AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY Management's discussion and analysis reviews our unaudited consolidated financial position atJune 30, 2020 , and the unaudited consolidated results of operations for the three and six month periods endedJune 30, 2020 and 2019, and where appropriate, factors that may affect future financial performance. This analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q, and the audited consolidated financial statements, notes thereto and selected consolidated financial data appearing in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Interim operating results for the three and six month periods endedJune 30, 2020 are not necessarily indicative of the results expected for the entire year, particularly in light of the material risks and uncertainties surrounding the spread of COVID-19 and the impact it may have on our business, results of operations and financial condition. Preparation of financial statements requires use of management estimates and assumptions. Our estimates and assumptions could change in the future as more information becomes known about the impact of COVID-19. Cautionary Statement Regarding Forward-Looking Information All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by us with theSEC , press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and other similar expressions, constitute forward-looking statements. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Accordingly, we cannot assure you that actual results will not differ materially from those expressed or implied by the forward-looking statements. Factors that could contribute to these differences 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 the
For a detailed discussion of these and other factors that might affect our performance, see Item 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2019 and Item 1A of our Quarterly Report on Form 10-Q for the quarterly period endedMarch 31, 2020 . Our Business and Profitability We specialize in the sale of individual annuities (primarily fixed index deferred annuities). 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 business model contemplates continued growth in invested assets and non-GAAP operating income while maintaining a high quality investment portfolio that will not experience significant credit losses. We are committed to maintaining a high quality investment portfolio with limited exposure to below investment grade securities and other riskier assets. Growth in invested assets is predicated on a continuation of our high sales achievements of the last five years while at the same time maintaining a high level of retention of the funds received. 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.
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The outbreak of the novel coronavirus (COVID-19), recognized as a pandemic by theWorld Health Organization , has created significant economic and financial turmoil both in theU.S. and around the world which has had a material effect on the global economy and financial markets and raised concerns of a global recession. At this time, it is not possible to predict how COVID-19 will impact the Company, our results of operations or our financial condition and liquidity. See Item 1A. Risk Factors of our Quarterly Report on Form 10-Q for the quarterly period endedMarch 31, 2020 for a discussion of risk factors related to major public health issues, specifically the COVID-19 pandemic. We moved decisively to first protect our employees and business partners and to pivot our operating platform to continue to provide industry leading levels of service to clients and producers, in a prolonged work from home environment. In addition, we increased our liquidity position and held$1.4 billion of unencumbered cash as ofJune 30, 2020 . Currently, most of our employees are working remotely with only operationally critical employees working at our offices inWest Des Moines, Iowa . COVID-19 has caused significant economic effects where we operate, including closures of many businesses deemed non-essential due to shelter-in-place, stay-at-home, travel limitations and other governmental regulations or self imposed social distancing practices. These actions have caused disruption to the distribution channels through which we sell our products, including independent agents, and their clients. It is currently unclear how long such COVID-19 related actions will last. Life insurance companies are subject to the NAIC risk-based capital ("RBC") requirements and rating agencies utilize a form of RBC to partially determine capital strength of insurance companies. Our RBC ratio atDecember 31, 2019 was 372%, and our estimated RBC ratio atJune 30, 2020 was 389%. 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. 