Life and its subsidiaries,American Equity Life ofNew York andEagle Life , 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 onJune 26, 2020 . OnApril 24, 2020 , 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, but revised its outlook to "negative" from "stable" on its financial strength, issuer default and senior unsecured debt ratings due to disruption to economic activity and the financial markets from the COVID-19 pandemic. 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
2020 2019 2018
Average yield on invested assets 4.12% 4.52% 4.47%
Aggregate cost of money 1.69% 1.84% 1.87%
Aggregate investment spread 2.43% 2.68% 2.60%
Impact of:
Investment yield - additional prepayment income 0.08% 0.06% 0.08%
Cost of money benefit from over hedging 0.02% 0.03% 0.05%
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-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 - Policy Liabilities for Fixed Index
Annuities and Financial Condition - Derivative Instruments.
The current environment of low interest rates and low yields for investments
with the credit quality we prefer presents a strong headwind to achieving our
target rate for investment spread. Active management of policyholder crediting
rates has continued to lower the aggregate cost of money. The most recent
actions include reductions to caps and crediting rates on $29.7 billion of
policyholder funds in January of 2020 and reductions to participation rates on
$4.3 billion of policyholder funds in June 2020 . We continue to have flexibility
to reduce our crediting rates if necessary and could decrease our cost of money
by approximately 62 basis points if we reduce current rates to guaranteed
minimums. Investment yields on fixed income securities purchased and mortgage
loans funded during most of 2020 and 2019 were at average rates below the
overall portfolio yield which has resulted in a decrease in the average yield on
invested assets. In addition, holding higher levels of cash and cash
equivalents, the decline in yields on our floating rate investment portfolio and
mark to market losses on investment partnerships contributed to the decrease in
the average yield on invested assets for year ended December 31, 2020 compared
to 2019. The higher level of cash and cash equivalent holdings was a result of
our decision in March of 2020 to increase liquidity in response to the COVID-19
pandemic and our decision to execute a series of trades in the fourth quarter of
2020 designed to raise liquidity to fund the Värde/Agam and Brookfield block
reinsurance transactions and de-risk the investment portfolio.
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Table of Conten t s
Results of Operations for the Three Years Ended December 31, 2020
Annuity deposits by product type collected during 2020, 2019 and 2018, were as
follows:
Year Ended December 31,
Product Type 2020 2019 2018
(Dollars in thousands)American Equity Life : Fixed index annuities$ 1,992,059 $ 4,058,638 $ 3,560,881 Annual reset fixed rate annuities 8,128 11,245 45,636 Multi-year fixed rate annuities 395,982 1,613 3,581 Single premium immediate annuities 33,461 12,002 23,813 2,429,630 4,083,498 3,633,911Eagle Life : Fixed index annuities 345,519 646,903 660,401 Annual reset fixed rate annuities 97 199 1,555 Multi-year fixed rate annuities 907,151 232,613 109,096 1,252,767 879,715 771,052 Consolidated: Fixed index annuities 2,337,578 4,705,541 4,221,282 Annual reset fixed rate annuities 8,225 11,444 47,191 Multi-year fixed rate annuities 1,303,133 234,226 112,677 Single premium immediate annuities 33,461 12,002 23,813 Total before coinsurance ceded 3,682,397 4,963,213 4,404,963 Coinsurance ceded 35,667 290,040 413,222 Net after coinsurance ceded$ 3,646,730 $ 4,673,173 $ 3,991,741 Annuity deposits before coinsurance ceded decreased 26% during 2020 compared to 2019. Annuity deposits after coinsurance ceded decreased 22% during 2020 compared to 2019. The decrease in sales in 2020 compared to 2019 was primarily due to the impact of the COVID-19 pandemic, including limitations on face to face meetings and increased social distancing requirements, as well as competitive pressures within each of our distribution channels. We continue to face a challenging environment for sales of fixed index annuities due to a highly competitive market. We coinsure 80% of the annuity deposits received from certain multi-year rate guaranteed annuities and 20% of certain fixed index annuities sold byEagle Life through broker/dealers and banks. The decrease in coinsurance ceded premiums in 2020 was attributable to a decrease in certain multi-year rate guaranteed annuities and fixed index annuities sold byEagle Life during 2020 compared to 2019. Net income available to common stockholders increased 173% to$671.5 million in 2020 and decreased 46% to$246.1 million in 2019 from$458.0 million in 2018. The increase in net income available to common stockholders for the year endedDecember 31, 2020 was primarily a result of the impact of assumption updates made during 2020 compared to the impact of assumption updates made during 2019. Net income available to common stockholders for the year endedDecember 31, 2020 was negatively impacted by a decrease in the aggregate investment spread as previously noted. In addition, net income available to common stockholders for the year endedDecember 31, 2020 was negatively impacted by net realized losses on investments of$80.1 million . See Net realized gains (losses) on investments and Note 3 - Investments and Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements for discussion of net realized gains (losses) on investments. Net income available to common stockholders for the year endedDecember 31, 2020 was positively impacted by$30.0 million related to the provision of the Coronavirus Aid, Relief and Economic Security Act ("CARES ACT") which allowed net operating losses for 2018 through 2020 to be carried back to previous tax years in which a 35% statutory tax rate was in effect. Net income is impacted by the change in fair value of derivatives and embedded derivatives which fluctuates from year to year 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, 2020 was negatively impacted by a net decrease in the discount rates used to estimate the fair value of our embedded derivative liabilities, the impact of which was partially offset by decreases in amortization of deferred policy acquisition costs and deferred sales inducements related to the change 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. 24 -------------------------------------------------------------------------------- Table of Conten t s 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) increased 2% to$53.3 billion for the year endedDecember 31, 2020 compared to$52.3 billion in 2019 and 5% for the year endedDecember 31, 2019 compared to$49.9 billion in 2018. Our investment spread measured in dollars was$1.3 billion ,$1.3 billion , and$1.2 billion for the years endedDecember 31, 2020 , 2019 and 2018, respectively. Our investment spread has been negatively impacted by the extended low interest rate environment and by holding higher levels of cash and cash equivalents (see Net investment income). The impact of the extended low interest rate environment and higher cash and cash equivalent holdings has been partially offset by a lower aggregate cost of money due to our continued active management of new business and renewal rates. We periodically update the key assumptions used in the calculation of amortization of deferred policy acquisition costs and deferred sales inducements retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of realized investment gains and losses) to be realized from a group of products are revised. In addition, we periodically update the assumptions used in determining the liability for lifetime income benefit riders and the embedded derivative component of our fixed index annuity policy benefit reserves as experience develops that is different from our assumptions. Net income available to common stockholders for 2020, 2019 and 2018 includes effects from updates to assumptions as follows: Year Ended December 31, 2020 2019 2018 (Dollars in thousands) Increase (decrease) in amortization of deferred sales inducements$ 428,101 $ (104,707) $ (21,465) Increase (decrease) in amortization of deferred policy acquisition costs 646,785 (192,982) (30,572)
Increase (decrease) in interest sensitive and index product benefits
285,825 315,383 (53,607)
Increase (decrease) in change in fair value of
embedded derivatives (2,341,279) 28,208 8,458
Effect on net income available to common
stockholders 769,611 (35,987) 76,194
We review these assumptions quarterly and as a result of these reviews, we made
updates to assumptions during each year. In addition, we implemented an enhanced
actuarial valuation system during 2019, and as a result, our 2019 assumption
updates include model refinements resulting from the implementation.
The most significant assumption updates from the 2020 review were to investment
spread assumptions, including the net investment earned rate and crediting rates
on policies, as well as updates to lapse rate and partial withdrawal
assumptions.
