Q2 2019 Earnings Call
Thank you good morning, and welcome to American equity investment life, holding Companys conference call to discuss second quarter 2019 earnings our earnings release and financial supplement can be found on our website at www Dot in American gosh equity dotcom.
non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents.
Presenting on today's call are John Madden, Mena, Chief Executive Officer, Ted Johnson, Chief Financial Officer, and Ron Grensteiner, President of American equity investment life Insurance company.
Some of the comments made during this call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied.
Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the FCC.
An audio replay will be made available on our website. Shortly after todays call. It is now my pleasure to introduce John Matovina.
Thank you Julie good morning, everyone and thank you for joining us this morning.
Our second quarter results were again solid, giving us a strong first half of the year.
non-GAAP operating income from the core for the quarter was 100 million or a dollar nine per share and that's a new record for any quarter that did not include the benefit from assumption revisions.
As we typically talk about the three key metrics that drive our financial performance, our growing our invested assets.
In policyholder funds under management.
Generating a high level of operating earnings on that growing asset base through our investment spread.
And then minimizing impairment losses in our investment portfolio.
So for the second quarter on those measures, we delivered a 1.6% sequential growth.
And 5% trailing 12 month growth in policyholder funds under management.
On a trailing 12 months basis, we generated a 16% non-GAAP operating return on average equity excluding the impact of our actuarial assumption reviews, and our investment impairment losses net of recoveries and after the effects of deferred acquisition costs and income taxes were just 110th of 1% of average equity.
The growth in policyholder funds under management was driven by 1.4 billion of net sales in the quarter.
Which brings the number of 4.6 billion for the trailing 12 months.
Sales are benefiting from new products, we introduced last year and the improvements in our competitive position dating back to the beginning of last year's fourth quarter and as usual you'll hear more about the sales environment and competition from run a little bit later.
Investment spread in the quarter increased sequentially, reflecting a modest increase in the trendable investments spread.
As well as a greater benefit from non trendable investment spread items that affected both investment yield and the cost of money.
The cost of option purchases was slightly higher than in the first quarter, but still remain well below the weighted average cost 2018 purchases.
Ted will have more details on investment spread in his remarks.
Are any I see risk based capital ratio rebounded during the quarter to 369% now stands nine points higher than the year end level of 360%.
During the quarter, we executed several transactions, which Ted will discuss the increased our statutory capital and surplus and reduced our required capital.
The benefits from these actions more than offset the increase in required capital from growth in the statutory balance sheet.
And the negative impact from lower statutory net income attributable to lower option expiration proceeds and related index credits.
So I'll be back at the end of the call for some closing remarks now I'd like to turn the call over to Ted Johnson for additional comments on second quarter financial results.
Thank you John .
As we reported yesterday afternoon, we had non-GAAP operating income of 100 million or a dollar nine per share for the second quarter of 2019.
Compared to non-GAAP operating income of $87 million or 95 cents per share for the second quarter of 2018.
An increase of 15% bolt on a dollar and per share basis.
Investment spread for the second quarter was 263 basis points up five basis points from the first quarter as a result of a two basis point decline in the cost of money and a three basis point increase in the average yield on invested assets.
Trendable spread in the second quarter was 254 basis points compared to 252 basis points in the first quarter of this year.
Average yield on invested assets was 451 in the second quarter of 2019 compared to 448 in the first quarter of 2019.
This increase was attributable to an increase in the benefit from non Trendable investment income items from two basis points in the first quarter to five basis points in the second quarter of this year.
The impact from the decline in short term yields on the $4.9 billion of floating rate instruments in our investment portfolio negatively affected our average yield by one basis point.
The average yield on fixed income securities purchased and commercial mortgage loans funded in the second quarter was 442 compared to 469 in the first quarter of 2019.
During the quarter, we purchased $1.3 billion of fixed income securities of which $372 million were higher yielding asset backed and structured securities.
The higher allocation to asset backed and structured securities in the second quarter tempered the impact from the general decline in interest rates and mild spread tightening in certain asset classes.
The average yield on fixed income securities purchased and commercial mortgage loans funded in July was 375.
The July new money yield reflects continued declines in available yields and a lower allocation to asset backed and structured securities.
Our expectation for the remainder of the year is for new money yields to range from 150 basis points to 200 basis points over the 10 year Treasury yield.
The average cost of money for annuity liabilities was 188 basis points down two basis points from the first quarter of 2019.
The benefit from over hedging of index linked interest obligations was four basis points in the second quarter compared to two basis points in the first quarter.
We estimate that the trendable cost them money declined by two basis points in the second quarter.
Option costs increased slightly in the second quarter as volatility declined.