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 . This provides us a strong capital cushion to weather turbulence from potential ratings migration and credit losses and would provide an additional 27 points of RBC if such proceeds were contributed toAmerican Equity Investment Life Insurance Company . OnJune 26, 2020 ,A.M. Best affirmed its "A-" financial strength rating ofAmerican Equity Investment Life Insurance Company and its subsidiaries,American Equity Investment Life Insurance Company of New York andEagle Life Insurance Company , its "bbb-" long-term issuer credit rating ofAmerican Equity Investment Life Holding Company , its "bbb-" senior unsecured debt ratings, and its "bb" perpetual, non-cumulative preferred stock ratings. The outlook for these credit ratings of "stable" was also affirmed byA.M. Best onJune 26, 2020 . OnMarch 26, 2020 , S&P affirmed its "A-" financial strength rating onAmerican Equity Investment Life Insurance Company and its "BBB-" long-term issuer credit rating onAmerican Equity Investment Life Holding Company , but revised its outlook to "negative" from "stable" on both its financial strength and long-term issuer credit ratings due to its expectation for credit deterioration under current stressed market conditions. 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: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019
Average yield on invested assets 4.12% 4.51% 4.24%
4.49%
Aggregate cost of money 1.73% 1.88% 1.73% 1.89%
Aggregate investment spread 2.39% 2.63% 2.51% 2.60%
Impact of:
Investment yield - additional
prepayment income 0.03% 0.04% 0.04% 0.03%
Cost of money benefit from over
(under) hedging (0.01)% 0.04% 0.02% 0.03%
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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 included in Management's Discussion and Analysis in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . 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 included in Management's Discussion and Analysis in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . 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$4.3 billion of policyholder funds inJune 2020 . We continue to have flexibility to reduce our crediting rates if necessary and could decrease our cost of money by approximately 65 basis points if we reduce current rates to guaranteed minimums. Investment yields on fixed income securities purchased and mortgage loans funded during most of 2020 and 2019 were at average rates below the overall portfolio yield which has resulted in a decrease in the average yield on invested assets. In addition, the decline in yields on our floating rate investment portfolio, mark to market losses on investment partnerships and our decision to hold higher levels of cash and cash equivalents since March of 2020 contributed to the decrease in the average yield on invested assets for the three and six month periods endedJune 30, 2020 compared to the same periods in 2019. Results of Operations for the Three and Six Months EndedJune 30, 2020 and 2019 Annuity deposits by product type collected during the three and six months endedJune 30, 2020 and 2019, were as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) American Equity Investment Life Insurance Company: Fixed index annuities$ 472,899 $ 1,211,004 $ 1,058,962 $ 2,238,662 Annual reset fixed rate annuities 2,316 3,614 4,647 7,062 Multi-year fixed rate annuities 83 566 452 714 Single premium immediate annuities 10,084 1,747 15,482 3,815 485,382 1,216,931 1,079,543 2,250,253Eagle Life Insurance Company : Fixed index annuities 72,371 235,558 178,873 413,038 Annual reset fixed rate annuities 17 66 58 193 Multi-year fixed rate annuities 1,031 47,004 5,180 72,572 73,419 282,628 184,111 485,803 Consolidated: Fixed index annuities 545,270 1,446,562 1,237,835 2,651,700 Annual reset fixed rate annuities 2,333 3,680 4,705 7,255 Multi-year fixed rate annuities 1,114 47,570 5,632 73,286 Single premium immediate annuities 10,084 1,747 15,482 3,815 Total before coinsurance ceded 558,801 1,499,559 1,263,654 2,736,056 Coinsurance ceded 5,691 72,487 23,394 126,551 Net after coinsurance ceded$ 553,110 $ 1,427,072 $ 1,240,260 $ 2,609,505 Annuity deposits before and after coinsurance ceded decreased 63% and 61%, respectively, during the second quarter of 2020 compared to the same period in 2019 and decreased 54% and 52%, respectively, during the six months endedJune 30, 2020 compared to the same period in 2019. The decrease in sales for the three and six months endedJune 30, 2020 compared to the same periods in 2019 was primarily due to the impact of the COVID-19 pandemic on limitations of 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 and until social distancing needs abate or producers find new ways to engage with clients, we would expect sales to remain subdued. We coinsure 80% of the annuity deposits received from multi-year rate guaranteed annuities and 20% of certain fixed index annuities sold byEagle Life Insurance Company ("Eagle Life") through broker/dealers and banks. The decrease in coinsurance ceded premiums was attributable to a decrease in multi-year rate guaranteed annuities and fixed index annuities sold by Eagle Life for the three and six months endedJune 30, 2020 compared to the same periods in 2019. 30