Due to the current economic and low interest rate environments, we updated our
assumption for aggregate investment spread to 2.40% in the near-term increasing
to 2.60% over an eight-year reversion period and our assumption for
crediting/discount rate to 1.60% increasing to 2.10% over an eight-year
reversion period. Prior to these assumption updates, our long-term assumption
for aggregate investment spread was steady at 2.60%, with a near term
crediting/discount rate of 1.90% increasing to 2.90% over a 20-year reversion
period. The assumption update 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. The decrease in the crediting rate, which is used as the discount
rate in the calculation of the liability for lifetime income benefit riders,
resulted in an increase in the liability for lifetime income benefit riders.
We updated lapse rate and partial withdrawal assumptions based on actual
historical experience. For certain annuity products without a lifetime income
benefit rider, lapse rate and partial withdrawal assumptions were increased
while for certain annuity products with a lifetime income benefit rider, lapse
rate and partial withdrawal assumptions were decreased. The net impact of the
updates to lapse rate and partial withdrawal assumptions 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. The net impact of the updates to lapse rate and partial withdrawal
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.
The most significant assumption update to the calculation of the fair value of
the embedded derivative component of our fixed index annuity policy benefit
reserves during 2020 was a decrease in the crediting rate/option budget to 2.10%
from 2.90% as a result of a revised estimate of the cost of options. This
assumption change resulted in a decrease in the fair value of the embedded
derivative component of our fixed index annuity policy benefit reserves due to a
reduction in the projected policy contract values over the expected lives of the
contracts. The net impact of the the updates to lapse and partial withdrawal
assumptions noted above resulted in an increase in the embedded derivative
component of our fixed index annuity policy benefit reserves as more funds
ultimately qualify for excess benefits. In addition, during 2020, we refined the
derivation of the discount rate used in calculating the fair value of embedded
derivatives which increased the discount rate and resulted in a decrease in the
change in fair value of embedded derivatives offset by increases in amortization
of deferred sales inducements and deferred policy acquisition costs.
The most significant assumption updates from the 2019 review were to lapse and
utilization assumptions. We had credible lapse and utilization data based upon a
comprehensive experience study spanning over 10 years on our products with
lifetime income benefit riders and have experienced lapse rates that are lower
than previously estimated.
25
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Table of Conten t s
Lower lapse assumptions resulted in an expectation that more policyholders will
turn on their lifetime income benefit than previously anticipated which results
in a greater amount of benefit payments in excess of account value and the need
for a greater liability for lifetime income benefit riders. The decrease in
lapse rate assumptions also resulted in policies being in force for a longer
period of time and an increase in expected gross profits as compared to previous
estimates. The higher level of expected future gross profits resulted in an
increase in the balances of deferred policy acquisition costs and deferred sales
inducements.
Our historical experience also indicated that the ultimate utilization of
certain lifetime income benefit riders was expected to be less than our prior
assumptions and the timing of utilization of lifetime income benefit riders is
later than in our prior assumptions. We have reduced our ultimate utilization
assumptions for fee riders from 75% to 60% and for no-fee riders from 37.5% to
30%, for policies issued in 2014 and prior years. The net effect of the
utilization assumption revisions resulted in a decrease in the liability for
lifetime income benefit riders and partially offset the increase in the reserve
for lifetime income benefit riders from the change in lapse assumptions.
In addition, we revised our assumptions regarding future crediting/discount
rates. We assumed a 3.80% U.S. Treasury rate with a 20 year mean reversion
period. Our assumption for aggregate investment spread was 2.60% which
translated to an ultimate discount rate of 2.90%. While the aggregate spread of
2.60% did not change from prior estimates, our estimates of the profitability of
individual cohorts changed with the use of an aggregate portfolio yield across
all cohorts. This assumption revision resulted in a change in the allocation of
profitability by cohort, which caused a reduction in the deferred policy
acquisition costs and deferred sales inducements assets and partially offset the
increase in the deferred policy acquisition costs and deferred sales inducements
assets from the change in lapse assumptions.
The most significant updates to the calculation of the fair value of the
embedded derivative component of our fixed index annuity policy benefit reserves
in 2019 were to decrease lapse rate assumptions as noted above. The impact of
the lapse rate assumption changes was partially offset by a decrease in the
option budget from 3.10% to 2.90% as a result of a revised estimate of the cost
of options over the 20 year mean reversion period.
Non-GAAP operating income available to common stockholders, a non-GAAP financial
measure (see reconciliation to net income available to common stockholders in
Item 6. Selected Consolidated Financial Data) decreased 87% to $69.1 million in
2020 and increased 29% to $548.2 million in 2019 from $425.7 million in 2018.
The decrease in non-GAAP operating income available to common stockholders for
the year ended December 31, 2020 was primarily a result of the impact of
assumption updates made during 2020 compared to the impact of assumption updates
made during 2019. 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 assumption updates, for the year
ended December 31, 2020 were $410.0 million and $4.44 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 assumption updates, for the year ended
December 31, 2019 were $424.4 million and $4.62 per share, respectively.
Non-GAAP operating income available to common stockholders for the year ended
December 31, 2020 was negatively impacted by a decrease in the aggregate
investment spread as previously noted. Non-GAAP operating income available to
common stockholders for the year ended December 31, 2020 was positively impacted
by $30.0 million related to the provision of the CARES ACT which allowed net
operating losses for 2018 through 2020 to be carried back to previous tax years
in which a 35% statutory tax rate was in effect.
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.
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Table of Conten t s
Non-GAAP operating income available to common stockholders for 2020, 2019 and
2018 includes effects from updates to assumptions as follows:
Year Ended December 31,
2020 2019 2018
(Dollars in thousands)
Increase (decrease) in amortization of deferred
sales inducements $ 57,467 $ (184,882) $ (20,466)
Increase (decrease) in amortization of deferred
policy acquisition costs 90,970 (288,332) (28,702)
Increase (decrease) in interest sensitive and index product benefits
285,825 315,383 (53,607)
Effect on non-GAAP operating income available to
common stockholders (340,895) 123,739 80,576
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 2020, 2019 and 2018 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.
Annuity product charges (surrender charges assessed against policy withdrawals
and fees deducted from policyholder account balances for lifetime income benefit
riders) increased 5% to $251.2 million in 2020 and 7% to $240.0 million in 2019
from $224.5 million in 2018. The components of annuity product charges are set
forth in the table that follows:
Year Ended December 31,
2020 2019 2018
(Dollars in thousands)
Surrender charges $ 72,551 $ 71,565 $ 65,644
Lifetime income benefit riders (LIBR) fees 178,676 168,470 158,844
$ 251,227 $
240,035
Withdrawals from annuity policies subject to surrender charges$ 776,305 $ 662,795 $ 572,802 Average surrender charge collected on withdrawals subject to surrender charges 9.3 % 10.8 % 11.5 %
Fund values on policies subject to LIBR fees
0.78 % 0.75 % 0.73 %
The increase in annuity product charges during 2020 was attributable to
increases in fees assessed for lifetime income benefit riders due to a larger
volume of business in force subject to the fee and increases in the average fees
being charged as compared to prior periods and to increases in surrender charges
due to increases in withdrawals from annuity policies subject to surrender
charges due to a larger volume of business in force and policyholder behavior,
which were partially offset by lower average surrender charges collected on
those withdrawals. See Interest sensitive and index product benefits below for
corresponding expense recognized on lifetime income benefit riders.
Net investment income decreased 5% to $2.2 billion in 2020 and increased 7% to
$2.3 billion in 2019 from $2.1 billion in 2018. The decrease for the 2020
compared to 2019 was attributable to a decrease in the average yield earned on
invested assets during 2020 compared to 2019. Average invested assets excluding
derivative instruments (on an amortized cost basis) increased 4% to $53.1
billion in 2020 and 6% to $51.1 billion in 2019 compared to $48.1 billion in
2018.