But we're still well below levels paid during most of 2018.
Continuing the trend of the last few quarters the change in product mix away from bonus products to non bonus products increased the cost of money by approximately two basis points in the second quarter compared to the first quarter.
Non bonus products, which include American equity asset shield and choice and select Eagle and Eagle select series have a lower requirement compared to bonus products as opponents needs to be recouped through a higher investment spread.
The decline in the cost of money continues to benefit from the renewal rate reductions we initiated last October on $35 billion of policyholder funds under management.
Given the decline in yields available from fixed income securities and other fixed income instruments, we will begin reducing caps on $9.9 billion of monthly point to point index strategy policyholder funds under management later this month.
We expect this reduction to produce annual savings in the cost of 21 basis points on the $9.9 billion and four basis points on our entire in force when fully implemented over the next 12 to 15 months.
Our most recent renewal rate reduction was determined several weeks ago and does not consider the decrease in investment yields of the last few days.
Should the yield available to us remain at current levels or the cost of money rise. We continue to have flexibility to produce our crediting rates if necessary and could decrease our cost of money by roughly 58 basis points, if we reduce current rates to guaranteed minimums.
This is down from 61 basis points at the end of the first quarter.
Operating expenses decreased 4% sequentially in the quarter. The sequential decrease in operating expenses reflected a $2.2 million decrease in miscellaneous items, such as legal fees and consulting fees.
Offset in part by 600000 in additional risk charges for excess regulatory reserves ceded to an unaffiliated reinsurer as a result of an increase in the excess regulatory reserves ceded.
The increase in the reserve credit resulted from the replacement of the previous reinsurance agreement with a new agreement effective April Onest 2019.
The impact from increasing the excess regulatory reserves ceded was partially offset by a 12.5% decrease and the risk charge rate.
Our estimated risk based capital ratio at June 30 is 369 compared to 352 at the end of March and 360 at the end of 2018.
The increase in the estimated RBC ratio reflects a 50 million cash contribution from the holding company to American equity life.
The increase in.
The increase in reserve credit I, just mentioned and the sale of certain holdings of lower rated securities, including PG any.
As John commented in his opening remarks, our RBC ratio continues to be negatively impacted by lower statutory net income in 2019 attributable to lower option expiration proceeds and lower index credits.
Net index credits were just 1% of account value in the first six months of 2019 compared to 1.4% in the fourth quarter of last year and 3.6% to 5.4% in each of the first three quarters of 2018.
Assuming current equity market levels, we expect third quarter option expiration proceeds and index credits to remain soft, but rebound in the fourth quarter.
Although low option expiration proceeds unrelated index credits can affect statutory capital and surplus and risk based capital in the short run over the long run market movements tend to even out and we expect the policies to perform in line with pricing expectations.
Now I'll turn the call over to Ron to discuss sales marketing and competition.
Thank you Ted good morning, everyone.
As we reported yesterday second quarter gross and net sales were 1.5 billion and 1.4 billion respectively.
Representing increases of 25, and 33% from second quarter 2018 sales.
On a sequential basis sales increased 21% both before and after co insurance. In addition to the gain in gross sales the year over year increase in net sales reflects a reduction in the coinsurance percentage for Eagle lifes reinsured products from 50% to 20% and increased sales of Eagle life's fixed index annuities that are not reinsured.
And the independent agent channel gross sales increased 18% sequentially driven by increases in sales of both accumulation and guaranteed income fixed index annuity products.
Combined sales for asset yield and the choice series, our primary accumulation products for independent agents were 46% of American equity lifes fixed index annuity sales in the second quarter compared to 41% in the first quarter of 2019.
Income shield accounted for 40% of sales in the second quarter compared to 39% of sales in the first quarter of 2019 and was the best selling guaranteed lifetime income product in the independent agent channel in the first quarter.
Our sense is that we increased our market share in the second quarter, we entered the quarter with a very attractive 50% participation rate for the S&P 500 annual point to point strategy on assets yield then.
And guaranteed income generated by the income shield series that matched or exceeded most of the companies in the air guaranteed income market space.
While the sales environment in the independent agent channel remain competitive for the most part competitors acted rationally.
We continue to see most competitors bring down crediting rates and guaranteed income through the quarter. Although a few have held steady, particularly with regards to income.
Reflecting the decline in interest rates since year end, we took our own actions to lower caps participation rates and declared rates.
As mentioned on our first quarter earnings call in mid April we lowered participation rates and caps on S&P 500 annual point to point strategies for accumulation products.
Since that call we've taken actions twice the effective June 19th and today, reducing caps and participation rates for our S&P 500 annual point to point strategies as well as our volatility controlled S&P 500 dividend aristocrats excess return strategies.