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Net income (loss) available to common stockholders decreased to$(253.4) million in the second quarter of 2020 and to$(17.0) million for the six months endedJune 30, 2020 compared to$18.6 million and$(11.4) million for the same periods in 2019. The net loss available to common stockholders for the three months endedJune 30, 2020 was driven primarily by the tightening of our own credit spread with improving market conditions which reduces the interest rate used to discount the embedded derivative liability. Net income (loss) is impacted by the change in fair value of derivatives and embedded derivatives which fluctuates from period to period based upon changes in fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in interest rates used to discount the embedded derivative liability. Net income (loss) for the three and six months endedJune 30, 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. Net income (loss) for the three and six months endedJune 30, 2019 was also 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. Net income for the three and six months endedJune 30, 2020 includes a benefit from the revision of assumptions used in determining the embedded derivative component of our fixed index annuity policy benefit reserves. The revision consisted of a refinement in the derivation of the discount rate used in calculating the fair value of embedded derivatives. The impact decreased change in fair value of embedded derivatives by$230.1 million , increased amortization of deferred sales inducements and deferred policy acquisition costs by$36.7 million and$57.6 million , respectively, and decreased both net loss and net loss available to common stockholders by$106.5 million . Net income, in general, has been positively impacted by the growth in 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$53.2 billion for the second quarter of 2020 and 3% to$53.2 billion for the six months endedJune 30, 2020 compared to$52.0 billion and$51.7 billion for the same periods in 2019. Our investment spread measured in dollars was$308.9 million for the second quarter of 2020 and$648.0 million for the six months endedJune 30, 2020 compared to$322.4 million and$631.3 million for the same periods in 2019. Our investment spread has been negatively impacted by the extended low interest rate environment and by holding higher levels of cash and cash equivalents due to current economic conditions caused by COVID-19 (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. Net income (loss) and net income (loss) available to common stockholders for the six months endedJune 30, 2020 were impacted by a discrete tax item that provided a tax benefit of$30.8 million related to the provision of the Coronavirus Aid, Relief, and Economic Security Act that allows 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. Non-GAAP operating income available to common stockholders, a non-GAAP financial measure, decreased to$93.1 million in the second quarter of 2020 and increased to$247.2 million for the six months endedJune 30, 2020 compared to$99.6 million and$189.0 million for the same periods in 2019. In addition to net income (loss) 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 (loss) available to common stockholders adjusted to eliminate the impact of items that fluctuate from quarter to quarter 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 (loss) 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 (loss) 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 (loss) available to common stockholders as part of their review of our overall financial results. 31
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The adjustments made to net income (loss) available to common stockholders to arrive at non-GAAP operating income available to common stockholders for the three and six months endedJune 30, 2020 and 2019 are set forth in the table that follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Reconciliation from net income (loss) available to common stockholders to non-GAAP operating income available to common stockholders: Net income (loss) available to common stockholders$ (253,379 ) $ 18,590 $ (17,043 ) $ (11,420 ) Adjustments to arrive at non-GAAP operating income available to common stockholders: Net realized gains/losses on financial assets, including credit losses 18,492 2,625 34,841 2,930 Change in fair value of derivatives and embedded derivatives - fixed index annuities 423,590 99,868 303,136 250,812 Change in fair value of derivatives - interest rate caps and swap - 854 (848 ) 1,490 Income taxes (95,599 ) (22,346 ) (72,897 ) (54,819 ) Non-GAAP operating income available to common stockholders$ 93,104 $ 99,591 $
247,189
The amounts disclosed in the reconciliation above are presented net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs where applicable. The decrease in non-GAAP operating income available to common stockholders for the three months endedJune 30, 2020 compared to the same period in 2019 was attributable to lower investment income and a greater increase in the liability for lifetime income benefit riders partially offset by a decline in deferred policy acquisition cost and deferred sales inducement amortization. The increase in the liability for lifetime income benefit riders and the decline in deferred policy acquisition cost and deferred sales inducement amortization were primarily a result of actuarial revisions made in the third quarter of 2019. The increase in non-GAAP operating income available to common stockholders for the six months endedJune 30, 2020 compared to the same period in 2019 was attributable to a decline in deferred policy acquisition cost and deferred sales inducement amortization. In addition, non-GAAP operating income available to common stockholders for the six months endedJune 30, 2020 was impacted by a$30.8 million tax benefit from a discrete tax item related to the Coronavirus Aid, Relief, and Economic Security Act. See Net income (loss) available to common stockholders. These items were partially offset by lower investment income and a greater increase in the liability for future benefits to be paid for lifetime income benefit riders during the six months endedJune 30, 2020 compared to the same period in 2019. The decline in deferred policy acquisition cost and deferred sales inducement amortization and the increase in the liability for lifetime income benefit riders were primarily a result of actuarial revisions made in the third quarter of 2019. Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for lifetime income benefit riders) increased 5% to$63.4 million in the second quarter of 2020 and 8% to$123.0 million for the six months endedJune 30, 2020 compared to$60.7 million and$113.7 million for the same periods in 2019. The components of annuity product charges are set forth in the table that follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) (Dollars in thousands) Surrender charges$ 19,390 $ 19,480 $ 39,095 $ 35,936 Lifetime income benefit riders (LIBR) fees 44,048 41,220 83,892 77,730$ 63,438 $ 60,700 $ 122,987 $ 113,666 Withdrawals from annuity policies subject to surrender charges$ 202,187 $ 167,744 $ 396,977 $ 309,844 Average surrender charge collected on withdrawals subject to surrender charges 9.6 % 11.6 % 9.8 % 11.6 % Fund values on policies subject to LIBR fees$ 5,837,051 $ 5,720,854 $ 11,032,388 $ 10,690,568 Weighted average per policy LIBR fee 0.75 % 0.72 % 0.76 % 0.73 % The increase in annuity product charges for the three and six month periods endedJune 30, 2020 compared to the same periods in 2019 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 for the six months endedJune 30, 2020 was also attributable to an increase in surrender charges due to an increase 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. 32
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Net investment income decreased 5% to$543.7 million in the second quarter of 2020 and 1% to$1,117 million for the six months endedJune 30, 2020 compared to$570.6 million and$1,129 million for the same periods in 2019. The decreases were attributable to a decrease in average yield earned on average invested assets during the three and six months endedJune 30, 2020 compared to the same periods in 2019, partially offset by increases in our invested assets during the three and six months endedJune 30, 2020 compared to the same periods in 2019. Average invested assets excluding derivative instruments (on an amortized cost basis) increased 4% to$52.9 billion for the second quarter of 2020 and 5% to$52.8 billion for the six months endedJune 30, 2020 compared to$50.7 billion and$50.3 billion for the same periods in 2019. The average yield earned on average invested assets was 4.12% for the second quarter of 2020 and 4.24% for the six months endedJune 30, 2020 compared to 4.51% and 4.49% for the same periods in 2019. The decrease in average yield earned for the three and six months endedJune 30, 2020 compared to the same periods in 2019 was primarily attributable to investment of new premiums and portfolio cash flows during most of 2020 and 2019 at average rates below the overall portfolio yield, a decline in yields on our floating rate investment portfolio due to decreases in the average benchmark rates associated with these investments, an increase in the level of cash and cash equivalent holdings due to our decision to hold higher levels of cash and cash equivalents sinceMarch 2020 and mark to market losses on investment partnerships during the three and six months endedJune 30, 2020 due to changes in fair market valuations. The average yield on fixed income securities purchased and mortgage loans funded during the three and six months endedJune 30, 2020 was 4.58% and 3.78%, compared to 4.42% and 4.52% for the same periods in 2019. At the end of the second quarter of 2020, we executed a block trade of residential mortgage loans at a yield of 5.92% which provided a meaningful increase in the purchase yield for the three and six months endedJune 30, 2020 . Change in fair value of derivatives consists of call options purchased to fund annual index credits on fixed index annuities, and an interest rate swap and interest rate caps that hedge our floating rate subordinated debentures. The components of change in fair value of derivatives are as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Call options: Gain (loss) on option expiration$ (109,367 ) $ (42,483 ) $ 736 $ (166,163 ) Change in unrealized gains/losses 437,029 119,425 (615,010 ) 628,271 Interest rate swap - (688 ) - (1,056 ) Interest rate caps - (209 ) 62 (538 )$ 327,662 $ 76,045 $ (614,212 ) $ 460,514 The differences between the change in fair value of derivatives between periods 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 periods. The change in unrealized gains/losses on call options for the three and six months endedJune 30, 2020 as compared to the same periods in 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 the three and six months endedJune 30, 2020 and 2019 is as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 S&P 500 Index Point-to-point strategy 0.0% - 7.0% 0.0% - 7.0% 0.0% - 17.4% 0.0% - 7.0% Monthly average strategy 0.0% - 8.0% 0.0% - 6.9% 0.0% - 11.9% 0.0% - 6.9% Monthly point-to-point strategy 0.0% - 0.0% 0.0% - 4.3% 0.0% - 14.0% 0.0% - 4.3% Fixed income (bond index) strategies 0.0% - 10.0% 0.0% - 10.0% 0.0% - 13.6% 0.0% - 10.0% The change in fair value of derivatives is also influenced by the aggregate cost of options purchased. The aggregate cost of options for the three and six months endedJune 30, 2020 were lower than for the same periods in 2019 as option costs generally decreased during 2019 and into 2020. The decrease in aggregate option costs was partially offset by an increase in the amount of fixed index annuities in force during the three and six months endedJune 30, 2020 compared to the same periods in 2019. 