The average yield earned on average invested assets was 4.12%, 4.52% and 4.47%
for 2020, 2019 and 2018, respectively. The decrease in yield earned on average
invested assets in 2020 was primarily attributable to an increase in our level
of cash and cash equivalent holdings as previously described, a decline in
yields on our floating rate investment portfolio due to decreases in the average
benchmark rates associated with these investments, investment of new premiums
and portfolio cash flows during 2020 at average rates below the overall
portfolio yield and mark to market losses on investment partnerships due to
changes in market valuations. The average yield on fixed income securities
purchased and mortgage loans funded was 3.84%, 3.88% and 4.79% for the years
ended December 31, 2020 , 2019 and 2018, respectively.
27
--------------------------------------------------------------------------------
Table of Conten t s
Change in fair value of derivatives consists of call options purchased to fund
annual index credits on fixed index annuities, and an interest rate swap and
interest rate caps that hedged our floating rate subordinated debentures. The
interest rate swap and interest rate caps were terminated during 2019 and 2020
in conjunction with the redemption of our floating rate subordinated debentures.
The components of change in fair value of derivatives are as follows:
Year Ended December 31,
2020 2019 2018
(Dollars in thousands)
Call options:
Gain (loss) on option expiration
Change in unrealized gains/losses 19,562 1,098,932 (1,435,852)
Interest rate swap - (1,059) 869
Interest rate caps 62 (591) 182
$ 34,666 $ 906,906 $ (777,848)
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 fair values and changes in the fair
values of those call options between years. The change in unrealized
gains/losses on call options for the year ended December 31, 2020 as compared to
2019 reflect the impact from equity market volatility throughout 2020 related to
the economic uncertainty caused by the COVID-19 pandemic. 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,
2020 2019 2018
S&P 500 Index
Point-to-point strategy 0.0% - 17.4% 0.0% - 22.3% 0.0% - 13.9%
Monthly average strategy 0.0% - 11.9% 0.0% - 14.7% 0.0% - 8.1%
Monthly point-to-point strategy 0.0% - 14.0% 0.0% - 14.0% 0.0% - 17.5%
Fixed income (bond index) strategies 0.0% - 13.6% 0.0% - 10.0% 0.0% - 5.1%
The change in fair value of derivatives is also influenced by the aggregate
costs of options purchased. During 2020, the aggregate cost of options were
lower than in 2019 as option costs generally decreased during 2019 and 2020. 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 - 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 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 environment 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.
During the fourth quarter of 2020, as part of the AEL 2.0 strategy work, we
executed a series of trades designed to raise liquidity to fund the Värde/Agam
and Brookfield block reinsurance transactions and de-risk the investment
portfolio. As part of the de-risking, we sold nearly $2 billion of structured
securities and an additional $2.4 billion of corporate securities, where we
generally focused on securities that we believed were at risk of future
downgrades. During the first quarter of 2020, securities were sold in order to
increase our cash and cash equivalent holdings in response to the COVID-19
pandemic. 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.
Interest sensitive and index product benefits increased 20% to $1.5 billion in
2020 and decreased 20% to $1.3 billion in 2019 from $1.6 billion in 2018. The
components of interest sensitive and index product benefits are summarized as
follows:
Year Ended December 31,
2020 2019 2018
(Dollars in thousands)
Index credits on index policies $ 747,489 $ 587,818 $ 1,285,555
Interest credited (including changes in minimum
guaranteed interest for fixed index annuities) 198,745 204,474 221,554
Lifetime income benefit riders 597,036 495,284 103,726
$ 1,543,270 $ 1,287,576 $ 1,610,835
28-------------------------------------------------------------------------------- Table of Conten t s 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$0.8 billion ,$0.6 billion and$1.3 billion for the years endedDecember 31, 2020 , 2019 and 2018, respectively. The decrease in interest credited in 2020 was primarily due to a decrease in the average rate credited to the annuity liabilities outstanding receiving a fixed rate of interest. The changes in benefits recognized for lifetime income benefit riders for 2020 compared to 2019 were primarily due to the impact that assumption updates made during 2020 and 2019 had on the lifetime income benefit riders liability and the pattern of growth of the liability due to those assumption updates. The assumption updates used in determining the liability for lifetime income benefit riders resulted in an increase in the liability for lifetime income benefit riders in both 2020 and 2019. 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, 2020 and 2019. Amortization of deferred sales inducements before gross profit adjustments increased in 2020 compared to 2019 primarily due to the impact of assumption updates made during 2020 compared to the impact of assumption updates made during 2019. Bonus products represented 75%, 76% and 81% of our net annuity account values atDecember 31, 2020 , 2019 and 2018, 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, 2020 2019 2018 (Dollars in thousands) Amortization of deferred sales inducements before gross profit adjustments$ 243,067 $ 78,398 $ 249,627 Gross profit adjustments: Fair value accounting for derivatives and embedded derivatives 202,660 12,189 (15,283) Net realized losses on investments (7,563) (2,002) (12,143) Amortization of deferred sales inducements after gross profit adjustments$ 438,164 $
88,585
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, 2020 and 2019. See Critical Accounting Policies - 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 5 - 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, 2020 2019 2018 (Dollars in thousands) Fixed index annuities - embedded derivatives$ (1,922,085) $ 562,302 $ (2,167,628) Other changes in difference between policy benefit reserves computed using derivative accounting vs. long-duration contracts accounting 635,298 891,740 778,137$ (1,286,787) $ 1,454,042 $ (1,389,491) 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 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" represents 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 - Policy Liabilities for Fixed Index Annuities. The primary reason for the decrease in the change in fair value of the fixed index annuity embedded derivatives during 2020 compared to 2019 was a decrease in the expected cost of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary date as a result of updates to assumptions made during 2020. SeeNet Income available to common stockholders above for a discussion of the impact of assumption updates on the fair value of the fixed index annuity embedded derivative for the years endedDecember 31, 2020 and 2019. The decrease as a result of assumption updates was partially offset by a larger decrease in the net discount rate during 2020 compared to 2019. The discount rates used in estimating our embedded derivative liabilities fluctuate from year to year based on the changes in the general level of risk free interest rates and our own credit spread. 29 -------------------------------------------------------------------------------- Table of Conten t s Amortization of deferred policy acquisition costs before gross profit adjustments increased in 2020 compared to 2019 primarily due to the impact of assumption updates made during 2020 compared to the impact of assumption updates made during 2019. 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, 2020 2019 2018 (Dollars in thousands) Amortization of deferred policy acquisition costs before gross profit adjustments$ 368,139 $ 97,736 $ 358,736 Gross profit adjustments: Fair value accounting for derivatives and embedded derivatives 293,827 (7,618) (14,504) Net realized losses on investments (12,412) (2,401) (16,241) Amortization of deferred policy acquisition costs after gross profit adjustments$ 649,554 $
87,717