To put these changes into context, the S&P 500 annual point to point participation rates on assets yield 10, or choice 10, with NVCA are now at 40% compared with 54% at the start of the year.
Participation rates on the volatility control dividend aristocrats excess return one year end to your strategies are now at 105, and 150%, respectively, compared with 120 and 175% respectively at the start of the year.
Over the coming months, our marketing team, we'll be emphasizing the two year term dividend aristocrats excess return strategy as a historical returns even after our latest change continue to illustrate very well against competing accumulation products featuring hybrid indices.
Also effective today, we reduced payout factors for the lifetime income benefit riders available with our guaranteed income products.
The reductions in payout factors will reduce guaranteed income on our best selling income shield products by roughly 6.5% to 7%.
While the reduction in payout factors means we will no longer be as competitive with the highest levels of income available in the marketplace, we will still be competitive with several key competitors.
We would not be surprised if competitors make reductions to guaranteed income.
Turning to pending pending business at American equity life averaged 3156 applications during the second quarter.
Compared to 3063 applications in the first quarter and 3146 applications. When we reported first quarter earnings.
Pending this morning stands at 2905 compared to 2341 a year ago.
Gross sales at Eagle life increased 39% sequentially and 25% over the second quarter of 2018, reflecting the addition of one of the country's 15 largest banks based on assets as a distributor.
We're seeing meaningful sales from this relationship and it was our third largest sales relationship in the first half of the year.
We've also seen a boost from the introduction of a five and seven year surrender charge products, which have become favorite in the broker dealer channel.
Eagle select focus five became the best selling product at Eagle life in the month of June .
At current run rates, we still see the possibility of seven accounts producing sales of $50 million or higher in 2019.
However, sales trends could change following the reductions in participation rates similar to those made at American equity life that are effective today.
At least one competitor is still offering caps at the 6% level in the broker dealer channel and a number still have caps north of 5% and both banks and broker dealers.
Select eight Eagle life's best selling product for the entire second quarter currently offers a cap of 4%.
Crediting rates on multi year guaranteed annuities are super competitive and may be siphoning off some sales from fixed index annuities as well.
We have completed the initial build out of Eagle life's employee wholesaler force with the addition of two new hires meeting our goal of 12 for the year.
We started the year with four.
Our employee wholesalers are working with those accounts not willing to work with third party wholesalers and are also assisting our third party wholesalers.
Our employee wholesalers are now working with six accounts.
We continue to put significant emphasis on account acquisition and hope to bring them at least two new meaningful accounts by year end.
Pending applications today at Eagle life stand at 285 applications compared to 380 applications. When we reported first quarter earnings and 263 a year ago.
And with that I will turn the call back over to John for closing remarks.
Thank you Ted and Ron.
We are pleased with our second quarter results, which included record operating income for a non unlocking quarter and our largest quarter for sales since the third quarter of 2016.
We're also pleased with the rebound in our regulatory capital ratio, which benefited from the replacement of the reinsurance agreement under which we cede redundant regulatory reserves.
Although the reductions in investment yields last few days of added another element of uncertainty to our near term outlook.
We are optimistic that we will have a strong second half of the year.
In addition to spread management key initiatives for the remainder of 2019 will be to continue to increase our footprint in the bank and broker dealer channels.
And introducing some new annuity products that would complement our current product lineup.
Our long term outlook remains favorable due to the growing number of Americans, who need attractive fixed index annuity products.
That offer principal protection with guaranteed lifetime income.
According to some recently released statistics from LIMRA.
The number of retirees in the U.S. is expected to grow from 50 million today to $72 million in 2035.
One in 465 year old men of average health will live to age 93, and one in 465 year old women will lift age 96, we believe favorable demographics product evolution and historical favorable results signal six significant market share growth potential for fixed index annuities.
So on behalf of the entire American equity team. Thank you for your time and attention. This morning.
I will now turn the call back to the operator for questions.
Thank you, ladies and gentlemen, if you'd like to add.
At this time please.
On your Touchtone telephone.
Ask the question.
We ask that you limit yourself to one question and one follow up question and then jump back into queue. If you have additional questions.
Our first question comes from the line of Randy Weiner with B. Riley Your line is open.
Hey, good morning, I, just wanted to start off by saying congrats to John in retirement, we'll Miss I will Miss working with you.
Thank you.
Billings mutual.
Hi, I wanted to talk a little bit just about the in force.
Data that that Ted gave out so the cap production on I think is $9 billion of business is a blended four basis points that you would expect to improve the cost of money by.
So I just wonder view, that's correct and then if if you could do another 58 pass at four basis points or if the if the four was in the 58 that would take you.