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 included in Management's Discussion and Analysis in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . 33
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Net realized gains (losses) on investments includes 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 to our unaudited 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 to our unaudited consolidated financial statements for discussion of credit losses recognized on mortgage loans on real estate. During the six months endedJune 30, 2020 , securities were sold at gains as we looked 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 decreased 4% to$241.0 million in the second quarter of 2020 and increased 65% to$641.2 million for the six months endedJune 30, 2020 compared to$251.1 million and$387.8 million for the same periods in 2019. The components of interest sensitive and index product benefits are summarized as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Index credits on index policies$ 97,875 $ 161,752 $ 376,815 $ 217,677 Interest credited (including changes in minimum guaranteed interest for fixed index annuities) 48,025 52,186 100,036 101,404 Lifetime income benefit riders 95,092 37,165 164,360 68,696$ 240,992 $ 251,103 $ 641,211 $ 387,777 The increase in index credits for the six months endedJune 30, 2020 and decrease in index credits for the three months endedJune 30, 2020 compared to the same periods in 2019 were due 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$97.0 million and$382.3 million for the three and six months endedJune 30, 2020 , compared to$166.4 million and$224.9 million for the same periods in 2019. The increases in benefits recognized for lifetime income benefit riders for the three and six months endedJune 30, 2020 compared to the same periods in 2019 were primarily due to the impact that assumption revisions made during the third quarter of 2019 had on the lifetime income benefit riders liability. Benefits recognized for lifetime income benefit riders also increased for the three and six months endedJune 30, 2020 as compared to the same periods in 2019 due to an increase in fund value of policies with lifetime income benefit riders, which correlates to the increase in fees discussed in Annuity product charges. The liability (net of coinsurance ceded) for lifetime income benefit riders was$1.5 billion and$1.3 billion atJune 30, 2020 andDecember 31, 2019 , respectively. Amortization of deferred sales inducements before gross profit adjustments decreased for the three and six months endedJune 30, 2020 compared to the same periods in 2019 primarily due to the impact that assumption revisions made during the third quarter of 2019 had on the pattern of amortization. Bonus products represented 77% and 79% of our net annuity account values atJune 30, 2020 andJune 30, 2019 , respectively. The amount of amortization is affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business and amortization associated with net realized gains (losses) on investments including credit losses on fixed maturity securities. Fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our fixed index annuity contracts. The change in fair value of the embedded derivatives will not correspond to the change in fair value of the derivatives (purchased call options), because the purchased call options are one-year options while the options valued in the fair value of embedded derivatives cover the expected lives of the contracts which typically exceed ten years. Amortization of deferred sales inducements is summarized as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Amortization of deferred sales inducements before gross profit adjustments$ 40,333 $ 68,886 $ 84,241 $ 137,689 Gross profit adjustments: Fair value accounting for derivatives and embedded derivatives (112,842 ) (48,034 ) (81,043 ) (83,421 ) Net realized gains (losses) on investments (2,669 ) (1,067 ) (4,785 ) (1,174 ) Amortization of deferred sales inducements after gross profit adjustments$ (75,178 ) $ 19,785 $ (1,587 ) $ 53,094 34
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Change in fair value of embedded derivatives includes changes in the fair value
of our fixed index annuity embedded derivatives (see Note 5 to our unaudited
consolidated financial statements). The components of change in fair value of
embedded derivatives are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(Dollars in thousands)
Fixed index annuities - embedded
derivatives $ 913,984 $ 204,590 $ (371,087 ) $ 857,232
Other changes in difference between
policy benefit reserves computed
using derivative accounting vs.