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, 2020 and 2019. See Critical Accounting Policies - Deferred Policy Acquisition Costs and Deferred Sales Inducements. Other operating costs and expenses increased 19% to$183.6 million in 2020 and increased 19% to$154.2 million in 2019 from$129.3 million in 2018 and are summarized as follows: Year Ended December 31, 2020 2019 2018 (Dollars in thousands) Salary and benefits$ 95,815 $ 82,883 $ 71,914 Risk charges 45,091 38,342 31,297 Other 42,730 32,928 26,090 Total other operating costs and expenses$ 183,636 $ 154,153 $ 129,301 Salary and benefits expense increased in 2020 as a result of an increase in salary and benefits of$10.2 million and an increase of$4.1 million related to expense recognized under our equity and cash incentive compensation programs ("incentive compensation programs"). The increases in salary and benefits were due to an increased number of employees related to our continued growth and implementation of AEL 2.0. The increase in expense for our incentive compensation programs was primarily due to an increase in the expected payouts due to a larger number of employees participating in the programs, higher potential payouts for certain employees participating in the programs and an increase in the percentage of restricted stock units expected to be earned. The increase in risk charges during 2020 compared to 2019 was due to an increase in the amount of excess regulatory reserves ceded to an unaffiliated reinsurer pursuant to a reinsurance agreement primarily as a result of the replacement of the previous agreement with a new agreement effectiveApril 1, 2019 . The impact from increasing the amount of excess regulatory reserves ceded was partially offset by a lower risk charge percentage in the new agreement. The regulatory reserves ceded atDecember 31, 2020 and 2019 were$1,398.9 million and$1,162.0 million , respectively. Other expenses increased in 2020 compared to 2019 primarily as a result of increases in legal and consulting fees related to the implementation of AEL 2.0, advisory fees related to the unsolicited offer for the Company in September of 2020, increases in depreciation and maintenance expenses primarily related to software and hardware assets, increases in licensing fees which are based on the level of policyholder funds under management allocated to index strategies and non-deferrable commission expenses. These increases were offset by decreases in expenses related to lower sales production activity, including agent conference related expenses, and travel expenses due to the COVID-19 pandemic. Income tax expense increased in 2020 primarily due to an increase in income before income taxes. The effective income tax rates were 17.7% and 22.0% for 2020 and 2019, 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 an effective 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 for the parent company and other non-life insurance subsidiaries (the "non-life insurance group") is generally taxed at an effective tax rate of 29.5% reflecting the combined federal / state income tax rates. The effective income tax rates resulting from the combination of the income tax provisions for the life / non-life sources of income vary from year to year based primarily on the relative size of pretax income from the two sources. 30 -------------------------------------------------------------------------------- Table of Conten t s The effective income tax rate for 2020 and 2019 were impacted by a discrete tax item related to share-based compensation that reduced income tax expense for 2020 and 2019 by approximately$0.4 million and$1.3 million , respectively. The effective tax rate for 2020 was also impacted by a discrete tax item that provided a tax benefit of$30.0 million related to the provision of the Coronavirus Aid, Relief, and Economic Security Act that allowed net operating losses for 2018 through 2020 to be carried back to previous tax years in which a 35% statutory tax rate was in effect. Income tax expense for the year endedDecember 31, 2019 reflects an increase in income tax expense of approximately$2.5 million related to the reversal of the impact of capital losses expected to be carried back to periods in which a 35% statutory rate was in effect. The effective income tax rates excluding the impact of the discrete items were 21.42% and 21.64%, respectively, for the years endedDecember 31, 2020 and 2019. Financial Condition Investments Our investment strategy is to maintain a predominantly investment grade fixed income portfolio, provide adequate liquidity to meet our cash obligations to policyholders and others and maximize current income and total investment return through active investment management. Consistent with this strategy, our investments principally consist of fixed maturity securities and mortgage loans on real estate. Insurance statutes regulate the type of investments that our life subsidiaries are permitted to make and limit the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and our business and investment strategy, we generally seek to invest inUnited States government and government-sponsored agency securities, corporate securities, residential and commercial mortgage backed securities, other asset backed securities andUnited States municipalities, states and territories securities rated investment grade NRSRO's or in securities of comparable investment quality, if not rated and mortgage loans on real estate. As previously noted, as part of our AEL 2.0 investment pillar, we intend to ramp up our allocation to alpha assets by partnering with proven asset managers in our focus expansion sectors of middle market credit, real estate, infrastructure debt and agricultural loans. The composition of our investment portfolio is summarized as follows: December 31, 2020 2019 Carrying Carrying Amount Percent Amount Percent (Dollars in thousands) Fixed maturity securities: United States Government full faith and credit$ 39,771 0.1 %$ 161,765 0.3 % United States Government sponsored agencies 1,039,551 1.9 % 625,020 1.1 %United States municipalities, states and territories 3,776,131 7.0 % 4,527,671 7.9 % Foreign government obligations 202,706 0.4 % 205,096 0.3 % Corporate securities 31,156,827 58.1 % 32,536,839 57.2 % Residential mortgage backed securities 1,512,831 2.8 % 1,575,664 2.8 % Commercial mortgage backed securities 4,261,227 8.0 % 5,786,279 10.2 % Other asset backed securities 5,549,849 10.4 % 6,162,156 10.8 % Total fixed maturity securities 47,538,893 88.7 % 51,580,490 90.6 % Mortgage loans on real estate 4,165,489 7.8 % 3,448,793 6.1 % Derivative instruments 1,310,954 2.4 % 1,355,989 2.4 % Other investments 590,078 1.1 % 492,301 0.9 %$ 53,605,414 100.0 %$ 56,877,573 100.0 %Fixed Maturity Securities 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 (NAIC designation 1 or 2) publicly traded or privately placed corporate securities. 31 -------------------------------------------------------------------------------- Table of Conten t s A summary of our fixed maturity securities by NRSRO ratings is as follows: December 31, 2020 2019 Carrying Percent of Fixed Carrying Percent of Fixed Rating Agency Rating Amount Maturity Securities Amount Maturity Securities (Dollars in thousands) Aaa/Aa/A$ 27,883,428 58.7 %$ 30,662,644 59.4 % Baa 18,408,954 38.7 % 19,833,309 38.4 % Total investment grade 46,292,382 97.4 % 50,495,953 97.8 % Ba 973,581 2.0 % 821,902 1.6 % B 122,553 0.3 % 81,407 0.2 % Caa 61,037 0.1 % 95,676 0.2 % Ca and lower 89,340 0.2 % 85,552 0.2 % Total below investment grade 1,246,511 2.6 % 1,084,537 2.2 %$ 47,538,893 100.0 %$ 51,580,490 100.0 % The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day credit quality assessment and the valuation of fixed maturity 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 an 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 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 higher 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. As stated previously, 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 has been to invest primarily in investment grade fixed maturity securities. Investment grade is NAIC 1 and 2 securities and Baa3/BBB- and better securities on the NRSRO scale. This strategy meets the objective of minimizing risk while also managing asset capital charges on a regulatory capital basis. 32
--------------------------------------------------------------------------------
Table of Conten t s
A summary of our fixed maturity securities by NAIC designation is as follows:
December 31, 2020 December 31, 2019
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 $ 23,330,149 $ 26,564,542 $ 26,564,542 55.9 % $ 27,781,525 $ 30,122,657 $ 30,122,657 58.4 %
2 17,312,485 19,377,013 19,377,013 40.8 % 19,278,355 20,316,911 20,316,911 39.4 %
3 1,292,124 1,299,455 1,299,455 2.7 % 1,001,087 977,191 977,191 1.9 %
4 282,049 256,651 256,651 0.5 % 114,497 112,534 112,534 0.2 %
5 29,396 16,288 16,288 - % 57,952 45,205 45,205 0.1 %
6 58,533 24,944 24,944 0.1 % 5,530 5,992 5,992 - %
$ 42,304,736 $ 47,538,893 $ 47,538,893 100.0 % $ 48,238,946 $ 51,580,490 $ 51,580,490 100.0 %
The amortized cost and fair value of fixed maturity securities at December 31,
2020 , by contractual maturity are 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.