Down to minimum guarantees.
The you're right, it's on the $9 billion or 9.6 billion overall that would reduce the.
Cost of money on the whole enforce by four basis points.
Now that hasn't been implemented yet so it's not included in the 58 that you see it will bring the 58 down and as we put new business on that can push it up some but it's not reflected in the 58 that I quoted.
Okay and then.
And that is going to be put on so we can think about that from a modeling perspective kind of going into 2020 is that the right cadence in the model.
It's over a 12 to 15 month period. So starting here at the end of August is one where we're starting to implement that.
Then I think you you touched on a number of kind of market comments in the call but I'd.
Just trying to ask the question.
I again, or maybe you can dig a little deeper I mean do you have pretty significant move in the 10 year Treasury yield.
Obviously, it's a very recent but do you have it give us a sense out there and talking with your wholesalers talking with.
With agents or.
As part of industry groups what.
What other insurance companies are planning to do as far as taking action on their enforced blocks.
This John Randy quite frankly, I don't know that.
Those conversations ever really take place.
Among the groups you suggested relative to in force blocks, you might get a little scuttlebutt here. There, there's certainly seems to be obviously active conversation.
About new money rates.
Because that's what they are selling today, but.
The we've often said that the the whole inforce renewal rate management is.
Not not subject to a lot of public discussion.
And in fact the.
One of our messages to distribution is the renewal rate integrity that we that we do have even though we've been reducing rates for quite a while and the fact that our rates are published on our website, where agents can get to look at them.
But.
Yes.
Long way of saying Theyre, just not a lot of public discussion about what others due for renewal rate activity.
Okay, Great I'll leave it there thank you.
Thank you. Our next question comes from the line.
Tom I missed research.
Hi. Thank you is first I had a question for Ron just.
Generally are you seeing any change in consumer appetite for indexed annuities. Following the pricing changes that you and others have made and then related John mentioned potentially introducing new products I think in the second half of the year would these be traditional phase or would you consider adjacent products such as a buffer to annuities.
Well first of all I think.
The appetite by consumers has been has been pretty decent up to this point now with these most recent changes that would just undertook today and as we continue to see rate slide thats, yet to be determined but.
Up until this point.
Our sales are reflective of the consumers' desire to have products like five days so.
As far as.
New initiatives.
We're not interested in buffer annuities at this point.
We're don't plan to in a near term b in the securities market because they are securities buffer annuities are.
But we have our mindset on perhaps.
And it's too early in the in the in the in the stage to talk specifics, but.
One area that we don't have on the independent agent channel is indexing income were really really strong on guaranteed income.
And we feel like if we come out with the right indexing income rider.
That maybe we could steal some of that market share from our competitors.
So.
That's it.
Got it. Thank you and then just a question for Ted I think that assumed index credits to policyholders have the most impact on your liver reserve.
How much of an input as interest rates to this assumption and could you talk about how you set.
The rate assumption.
And certainly as we go forward and we look at.
How we set reserves and what our assumptions, partly I guess whats directly or indirectly goes into that model is what are the level of caps and par rates et cetera on the in force block of business. So we do have to take into consideration indeed decreases in interest rates on what potential renewal rate actions and how that might impact the liver reserves.
Got it so it's more a function of how your pricing changes in the terms on the product.
So it's sort of a second derivative of interest rates as opposed to.
Kind of a direct assumption that you make.
Correct.
Got it okay. Thank you.
Thank you our next question comes from.
KBW Your line is open.
Hi, Thanks, good morning.
First on the renewal rate actions on the that you are already started to implement on the $35 billion how much additional benefit do you anticipate from those relative to what you've already achieved.
We started doing those last October and I think overall, we felt that that would take down the overall cost of money on the total enforced by five basis points.
Were getting towards the end of that so theres, maybe maybe a basis point or two left of that.
Okay.
And then I guess.
So this quarter I think.
Two two things that were pretty.
I think fairly favorable were the DAC amortization rate and low and.
Lower living benefit.
Reserves over the last couple of quarters I guess can you discuss to what extent do you view those those two factors as sustainable going forward.
Well, the lower DAC amortization again.
I think that was more driven by the mix of what was rolling off versus whats coming on.
Some of the older business, that's rolling off at higher acquisition costs higher K factor, albeit a higher spread target with that.
With the higher K factor rolling off and the newer business coming on which is non premium bonus products lower acquisition with a lower K factor that's driving that.
When you go to the Labor reserve some of that is a function of newer business coming on and the volume at that business coming on and the pattern of the increase in the reserve.
Albeit the newer business when it comes on that growth in the.
SLP reserve is lower in the beginning and there is a bigger differential where the fees are in excess of that growth of reserve and then changes over time.