long-duration contracts accounting 212,951 122,972 247,961 236,653
$ 1,126,935 $ 327,562 $ (123,126 ) $ 1,093,885
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 discount rates used in estimating our
embedded derivative liabilities; and (iii) the growth in the host component of
the policy liability. The amounts presented as "Other changes in difference
between policy benefit reserves computed using derivative accounting vs.
long-duration contracts accounting" represent the total change in the difference
between policy benefit reserves for fixed index annuities computed under the
derivative accounting standard and the long-duration contracts accounting
standard at each balance sheet date, less the change in fair value of our fixed
index annuities embedded derivative. See Critical Accounting Policies - Policy
Liabilities for Fixed Index Annuities included in Management's Discussion and
Analysis in our Annual Report on Form 10-K for the year ended December 31, 2019 .
The primary reasons for the decrease in the change in fair value of the fixed
index annuity embedded derivatives during the six months ended June 30, 2020
were decreases in the expected index credits on the next policy anniversary
dates resulting from decreases in the fair value of the call options acquired to
fund these index credits during the six months ended June 30, 2020 compared to
increases in the expected index credits on the next policy anniversary dates
resulting from increases in the fair value of the call options acquired to fund
these index credits during the six months ended June 30, 2019 partially offset
by a larger decrease in the net discount rate during the six months ended June
30, 2020 compared to the same period of 2019. The decrease in the net discount
rate for the six months ended June 30, 2020 consists of a decrease in treasury
rates partially offset by a widening of credit spreads. The discount rates used
in estimating our embedded derivative liabilities fluctuate based on the changes
in the general level of risk free interest rates and our own credit spread. The
primary reasons for the increase in the change in fair value of the fixed index
annuity embedded derivatives during the three months ended June 30, 2020 were a
larger increase in the expected index credits on the next policy anniversary
dates resulting from a larger increase in the fair value of the call options
acquired to fund these index credits during the three months ended June 30, 2020
compared to the same period of 2019 and a larger decrease in the discount rates
during the three months ended June 30, 2020 compared to the same period of 2019.
The decrease in the discount rates for the three months ended June 30, 2020
consists of a tightening of credit spreads and a decrease in treasury rates. See
Net Income above for discussion of the impact of assumption revisions on the
fair value of of the fixed index annuity embedded derivative for the three and
six months ended June 30, 2020 .