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, 2020
Fixed maturity securities, available
for sale:
United States Government sponsored
agencies 3 $ 250,521
14 36,558 (1,044) (2,844) 32,670
Corporate securities:
Finance, insurance and real estate 11 111,522 (1,733) - 109,789
Manufacturing, construction and mining 2 20,719 (1,384) - 19,335
Utilities and related sectors 49 377,368 (19,141) (11,996) 346,231
Wholesale/retail trade 12 85,937 (4,370) - 81,567
Services, media and other 29 261,449 (9,264) (48,197) 203,988
Residential mortgage backed securities 43 173,875 (2,526) (1,734) 169,615
Commercial mortgage backed securities 122 1,034,424 (64,678) - 969,746
Other asset backed securities 558 3,728,144 (146,640) - 3,581,504
843 $ 6,080,517 $ (250,826) $ (64,771) $ 5,764,920
December 31, 2019
Fixed maturity securities, available
for sale:
United States Government full faith
and credit 5 $ 144,678
6 374,961 (4,785) - 370,176
United States municipalities, states
and territories 42 296,812 (8,250) - 288,562
Corporate securities:
Finance, insurance and real estate 38 399,043 (9,529) - 389,514
Manufacturing, construction and mining 20 216,229 (9,990) - 206,239
Utilities and related sectors 32 397,116 (11,212) - 385,904
Wholesale/retail trade 12 194,815 (11,162) - 183,653
Services, media and other 65 631,587 (40,366) - 591,221
Residential mortgage backed securities 34 227,427 (3,691) - 223,736
Commercial mortgage backed securities 127 810,505 (13,783) - 796,722
Other asset backed securities 652 4,306,620 (179,191) - 4,127,429
1,033 $ 7,999,793 $ (292,055) $ - $ 7,707,738
33-------------------------------------------------------------------------------- Table of Conten t s The unrealized losses atDecember 31, 2020 are principally related to the impacts the COVID-19 pandemic has had on credit markets. Approximately 75% and 79% of the unrealized losses on fixed maturity securities shown in the above table forDecember 31, 2020 andDecember 31, 2019 , respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. The decrease in unrealized losses fromDecember 31, 2019 to 2020 was primarily related to declines in treasury yields during the twelve months endedDecember 31, 2020 , partially offset by the impact the COVID-19 pandemic had on credit markets during the same period. The 10-yearU.S. Treasury yield rates atDecember 31, 2020 and 2019 were 0.93% and 1.92%, respectively. The 30-yearU.S. Treasury yields atDecember 31, 2020 and 2019 were 1.65% and 2.39%, respectively. 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, 2020 1$ 2,625,341 45.5 %$ (82,045) 32.7 % 2 2,286,377 39.7 % (106,700) 42.5 % 3 650,364 11.3 % (42,040) 16.8 % 4 178,669 3.1 % (16,274) 6.5 % 5 4,991 0.1 % (1,640) 0.7 % 6 19,178 0.3 % (2,127) 0.8 %$ 5,764,920 100.0 %$ (250,826) 100.0 %December 31, 2019 1$ 3,580,578 46.4 %$ (79,638) 27.3 % 2 3,412,695 44.3 % (151,826) 52.0 % 3 613,240 8.0 % (38,216) 13.1 % 4 74,027 1.0 % (8,575) 2.9 % 5 26,998 0.3 % (13,437) 4.6 % 6 200 - % (363) 0.1 %$ 7,707,738 100.0 %$ (292,055) 100.0 % (1) Gross unrealized losses have been adjusted to reflect the allowance for credit loss as ofDecember 31, 2020 of$64.8 million . Our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 843 and 1,033 securities, respectively) have been in a continuous unrealized loss position atDecember 31, 2020 and 2019, 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. 34 -------------------------------------------------------------------------------- Table of Conten t s 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, 2020 Fixed maturity securities, available for sale: Investment grade: Less than six months 54 $
686,711
310 2,201,769 2,118,844 (82,925)
Twelve months or greater 338 2,400,833 2,288,755 (112,078)
Total investment grade 702 5,289,313 5,086,936 (202,377)
Below investment grade:
Less than six months 9 48,355 47,984 (371)
Six months or more and less than twelve
months 37 155,451 146,779 (8,672)
Twelve months or greater 95 522,627 483,221 (39,406)
Total below investment grade 141 726,433 677,984 (48,449)
843 $ 6,015,746 $ 5,764,920 $ (250,826)
December 31, 2019
Fixed maturity securities, available for
sale:
Investment grade:
Less than six months 352 $
2,960,557
46 290,674 282,347 (8,327)
Twelve months or greater 513 4,003,478 3,829,474 (174,004)
Total investment grade 911 7,254,709 7,023,730 (230,979)
Below investment grade:
Less than six months 11 32,607 31,695 (912)
Six months or more and less than twelve
months 8 35,080 33,268 (1,812)
Twelve months or greater 103 677,397 619,045 (58,352)
Total below investment grade 122 745,084 684,008 (61,076)
1,033 $ 7,999,793 $ 7,707,738 $ (292,055) (1) Amortized cost and gross unrealized losses have been adjusted to reflect the
allowance for credit loss as of
35
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Table of Conten t s
The amortized cost and fair value of fixed maturity securities (excluding United
States Government and United States Government sponsored agency securities)
segregated by investment grade (NRSRO rating of BBB/Baa or higher) and below
investment grade that had unrealized losses greater than 20% 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, 2020
Investment grade:
Less than six months 1 $ 2,453 $ 1,909 $ (544)
Six months or more and less than twelve
months 4 21,368 15,589 (5,779)
Twelve months or greater - - - -
Total investment grade 5 23,821 17,498 (6,323)
Below investment grade:
Less than six months 1 5,963 4,323 (1,640)
Six months or more and less than twelve
months 8 38,046 38,046 -
Twelve months or greater 5 3,875 3,062 (813)
Total below investment grade 14 47,884 45,431 (2,453)
19 $ 71,705 $ 62,929 $ (8,776)
December 31, 2019
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 1 2,640 1,755 (885)
Twelve months or greater 4 53,800 35,541 (18,259)
Total below investment grade 5 56,440 37,296 (19,144)
5 $ 56,440 $ 37,296 $ (19,144) (1) Amortized cost and gross unrealized losses have been adjusted to reflect the
allowance for credit loss as of
36
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Table of Conten t s
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, 2020
Due in one year or less $ 2,324 $ 1,864 Due after one year through five years 382,843 360,761 Due after five years through ten years 396,842 355,188 Due after ten years through twenty years 216,725 203,282 Due after twenty years
145,340 122,960
1,144,074 1,044,055
Residential mortgage backed securities 173,875 169,615 Commercial mortgage backed securities 1,034,424 969,746 Other asset backed securities
3,728,144 3,581,504
$ 6,080,517 $ 5,764,920
December 31, 2019
Due in one year or less $ 5,073 $ 5,071 Due after one year through five years 278,165 273,869 Due after five years through ten years 555,200 544,687 Due after ten years through twenty years 1,041,474 1,008,487 Due after twenty years
775,329 727,737
2,655,241 2,559,851
Residential mortgage backed securities 227,427 223,736 Commercial mortgage backed securities 810,505 796,722 Other asset backed securities
4,306,620 4,127,429
$ 7,999,793 $ 7,707,738
International Exposure
We hold fixed maturity securities with international exposure. As of
December 31, 2020 , 16% of the carrying value of our fixed maturity securities
was comprised of corporate debt securities of issuers based outside of the
United States and debt securities of foreign governments. All of our fixed
maturity securities with international exposure are denominated in U.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, 2020
Percent
of Total
Amortized Carrying Amount/ Carrying
Cost Fair Value Amount
(Dollars in thousands)
GIIPS (1) $ 192,869 $ 220,637 0.5 %
Asia/Pacific 422,297 484,850 1.0 %
Non-GIIPS Europe 2,741,638 3,109,920 6.5 %
Latin America 253,717 293,698 0.6 %
Non-U.S. North America 1,342,100 1,540,491 3.2 %
Australia & New Zealand 955,190 1,039,809 2.2 %
Other 1,058,843 1,156,522 2.4 %
$ 6,966,654 $ 7,845,927 16.4 %
(1)Greece , Ireland , Italy , Portugal and Spain ("GIIPS"). All of our exposure in
GIIPS are corporate securities with issuers domiciled in these countries. None
of our foreign government obligations were held in any of these countries.