Both of those points again, those patterns and whether they continue are subject to.
Unlocking.
And as typical in the third quarter will look at our assumptions and make decisions on unlocking will which will reset the patterns for both of those as we go forward.
When you talk about Liberty view, there is a little bit of seasonality in that but I think we've seen.
Over year over year that kind of drives what you're seeing two over the past few quarters.
Thank you.
Our next question comes from the line.
Dan Bergman with Citi. Your line is open.
Thanks, Good morning, I guess to start I know you touched on this a little bit earlier, but with all the product and pricing changes over the past few months I just wanted to see if theres any further sense you give around.
How competitive your current product features our.
Maybe post those August changes relative to your competitors.
And then how that compares to recent levels of competitiveness and then if there's any noticeable difference.
You're seeing between the independent and bank broker dealer channels.
Well with the current changes.
You know, we still feel like we're going to be in the hunt.
When we look at a couple of key competitors, they've been making changes right along with us.
And when we look at it.
Different illustrations and what the outcome is of our products compared to theirs, we're actually just as good or even better and a lot of cases.
So you know.
In the end it just depends on.
Is the consumer willing to take the rates that we can afford to pay given you know everybody is kind of in the same boat and are they going to choose to.
No not do anything and put it under the mattress or by CD or what we don't know but from relative relative to competition.
On an accumulation basis, I think were actually pretty good as far as our rates go.
On the income.
Side.
I would say that.
We are probably one of the first companies to make some changes to guaranteed income.
We're not going to be at the top but we're going to be.
Decent and we have our eyes on a couple of competitors that we knock heads with on a regular basis, where we're right there with them. So thats another important.
Facet, there in the bank and broker dealer side.
Thats.
A little bit different in that.
We are one of the only companies that have a participation rate strategy in the.
And the banks and broker dealers our participation rate.
As 40% on our best selling product to select eight which actually.
If you do the the back testing performs better than.
A 6% cap there aren't any 6% caps out there in the in the broker dealer or excuse me in the bank channel anymore.
Most of those caps are in the.
Mid to low five percents.
And we don't have any cap set high our cap on our on our best selling product in the bank and broker dealer channels for us So thats kind of a long winded way of saying that even after the changes were were still pretty competitive but it just depends on how low the consumers are willing to accept to continue to buy him.
Got it Thats really really helpful. Thank you.
And then maybe one just on the yield it looks like the core yield ex the non trendable items has been pretty steady in.
The mid 4.4% range over the past few quarters.
Given it sounds like the new money yield in the second half is likely to be below that range, assuming a there's not an uptick in rates and there's potentially some pressure on the floating rate portfolio I just wanted to see if you could provide any thoughts around how we should expect a core yield core yield to trend and how quickly we would expect any pressure from the current rate environment.
Manifest itself in a lower overall yield.
Well, we don't have any projection on that to so to specifically answer. Your question. Obviously, we have new money coming in that will be invested at those lower yields.
I'm not sure what the expected.
Asset term maturities of assets might be that would.
Be another influence.
But yes, we're obviously not going to have 10% of the portfolio turnover in the next six months, but what the number is.
I really couldn't.
Speculate on.
Okay got it thank you.
Thank you. Our next question comes from the line of John Barnidge with Sandler O'neill. Your line is open.
Thanks.
You had increased surrender activity in the quarter. It was the highest level since 2012 on a percent of beginning of period assets is there any color you can provide on this and maybe what your expectations for surrender activity going forward would be.
We did see a little bit of an uptick in surrender charge.
That was.
When I looked at the detail, we do have a product structure that has a 10 year surrender charge wallet, albeit it has a bonus vesting that goes longer than that some of the product we notice.
That was being surrendered was related to that product, but nothing really unusual and respect to surrenders continued to be below what our estimates are.
I mean, we expected we expected surrenders.
When you look back.
At 28 team I guess Thats right now for the first half of 2019 expected surrenders were 2.4% and actual was 2.2. So it's still below our assumptions, but we did see a little bit of an uptick.
From the prior quarter.
Okay and then on the.
Internal wholesalers, you've clearly been ramping that up can you talk about maybe expected ramp up time for each wholesaler too.
I guess in production and really roughly what you think each wholesaler can contribute and time to volume.
Uhhuh.
Well you know it takes time of course, and we have a variety of different.
Situations for employee wholesalers.
We have six that.
You know, they're responsible for six accounts that they're responsible for so there and that's a mixture of financial institutions.
And.
Some independent broker dealers.
The one in particular independent broker dealer has.
Representatives across the United States and that is a little bit more difficult to get ramped up because that's literally no one no one.