Amortization of deferred policy acquisition costs before gross profit
adjustments decreased for the three and six months ended June 30, 2020 compared
to the same periods in 2019 primarily due to the impact that assumption
revisions made during the third quarter of 2019 had on the pattern of
amortization. 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 including credit losses on fixed maturity
securities. 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:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(Dollars in thousands)
Amortization of deferred policy
acquisition costs before gross
profit adjustments $ 61,240 $ 101,444 $ 127,496 $ 201,515
Gross profit adjustments:
Fair value accounting for
derivatives and embedded derivatives (177,014 ) (70,144 ) (119,375 ) (124,933 )
Net realized gains (losses) on
investments (4,115 ) (1,354 ) (7,308 ) (1,504 )
Amortization of deferred policy
acquisition costs after gross profit
adjustments $ (119,889 ) $ 29,946 $ 813 $ 75,078
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Other operating costs and expenses increased 12% to$42.0 million in the second quarter of 2020 and 12% to$85.6 million for the six months endedJune 30, 2020 compared to$37.4 million and$76.4 million for the same periods in 2019 and are summarized as follows: Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Salary and benefits$ 21,832 $ 20,874
$ 43,987 $ 41,093 Risk charges 11,107 9,322 21,947 18,031 Other 9,012 7,230
19,643 17,281
Total other operating costs and expenses
Salary and benefits for the three and six months endedJune 30, 2020 reflect increases of$2.3 million and$4.2 million , respectively, due to an increased number of employees related to our growth. These increases were offset by decreases of$1.1 million and$1.0 million , respectively, related to compensation costs for our incentive compensation programs for the three and six months endedJune 30, 2020 compared to the same periods in the prior year. The decreases in expenses for our incentive compensation programs were primarily due to lower expected payouts based on estimated financial results as compared to the prior year as well as lower stock compensation expense compared to the prior year due to the prior year containing expense related to a 2018 grant that had a one year vesting period that was fully expensed prior to 2020. The increase in risk charges expense for the three and six months endedJune 30, 2020 compared to the same periods in 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 excess regulatory reserves ceded atJune 30, 2020 and 2019 were$1,276.6 million and$1,050.9 million , respectively. Other expenses increased for the three and six months endedJune 30, 2020 as compared to the same periods in 2019 primarily as a result of increases in consulting fees, depreciation and maintenance expense related to software and hardware assets, licensing fees which are based on the level of policyholder funds under management allocated to index strategies and non-deferrable commission expenses. These increases were offset by decreases in expenses related to lower sales promotion activity due to the COVID-19 pandemic. Income tax expense (benefit) was$(68.5) million in the second quarter of 2020 and$(41.2) million for the six months endedJune 30, 2020 compared to$4.6 million and$(4.8) million for the same periods in 2019. The change in income tax expense (benefit) was primarily due to changes in income (loss) before income taxes. The effective income tax rates for the three and six months endedJune 30, 2020 were 21.7% and 90.2%, respectively, and 19.9% and 29.8% for the same periods in 2019, respectively. Income tax expense (benefit) and the resulting effective tax rate are based upon two components of income (loss) before income taxes ("pretax income") that are taxed at different tax rates. Life insurance income is generally taxed at an effective rate of approximately 21.6% reflecting the absence of state income taxes for substantially all of the states that the life insurance subsidiaries do business in. The income (loss) for the parent company and other non-life insurance subsidiaries (the "non-life insurance group") is generally taxed at 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 (loss) vary from period to period based primarily on the relative size of pretax income (loss) from the two sources. The effective tax rate for the six months endedJune 30, 2020 was impacted by a discrete tax item that provided a tax benefit of$30.8 million related to the provision of the Coronavirus Aid, Relief, and Economic Security Act that allows 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. The effective income tax rate was also impacted by a discrete tax item related to share-based compensation that provided a tax benefit for the six months endedJune 30, 2020 of approximately$0.4 million compared to a tax benefit for the three and six months endedJune 30, 2019 of$0.3 million and$1.4 million , respectively. The effective income tax rates excluding the impact of these discrete items were 21.7% and 22.0%, respectively, for the three and six months endedJune 30, 2020 and 21.3% and 21.4% for the same periods in 2019, respectively. 36