37
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Table of Conten t s
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, 2020
Carrying Amount/
Amortized Cost Fair Value
(Dollars in thousands)
GIIPS $ 14,551 $ 18,077
Asia/Pacific 11,000 11,057
Non-GIIPS Europe 144,127 130,430
Latin America 74,602 81,806
Non-U.S. North America 81,303 82,652
Other 109,958 113,340
$ 435,541 $ 437,362
Watch List
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 its 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 issues, 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 asset-backed securities, we evaluate changes in factors such
as collateral performance, default rates, loss severities and expected cash
flows. At December 31, 2020 , the amortized cost and fair value of securities on
the watch list (all fixed maturity securities) are as follows:
Net
Unrealized
Gains
Amortized Cost, (Losses),
Number of Amortized Allowance for Net of Net of
General Description Securities Cost Credit Losses Allowance Allowance Fair Value
(Dollars in thousands)
Corporate securities - Public
securities 12 $ 149,419 $ (48,197) $ 101,222 $ (3,416) $ 97,806
Corporate securities - Private
placement securities 35 336,910 (11,996) 324,914 1,565 326,479
Residential mortgage backed
securities 16 31,127 (1,734) 29,393 (348) 29,045
Commercial mortgage backed
securities 7 78,269 - 78,269 (11,254) 67,015
Other asset backed securities 2 69,650 - 69,650 (2,826) 66,824
United States municipalities, states and territories 5 19,427 (2,844) 16,583 (951) 15,632 77$ 684,802 $ (64,771) $ 620,031 $ (17,230) $ 602,801 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 atDecember 31, 2020 is as follows: Corporate securities - public securities: The public corporate securities included on the watch list are primarily domestic oil drillers or securities with exposure to the travel industry. The decline in value of the securities of domestic oil drillers is due to the continuing low level of oil prices, which has caused credit metrics to continue to be under pressure. The decline in value and the heightened credit risk on the securities with exposure to the travel industry is primarily due to the impact COVID-19 has had on the travel industry As a result of our process for identifying securities that could potentially have credit losses, we recognized credit losses of$48.4 million on these securities during 2020. Corporate securities - private placement securities: The private placement securities included on the watch list are spread across numerous industries, the most significant of which is the airlines industry. The heightened credit risk on these securities is primarily due to the impact COVID-19 has had on the travel industry. As a result of our process for identifying securities that could potentially have credit losses, we recognized credit losses of$12.0 million on these securities during 2020. Residential mortgage backed securities: The residential mortgage backed securities included on the watch list have generally experienced higher levels of stress due to the impact COVID-19 is having on the economy. While there is a heightened level of credit risk for the residential mortgage backed securities included on the watch list, we expect minimal credit losses on these securities based on our current analyses. Based on these analyses, we recognized credit losses of$1.7 million on these securities during 2020. Commercial mortgage backed securities: The commercial mortgage backed securities included on the watch list have generally experienced higher levels of stress due to the impact COVID-19 is having on the economy. As a result of our process for identifying securities that could potentially have credit losses and our intent to sell certain commercial mortgage backed securities, we recognized credit losses of$29.2 million on these securities during 2020. 38 -------------------------------------------------------------------------------- Table of Conten t s Other asset backed securities: The decline in value of these securities, which are primarily related to the auto rental industry, is primarily a result of the impact COVID-19 has had on the travel industry. We did not take any credit losses on these securities during 2020 as we do not expect any credit losses on the securities based on our current analyses. We recognized a credit loss of$0.5 million on an other asset backed security during 2020 due to our intent to sell the security.United States municipalities, states and territories: The decline in value of these securities, which are related to senior living facilities in the Southeastern region ofthe United States , is primarily due to the financial strain COVID-19 is having on this industry. As a result of our process for identifying securities that could potentially have credit losses, we recognized credit losses of$2.8 million on these securities during 2020. 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-Evaluation of Allowance for Credit Losses on Available forSale Fixed Maturity Securities and Mortgage Loan Portfolios. Prior to the implementation of authoritative guidance in 2020, we evaluated our investments for other than temporary impairments ("OTTI") In 2019, we recognized OTTI losses of$17.3 million on corporate securities with exposure to the offshore drilling industry. In addition, during 2019 we recognized additional credit losses on residential mortgage backed securities on which we have previously recognized OTTI, recognized OTTI of$0.5 million related to two commercial mortgage backed securities due to our intent to sell the securities and an OTTI of$0.6 million on an other asset backed security on which we have previously recognized OTTI. Several factors led us to believe that full recovery of amortized cost is not expected on the securities for which we recognized credit losses. A discussion of these factors, our policy and process to identify securities that could potentially have credit loss 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. 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 mortgage loans collateralized by the related properties and 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$245.8 million . 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$366.3 million that have been purchased throughout 2020. These loans are collateralized by the related properties and 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, 2020 and 2019, the largest principal amount outstanding for any single commercial mortgage loan was$34.7 million and$28.5 million , respectively, and the average loan size was$4.8 million and$4.4 million , respectively. In addition, the average loan to value ratio for commercial mortgage loans was 53.6% and 54.3% atDecember 31, 2020 and 2019, respectively, based upon the underwriting and appraisal at the time the loan was made. This loan to value is indicative of our conservative underwriting policies and practices for making commercial 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 commercial mortgage loans up to 90 days in advance. AtDecember 31, 2020 , we had commitments to fund commercial mortgage loans totaling$75.3 million , with interest rates ranging from 3.00% to 5.65%. During 2020 and 2019, due to historically low interest rates, the commercial mortgage loan industry has been very competitive. This competition has resulted in a number of borrowers refinancing with other lenders. For the year endedDecember 31, 2020 , we received$199.5 million in cash for loans being paid in full compared to$187.6 million for the year endedDecember 31, 2019 . Some of the loans being paid off have either reached their maturity or are nearing maturity; however, some borrowers are paying the prepayment fee and refinancing at a lower rate. See Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements, incorporated by reference, for a presentation of our valuation allowance, foreclosure activity and troubled debt restructure analysis. We have a process by which we evaluate the credit quality of each of our mortgage loans. This process utilizes each loan's loan-to-value and debt service coverage ratios as primary metrics. See Note 4 - Mortgage Loans on Real Estate to our audited consolidated financial statements, incorporated by reference, for a summary of our portfolio by loan-to-value and debt service coverage ratios. 39 -------------------------------------------------------------------------------- Table of Conten t s We closely monitor loan performance for our commercial, agricultural and residential mortgage loan portfolios. Commercial, agricultural and residential loans are considered nonperforming when they are 90 days or more past due. Aging of financing receivables is summarized in the following table: 30-59 days 60-89 days Over 90 days Current past due past due past due Total As of December 31, 2020: (Dollars in thousands) Commercial mortgage loans$ 3,578,888 $ - $ - $ -$ 3,578,888 Agricultural mortgage loans 245,173 - - - 245,173.00 Residential mortgage loans 346,730 25,449 111 167 372,457 Total mortgage loans$ 4,170,791 $ 25,449 $ 111 $ 167$ 4,196,518 Derivative Instruments Our derivative instruments primarily consist of call options purchased to provide the income needed to fund the annual index credits on our fixed index annuity products. 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. None of our derivatives qualify for hedge accounting, thus, 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 is included in Note 5 - 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$61.8 billion atDecember 31, 2020 compared to$61.9 billion atDecember 31, 2019 . The increase in policy benefit reserves due to net cash flows from annuity deposits and funds returned to policyholders and interest and index credits credited to policyholders during 2020 was offset by a decrease in the fair value of our fixed index annuity embedded derivatives during 2020. 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 9 - Notes Payable and Amounts Due Under Repurchase Agreements 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 and borrowings under repurchase agreements. See Note 10 - 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, 2020 , approximately 93% or$50.2 billion of our annuity liabilities were subject to penalty upon surrender, with a weighted average remaining surrender charge period of 6.1 years and a weighted average surrender charge percentage of 9.9%. 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$39.5 million for the year endedDecember 31, 2020 compared to$1.5 billion for the year endedDecember 31, 2019 with the decrease attributable to a$1,048.0 million decrease in net annuity deposits after coinsurance and a$370.0 million (after coinsurance) increase in funds returned to policyholders. In addition, we have a highly liquid investment portfolio that can be used to meet policyholder and other obligations as needed. Scheduled principal repayments, calls and tenders of available for sale fixed maturity securities and net investment income were$2.9 billion and$2.2 billion , respectively, during the year endedDecember 31, 2020 . 