Hand to hand combat.
Are those employed wholesalers busy.
When we do our research.
The kind of the breakeven point for our employees employee wholesalers is about $15 million.
Of sales.
If they if we have an account that they're working on that writes north of 15 million, that's kind of where it becomes more cost effective for employee wholesaler than it does for a third party wholesaler.
So we're at 12 because of anticipation of.
Additional accounts and also just to help.
To cover the accounts in our current footprint.
As far as time that it takes John Thats a good question.
I don't have a handle on how long, it's going to take for all of us to come to fruition, but.
Our heads are down and they're very motivated to make a difference for eagle life.
Thanks for the answer.
Thank you. Our next question comes from the line Alex Scott.
Goldman Sachs. Your line is open.
Hey, the first question I had was a follow up on the on the deck.
Yes, I heard you mentioned that I guess are there was maybe a higher K factor higher DAC balances on some of the software is rolling off.
When I think about.
Some of that activity and also lower rates I mean, I think you commented on on the liver reserve a bit but would you expect there to be.
Yes, any impact on DAC as we kind of approach the three Q.
Review.
And would that would that I guess and result in higher K factors going forward.
When we when we consider.
Fully baking in some of those new assumptions and the debt going forward.
So if we go back to third quarter last time, we did the assumption review.
I believe what we were there we said we had put into our assumptions in the DAC model that are spread was pretty much equal to where we currently we're at which was approximately 249 250 basis points as our reported spread than and we had that.
Going up over a five year period of time to 256 basis points as our ultimate spread number that we are our grading up too.
We'll have to assess that here, we have had some near term changes in rates and it depends on whether these rates stay at this level or change, but we'll have to take that in consideration as we look at what ultimate spread we believe that we are getting back up to in the DAC model.
And if we decide to make that be lower obviously that would have a negative DAC unlocking effect.
Got it okay and.
And then in terms of the lifetime income benefit rider.
Maybe maybe some impact one way or the other with the actuarial review, but would you expect.
Changes in similar to what you were just describing I guess, but.
Before you are talking about reducing cap rates and how that might impact the liver reserve could that result, and needing to accrue more liberal reserve.
As a percentage of cgps out into the future. Following the Threeq. Your review I mean is that something that we should be thinking about.
Well that could be a possibility you overall.
Make a change in assumption what the overall returns are going to be and what the land and what the caps and participation rates are going to be.
Back did have a negative effect on the your labor reserve and the fact that it could accrue at a higher rate.
Hey, we're using we're using a variety of stochastic.
You know scenarios in coming up with those what those potential returns and credits could be to those policyholders.
And then just just mechanically can you help me understand why reducing cap rates on some of the policies would impact the liver reserve I guess I'm just not as familiar with how that calculation works. It's it's a less opportunity that that I mean, if you reduce the cap rate on it enforce policy that reduces the opportunity of what the level of the index credit can be to their base policy. So the differential between their benefit base their income account value and their actual account value could be greater in your projection period going forward.
I see you just set up more.
Thats LPL three dash one reserves.
And so the the amount that the benefit base is rolling off is not necessarily the same as the cap rate does that like remain at the original cap rate or how does how does that work.
Sorry, I don't really the better the benefit bays rolls up at a constant rate set at policy issue subject to a change when the policy gets to something we call. The reset date, which often might be 10 years from the original issue date and can be extended in earlier policies at the same rate incur current policies at a lower rate.
But that the the question then with caps is how much of that guaranteed increase is going to be funded with policy returns.
And if if you reduce the caps you're going to fund last with policy returns and more is going to come out of the.
The spread.
Hi, guys you okay.
Okay that clears it up thanks very much.
Thank you. Our next question comes from the line of John .
Your line is open.
Hey, good morning, everybody.
If following up and thinking about.
New money rate and I know the new money rate in the second quarter was really close to your overall portfolio rate, but I'm I'm wondering given the more recent drop in rates and.
Obviously anything can happen from here, but I am wondering if you can give us a sense on a on a closer to a real time basis.
You know what that new money rate looks like relative to the 4.42 that you achieved in the second quarter.
Well well that new money rate adjustments that are going into day were based upon knowledge of tenure treasury at 2%.
And and and the expectations that we were not going to repeat the 442.
Obviously that those calls were made several weeks ago, and we had no insight into the.
The recent happenings in rates so.
What's happened to yields over the last few days is not in any of our new money pricing at this point in time.
Okay. Thanks for that.
I appreciate that I mean, I guess I don't know you could sit in a room every day and respond to it right now, but we were we were contemplating a 2% 10, we had 2% 10 year treasuries and we had expectations that the shift in asset allocations.
The higher the higher percentage of.
Of the.
Our asset backed and structured securities was not going to persist for the balance of the year and so.
We're we're looking at rates.
Maybe not necessarily as low as what the July outcome was.
Yes.
Lower than 442.
Got you understood and then and it's a good segue thinking about asset back.
I had a question in the any guys Steve over the weekend themed.
Two.
Moving toward taken a much more serious and significant.
Review.
Of steel lows.
You know as we head into maybe at year end 19, maybe it's going to take them longer but applying more specific stress testing to those assets.
As opposed to maybe simply relying on credit ratings in the current formulaic risk charges under RBC.
I'm just wondering.
How big has the COO portfolio gotten for you guys. This point I know, it's been part of your strategy over the past year or so and how confident are you.
In sort of the underlying true credit quality of those assets and the protection do you have under a stress scenario.
The portfolio are the CLL portfolio is between nine and 10% is it's at the higher end of our allocation of what we're going to be long term.
We feel very comfortable with.
The overall performance of the collateral.
And the evaluation of the cloud are we stress test using stochastic models of multiple scenarios that would even be worse than what we would see in the end the lsevena Lado nine period and those scenarios are our collateral performs with minimal losses. So from an it from an actual loss of capital we see very little risk in our portfolio. We we look at it from three perspectives, we look at it at the manager level, we look at it at the Q4 levels the manager level the collateral level the structure of the transaction itself and then the dynamic stochastic stress testing through index to run multiple.
Stress scenarios to allow us to really be able to assess the performance of the underlying loans in those CLO.
Structures.
Yes, I would point out to you.
The most recent communication the FDIC put out was also referencing combo see lows.
Re looking at those and re rating those we do not have any combo close so we're not going to have capital reduction related to that but certainly they're looking at filos overall, but we don't have any combo. One no. Thanks, Ted for that clarification I know that's been a trouble spot too so.
Let the last quick one I have is is just for you John you know as the board.
Under it has started a search for your successor.
And congratulations.
They are both internal and external candidates are being considered and and maybe you could sort of give us a sense for what the.
Two or three most important characteristics of dust or might be.
Well.
Well the answer is yes, both internal and external.
Be considered the.
I don't know that you can boil down to just two or three characteristics.
That are going to rise to the top and be the.
The most important.
Okay.
Is is.
Let me can I rephrase. It then is.
His industry is direct industry experience critical.
Industry experience is important I don't know that I would that would be identified as critical.
Okay.
Thanks again.
Thank you. Our next question comes from a line of Mako Alonzo with Raymond James.
Hey, good morning, Thanks for taking my questions.
Do you guys do you guys break out how much of your book is running a minimum guarantees.
If you will.
Look in our Investor supplement, we do break it out in there and some table that shows you both from a fixed rate and an index or if it's a par radar a cap rate what.
What's running at minimums versus what is has a differential.
Okay.
Pivoting to capital in.
The bump up your RBC this quarter.
This.
This suggests that you know maybe two three years from here.
So we could see a well managing with excess capital or this sort of just idiosyncratic to the quarter.
I think it's really specific to the current environment. We're in as we kind of talked on the call.
We can go through periods of time, where we have low index credits below average and that can have a negative effect on our our own organic growth of our capital.
Albeit over time, it'll even now but at this period of time, we're seeing a lower growth in our organic capital and we took actions to.
Solidify that so we can continue with our our business plan.
Now I don't necessarily think that that point that at some point in time, we would have excess capital in the future that's really dependent on wind economic factors, but also to what the level of our production is of how much new business, we put on in the future.
Okay.
We've always been a company that have utilized our organic capital growth through through sales and we continue to believe that we should be able to do that.
Okay, Yes.
And then and then I guess my.
My final question would be if maybe you guys can perhaps comment if the.
Ccs standards, having any effect on your business.
And also maybe you guys its been a minute and talk about.
Annuities and direct to consumer in your partnership with Cantor.
This is John on the FCC best interest.
Certainly its going to apply to registered reps that are selling annuities in a lift in addition to securities products, but.
We're not aware that.
Theres going to be any restrictions on what they can sell their you're going to have to comply with with the the best interest standard.
As it rolls out.
And Ron you can talk about candor.
From Kinner standpoint.
They are continuing to learn how to engage and put on customers.
They.
Have.
Increasing their presence online they're getting.
A lot of people to engage with them and give them private information and such.
We havent received any fixed annuity applications, yet, but we are very optimistic for the future. We think that there a smart group of people that knows what they're doing and we're still thrilled to to be partners with them and know that there will be a meaningful account in the future.
Okay. Thank you for your answers.
Thank you. Our next question comes from the line of Pablo.