40 -------------------------------------------------------------------------------- Table of Conten t s 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 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 2021. 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 2021, up to$372.9 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$2.1 billion of statutory earned surplus atDecember 31, 2020 . 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, 2020 , 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. The transfer of funds byAmerican Equity Life is also restricted by a covenant in our line of credit agreement which requiresAmerican Equity Life to maintain a minimum risk-based capital ratio of 275% and a minimum level of statutory surplus equal to the sum of 1) 80% of statutory surplus atJune 30, 2016 , 2) 50% of the statutory net income for each fiscal quarter ending afterJune 30, 2016 , and 3) 50% of all capital contributed toAmerican Equity Life afterJune 30, 2016 .American Equity Life's risk-based capital ratio was 372% atDecember 31, 2020 . Under this agreement, we are also required to maintain a maximum ratio of adjusted debt to total adjusted capital of 0.35. OnNovember 21, 2019 we issued 16,000 shares of 5.95% fixed-rate reset non-cumulative preferred stock, Series A, with a$1.00 par value per share and a liquidation preference of$25,000 per share, for aggregate net proceeds of$388.9 million . We used a portion of the proceeds to redeem$165 million of our floating rate subordinated debentures in the fourth quarter of 2019 and the first quarter of 2020 and contributed$200 million toAmerican Equity Life during May of 2020. OnJune 10, 2020 , we issued 12,000 shares of 6.625% fixed-rate reset non-cumulative preferred stock, Series B with a$1.00 par value per share and a liquidation preference of$25,000 per share, for aggregate net proceeds of$290.3 million . 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 During the fourth quarter of 2020, we repurchased 1.9 million shares of our common stock for$50 million in the open market under our share repurchase program. In addition, onNovember 30, 2020 we entered into an accelerated share repurchase (ASR) agreement withCitibank, N.A . to repurchase an aggregate of$115 million of our common stock. Under the ASR agreement, we received an initial share delivery of approximately 3.5 million shares. The final settlement of 0.5 million shares, which was based on the volume-weighted average price of our common stock during the term of the transaction, less a discount and subject to customary adjustments, was delivered onFebruary 25, 2021 . The average price paid for shares repurchased under the ASR was$28.45 per common share. Cash and cash equivalents of the parent holding company atDecember 31, 2020 , were$486.7 million . In addition, as discussed in Note 9 - Notes Payable and Amounts Due Under Repurchase Agreements to our audited consolidated financial statements, we have a$150 million revolving line of credit agreement, with no borrowings outstanding atDecember 31, 2020 . This revolving line of credit terminates onSeptember 30, 2021 , and borrowings are available for general corporate purposes of the parent company and its subsidiaries. We also have the ability to issue equity, debt or other types of securities through one or more methods of distribution. The terms of any offering would be established at the time of the offering, subject to market conditions. 41 -------------------------------------------------------------------------------- Table of Conten t s Statutory accounting practices prescribed or permitted for our life subsidiaries differ in many respects from those governing the preparation of financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. Information as to statutory capital and surplus and statutory net income for our life subsidiaries as ofDecember 31, 2020 and 2019 and for the years endedDecember 31, 2020 , 2019 and 2018 is included in Note 12 - Statutory Financial Information and Dividend Restrictions to our audited consolidated financial statements. In the normal course of business, we enter into financing transactions, lease agreements, or other commitments. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations as ofDecember 31, 2020 . Payments Due by Period Less Than After Total 1 year 1-3 Years 4-5 Years 5 Years (Dollars in thousands) Annuity and single premium universal life products (1)$ 70,582,225 $ 3,404,380
662,809 25,309 50,000 50,000 537,500
Subordinated debentures, including
interest payments (3) 225,525 4,850 9,700 9,700 201,275
Operating leases 11,245 2,354 3,951 3,543 1,397
Mortgage loan funding and other
investments 143,428 143,428 - - -
Total $ 71,625,232 $ 3,580,321 $ 11,896,950 $ 8,293,283 $ 47,854,678
(1)Amounts shown in this table are projected payments through the year 2070
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
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 that are complex
and require significant judgment. The following summary of our critical
accounting policies 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 and
deferred sales inducements. 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.
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.
42
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Table of Conten t s
The following table presents the fair value of fixed maturity securities,
available for sale, by pricing source and hierarchy level as of December 31,
2020 and 2019, respectively:
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, 2020
Priced via third party pricing services $ 33,948 $ 46,445,244 $ - $ 46,479,192
Priced via independent broker quotations - 296,022 - 296,022
Priced via other methods - 763,679 - 763,679
$ 33,948 $ 47,504,945 $ - $ 47,538,893
% of Total 0.1 % 99.9 % - % 100.0 %
$ 50,726,859 Priced via independent broker quotations - 228,401 - 228,401 Priced via other methods - 625,230 - 625,230$ 155,949 $ 51,424,541 $ -$ 51,580,490 % of Total 0.3 % 99.7 % - % 100.0 % Management's assessment of all available data when determining fair value of our investments is necessary to appropriately apply fair value accounting. 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, 2020 and 2019. 43 -------------------------------------------------------------------------------- Table of Conten t s Evaluation of Allowance for Credit Losses on Available forSale Fixed Maturity Securities and Mortgage Loan Portfolios 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. 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 44 -------------------------------------------------------------------------------- Table of Conten t s 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. Prior to the implementation of authoritative guidance in 2020, we evaluated our investments for other than temporary impairments using a method consistent with our current credit loss evaluation process discussed above. In addition, we also considered length of time the fair value had been less than amortized cost or cost in our evaluation. 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 allowance for commercial mortgage loans is calculated by pooling our loans based on risk rating and property collateral type and applying an estimated loss ratio against each risk pool. Risk ratings are based on an analysis of 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 and economic outlook, among others. The loss ratios are generally based upon historical loss experience for each risk pool and are adjusted for current and forecasted economic factors management believes to be relevant and supportable. Economic factors are forecasted for two years with immediate reversion to historical experience. A commercial loan is individually evaluated for impairment if it does not continue to share similar risk characteristics of a pool. A commercial mortgage loan that is individually evaluated is impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell. The valuation allowance for agricultural and residential mortgage loans are estimated by deriving probability of default and recovery rate assumptions based on the characteristics of the loans in our portfolio, historical economic data and loss information, and current and forecasted economics conditions. Key loan characteristics impacting the estimate include delinquency status, time to maturity, original credit scores and loan-to-value ratios. 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. 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. 45 -------------------------------------------------------------------------------- Table of Conten t s 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, 2020 were to increase by 100 basis points, our reserves for fixed index annuities would decrease by$614.1 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$639.0 billion . As ofDecember 31, 2020 , we utilized an estimate of 2.10% 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$647.2 million . A decrease of 25 basis points in the expected cost of annual call options would decrease our reserves for fixed index annuities by$610.7 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$26.4 million . A decrease in lapse rates of 10% would increase our reserves for fixed index annuities by$27.2 million . 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, 2020 in this Item 7 for a discussion and presentation of the actual 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, 2020 , we utilized an estimate of 2.10% 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 our actual call options. If the expected cost of annual call options and fixed crediting rates were to increase by 25 basis points, our liability for lifetime income benefit riders would decrease by$131.7 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$102.7 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 percentage of policyholders who elect to receive lifetime income benefit payments was increased by 10% atDecember 31, 2020 , our liability for lifetime income benefit riders would increase by$79.8 million . A decrease by 10% in the percentage of policyholders who elect to receive lifetime income benefit payments would decrease our liability for lifetime income benefit riders by$58.5 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$39.9 million . A decrease in lapse rates of 10% would increase our liability for lifetime income benefit riders by$40.1 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 spot rates, the expected mean reversion period and expected spread we will earn above the risk-free rate. If the net investment earned rate were to increase 10 basis points, our liability for lifetime income benefit riders would decrease by$23.4 million . A decrease in the net investment earned rate of 10 basis points would increase our liability for lifetime income benefit riders by$24.0 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. 46 -------------------------------------------------------------------------------- Table of Conten t s 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, 2020 in this Item 7 for a discussion and presentation of the actual effects of unlocking. 