With JP Morgan your line is open.
Hi, Thanks for taking my questions. So I was wondering if you could provide a rule of thumb.
You have a sensitivity you for portfolio do short term interest rates. You mean, you called out the one point sequential decline in the yield from lower rates, but.
Just given the lag in LIBOR resets, you think there could be interested in real impact in the second half from lower rates in the first half of 2019.
I think if you continue to see pressure on with fed wanting to cut short term rates, we will see some of that get back in that yield.
Over the second half of the year I can't say, it's easy to take the percent of the portfolio and you take an adjustment you can back into kind of a rough number about what that basis point.
Decline would be but there is going to be some impact Roger.
Okay.
And then second question just to follow up on the comments about the 2018 assumption review so on the one hand rates have declined materially since last year, but on the other your actual spreads since the third quarter of last year have actually been above your long term assumption, which I suppose would create a buffer.
You also have discretion in adjusting crediting rate. So I guess the question is and your past assumption reviews have you accounted for potential in force actions on.
I assume you are able to offset a decent amount of lower rates from enforce actions when assumptions on it.
Yes, when we do our assumption review, we do take into consideration our ability to adjust rates on in force.
We have to also look at what our practice has been over time on how we adjust rates, but we can take that into consideration and we always do when we look forward and setting assumptions and the other side of that too is we do take into consideration into a conservative level. What we believe we always reference core spread but we also know that there is going to be some level of non trendable items, either from prepayments or through over hedging that we need to take into consideration too, but we try to be conservative with our estimates when we do that.
Got it and then just a last question for Ron So theres several large carriers as for CHC on Lincoln have been trying to grow in the agency channel by partnering with some Brian Wilson.
It seems like you see Brian let us at least based on data from three or four years ago upon for a decent chunk of industry sales.
Seems like these types have not had a large impact on American equity sales can you confirm if that's the case then secondly, maybe just provide more commentary on what's going on there on under the Hood there.
Well.
If you're talking about Super I am most and we have seen some consolidation in the industry and with almost saying when you say Super IMO is Pablo you talking like something like the Nexus group.
Yep.
Our market sorry, yes.
Okay.
So now why don't we partner with why don't we sell through those groups such that well we know from the marketing companies that are part of the groups we already have.
Contracts with most of them individually.
So it doesn't make sense for us too.
Allow them to combine all of their production under one umbrella.
When we already have contracts with the majority of them.
In general.
Excluding those groups, we have seen some consolidations.
There are.
Fewer I am most today probably than they were five years ago, when I look at our distribution of our top marketing companies.
When you look at.
So say 15 to 20 that right.
A fair amount of business with us there's probably five of them that have either gotten purchased are consolidated within larger IMO for efficiencies. So the universe has gotten a little bit smaller, but I don't anticipate that it's going to go against us.
Okay got it so it seems like the despite these exclusive buyers have been siphoned off sales from your.
From the distribution relationships, we have of the individual Imus right is sort of the message, yes, they haven't siphoned anything.
Stay safe and in a way they probably have made arrangements with some other insurance companies that have agreed to do that.
We havent to this point as I said, because we already have contracts with them individually.
Got it okay.
And then John just best of luck with your retirement, there was a pleasure working with you on this I had to ask thanks.
Thank you.
As a reminder, ladies and gentlemen.
Ask the question.
Then the one key.
Thats Star one.
Ask the question.
Our next question comes from the line.
From Suntrust. Your line is open.
I think you suggested that you anticipate lower index credits in the third quarter based presumably on the equity market activity here.
Does that necessarily imply that you would see less benefit of over hedging in the quarter as well.
It could yes.
I think we were mostly referencing the lower index credits in relation to organic growth of regulatory capital that.
In periods of time, where we have lower index credits, we see lower statutory income.
Right. Yes, you could also you could also look at that and say that in typically in periods of time of lower index credits, we have lower over hedging results.
Within that you've got at least an easier comp in the fourth quarter I think was your point as well.
Based upon where any equity markets are we felt that.
Albeit we don't see drastic changes obviously a lot has happened in the last few days and continues to happen. We would expect index credits to rebound in the fourth quarter.
Okay.
And John I Hope you are one of the warning for that make it the age 93.
So do I provided I stay in good health [laughter], yes, indeed, thank you.
I'd like to be shooting my age on the golf course fit in the Ninetys out of that.
Sounds good.
Im showing no further questions at this time I would now like to turn the call back over to Jim.
Okay, well final remarks.
Thank you for your interest in American equity and for participating in today's call should you have any follow up questions. Please feel free to contact us.
Ladies and gentlemen that conclude.
Thank you for participating you may now disconnect.
Everyone have a wonderful day.