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 spot rates, the expected mean reversion period and expected spread we will earn above the risk-free rate. 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, 2020 would increase by$94.8 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, 2020 by$97.5 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$79.5 million . A decrease in lapse rates of 10% would increase our combined balance of deferred policy acquisition costs and deferred sales inducements by$84.1 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, 2020 , we utilized an estimate of 2.10% 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 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 increase by$0.9 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$45.1 million . 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. 47 -------------------------------------------------------------------------------- Table of Conten t s New Accounting Pronouncements See Note 1 - Significant Accounting Policies to our audited consolidated financial statements in this Form 10-K beginning on page F-11, which is incorporated by reference in this Item 7, for new accounting pronouncement disclosures. Item 7A. Quantitative and Qualitative Disclosures About Market Risk We seek to invest our available funds in a manner that will maximize shareholder value and fund future obligations to policyholders and debtors, subject to appropriate risk considerations. We seek to meet this objective through investments that: (i) consist substantially of investment grade fixed maturity securities, (ii) have projected returns which satisfy our spread targets, and (iii) have characteristics which support the underlying liabilities. Many of our products incorporate surrender charges, market interest rate adjustments or other features, including lifetime income benefit riders, to encourage persistency. We seek to maximize the total return on our fixed maturity securities through active investment management. Accordingly, we have determined that our available for sale portfolio of fixed maturity securities is available to be sold in response to: (i) changes in market interest rates, (ii) changes in relative values of individual securities and asset sectors, (iii) changes in prepayment risks, (iv) changes in credit quality outlook for certain securities, (v) liquidity needs, and (vi) other factors. Interest rate risk is our primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the profitability of our products and the fair value of our investments. The profitability of most of our products depends on the spreads between interest yield on investments and rates credited on insurance liabilities. We have the ability to adjust crediting rates (caps, participation rates or asset fee rates for fixed index annuities) on substantially all of our annuity liabilities at least annually (subject to minimum guaranteed values). Substantially all of our annuity products have surrender and withdrawal penalty provisions designed to encourage persistency and to help ensure targeted spreads are earned. In addition, a significant amount of our fixed index annuity policies and many of our annual reset fixed rate deferred annuities were issued with a lifetime income benefit rider which we believe improves the persistency of such annuity products. However, competitive factors, including the impact of the level of surrenders and withdrawals, may limit our ability to adjust or maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. A major component of our interest rate risk management program is structuring the investment portfolio with cash flow characteristics consistent with the cash flow characteristics of our insurance liabilities. We use models to simulate cash flows expected from our existing business under various interest rate scenarios. These simulations enable us to measure the potential gain or loss in fair value of our interest rate-sensitive financial instruments, to evaluate the adequacy of expected cash flows from our assets to meet the expected cash requirements of our liabilities and to determine if it is necessary to lengthen or shorten the average life and duration of our investment portfolio. The "duration" of a security is the time weighted present value of the security's expected cash flows and is used to measure a security's sensitivity to changes in interest rates. When the durations of assets and liabilities are similar, exposure to interest rate risk is minimized because a change in value of assets should be largely offset by a change in the value of liabilities. If interest rates were to increase 10% (16 basis points) from levels atDecember 31, 2020 , we estimate that the fair value of our fixed maturity securities would decrease by approximately$495.0 million . The impact on stockholders' equity of such decrease (net of income taxes and certain adjustments for changes in amortization of deferred policy acquisition costs and deferred sales inducements) would be a decrease of$237.8 million in accumulated other comprehensive income and a decrease in stockholders' equity. The models used to estimate the impact of a 10% change in market interest rates incorporate numerous assumptions, require significant estimates and assume an immediate and parallel change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, our net exposure to interest rates can vary over time. However, any such decreases in the fair value of our fixed maturity securities (unless related to credit concerns of the issuer requiring recognition of a credit loss) would generally be realized only if we were required to sell such securities at losses prior to their maturity to meet our liquidity needs, which we manage using the surrender and withdrawal provisions of our annuity contracts and through other means. See Financial Condition-Liquidity for Insurance Operations for a further discussion of the liquidity risk. The amortized cost of fixed maturity securities that are callable at the option of the issuer, excluding securities with a make-whole provision, was$6.9 billion as ofDecember 31, 2020 . During the years endedDecember 31, 2020 and 2019, we received$1.6 billion and$1.5 billion , respectively, in net redemption proceeds related to the exercise of such call options. We have reinvestment risk related to these redemptions to the extent we cannot reinvest the net proceeds in assets with credit quality and yield characteristics similar to the redeemed bonds. Such reinvestment risk typically occurs in a declining rate environment. In addition, we have$4.3 billion of floating rate fixed maturity securities as ofDecember 31, 2020 . Generally, interest rates on these floating rate fixed maturity securities are based on the 3 month LIBOR rate and are reset quarterly. Should rates decline to levels which tighten the spread between our average portfolio yield and average cost of interest credited on annuity liabilities, we have the ability to reduce crediting rates (caps, participation rates or asset fees for fixed index annuities) on most of our annuity liabilities to maintain the spread at our targeted level. AtDecember 31, 2020 , approximately 97% of our annuity liabilities were subject to annual adjustment of the applicable crediting rates at our discretion, limited by minimum guaranteed crediting rates specified in the policies. AtDecember 31, 2020 , approximately 19% of our annuity liabilities were at minimum guaranteed crediting rates. We purchase call options on the applicable indices to fund the annual index credits on our fixed index annuities. These options are primarily one-year instruments purchased to match the funding requirements of the underlying policies. Fair value changes associated with those investments are substantially offset by an increase or decrease in the amounts added to policyholder account balances for fixed index products. The difference between proceeds received at expiration of these options and index credits, as shown in the following table, is primarily due to under or over-hedging as a result of policyholder behavior being different than our expectations. 48
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Table of Conten t s
Year Ended December 31,
2020 2019 2018
(Dollars in thousands) Proceeds received at expiration of options related to such credits
$ 758,604 $ 605,005 $ 1,307,755 Annual index credits to policyholders on their anniversaries 747,489 587,818 1,285,555 On the anniversary dates of the index policies, we purchase new one-year call options to fund the next annual index credits. The risk associated with these prospective purchases is the uncertainty of the cost, which will determine whether we are able to earn our spread on our fixed index business. We manage this risk through the terms of our fixed index annuities, which permit us to change caps, participation rates and asset fees, subject to contractual features. By modifying caps, participation rates or asset fees, we can limit option costs to budgeted amounts, except in cases where the contractual features would prevent further modifications. Based upon actuarial testing which we conduct as a part of the design of our index products and on an ongoing basis, we believe the risk that contractual features would prevent us from controlling option costs is not material. Item 8. Consolidated Financial Statements and Supplementary Data The audited consolidated financial statements are included as a part of this report on Form 10-K on pages F-1 through F-54. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures (a)Evaluation of Disclosure Controls and Procedures In accordance with the Securities Exchange Act Rules 13a-15(e) and 15d-15(e), our management, under the supervision of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures were effective as ofDecember 31, 2020 in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act. (b)Management's Report on Internal Control over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Company's management assessed the effectiveness of the Company's internal control over financial reporting as ofDecember 31, 2020 based upon criteria established in Internal Control-Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of theTreadway Commission (COSO). Based on the assessment, management has determined that we maintained effective internal control over financial reporting as ofDecember 31, 2020 . The Company's independent registered public accounting firm,KPMG LLP , who audited the consolidated financial statements included in this annual report on Form 10-K, has issued an attestation report on the effectiveness of management's internal control over financial reporting as ofDecember 31, 2020 . This report appears on page F-2 of this annual report on Form 10-K. (c)Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during the quarter endedDecember 31, 2020 , that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 49
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Table of Conten t s
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