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Financial Condition Investments Our investment strategy is to maintain a predominantly investment grade fixed income portfolio, provide adequate liquidity to meet our cash obligations to policyholders and others and maximize current income and total investment return through active investment management. Consistent with this strategy, our investments principally consist of fixed maturity securities and mortgage loans on real estate. Insurance statutes regulate the type of investments that our life subsidiaries are permitted to make and limit the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and our business and investment strategy, we generally seek to invest inUnited States government and government-sponsored agency securities, corporate securities, residential and commercial mortgage backed securities, other asset backed securities andUnited States municipalities, states and territories securities rated investment grade by established NRSRO's or in securities of comparable investment quality, if not rated and mortgage loans on real estate. The composition of our investment portfolio is summarized as follows: June 30, 2020 December 31, 2019 Carrying Carrying Amount Percent Amount Percent (Dollars in thousands) Fixed maturity securities: United States Government full faith and credit$ 39,342 0.1 %$ 161,765 0.3 % United States Government sponsored agencies 343,387 0.6 % 625,020 1.1 %United States municipalities, states and territories 3,778,710 6.8 % 4,527,671 7.9 % Foreign government obligations 207,509 0.4 % 205,096 0.3 % Corporate securities 33,330,711 59.7 % 32,536,839 57.2 % Residential mortgage backed securities 1,712,725 3.1 % 1,575,664 2.8 % Commercial mortgage backed securities 5,393,062 9.6 % 5,786,279 10.2 % Other asset backed securities 5,933,346 10.6 % 6,162,156 10.8 % Total fixed maturity securities 50,738,792 90.9 % 51,580,490 90.6 % Mortgage loans on real estate 3,958,233 7.1 % 3,448,793 6.1 % Derivative instruments 672,958 1.2 % 1,355,989 2.4 % Other investments 479,099 0.8 % 492,301 0.9 %$ 55,849,082 100.0 %$ 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 impairments 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. A summary of our fixed maturity securities by NRSRO ratings is as follows: June 30, 2020
Carrying Percent of Fixed Carrying Percent of Fixed
Rating Agency Rating Amount Maturity Securities Amount Maturity Securities
(Dollars in thousands)
Aaa/Aa/A $ 29,240,135 57.6 % $ 30,662,644 59.4 %
Baa 19,857,663 39.1 % 19,833,309 38.4 %
Total investment grade 49,097,798 96.7 % 50,495,953 97.8 %
Ba 1,347,637 2.7 % 821,902 1.6 %
B 126,141 0.3 % 81,407 0.2 %
Caa 68,192 0.1 % 95,676 0.2 %
Ca and lower 99,024 0.2 % 85,552 0.2 %
Total below investment grade 1,640,994 3.3 % 1,084,537 2.2 %
$ 50,738,792 100.0 % $ 51,580,490 100.0 %
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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 a NAIC designation and/or unit price.
Typically, if a security has been rated by an NRSRO, the SVO utilizes that
rating and assigns an 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.
A summary of our fixed maturity securities by NAIC designation is as follows:
June 30, 2020 December 31, 2019
Percent Percent
of Total of Total
Amortized Carrying Carrying Amortized Carrying CarryingNAIC Designation Cost Fair Value Amount Amount
Cost Fair Value Amount Amount
(Dollars in thousands) (Dollars in thousands)
1 $ 25,587,355 $ 28,327,288 $ 28,327,288 55.8 %
2 19,487,757 20,765,334 20,765,334 40.9 % 19,278,355 20,316,911 20,316,911 39.4 %
3 1,577,056 1,430,998 1,430,998 2.8 % 1,001,087 977,191 977,191 1.9 %
4 185,879 156,234 156,234 0.3 % 114,497 112,534 112,534 0.2 %
5 51,893 31,644 31,644 0.1 % 57,952 45,205 45,205 0.1 %
6 61,103 27,294 27,294 0.1 % 5,530 5,992 5,992 - %
$ 46,951,043 $ 50,738,792 $ 50,738,792 100.0 %
The amortized cost and fair value of fixed maturity securities atJune 30, 2020 , by contractual maturity, are presented in Note 3 to our unaudited consolidated financial statements in this Form 10-Q, which is incorporated by reference in this Item 2. 38
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Unrealized Losses
The amortized cost and fair value of fixed maturity securities that were in an
unrealized loss position were as follows:
Unrealized
Number of Amortized Losses, Net of Allowance for
Securities Cost Allowance Credit Losses Fair Value
(Dollars in thousands)
June 30, 2020
Fixed maturity securities,
available for sale:
United States
municipalities, states and
territories 12 $ 53,970 $ (2,039 ) $ - $ 51,931
Foreign government
obligations 2 24,185 (1,128 ) - 23,057
Corporate securities:
Finance, insurance and real
estate 46 650,313 (23,749 ) - 626,564
Manufacturing, construction
and mining 38 314,378 (15,655 ) - 298,723
Utilities and related
sectors 68 566,352 (71,642 ) (127 ) 494,583
Wholesale/retail trade 33 340,002 (48,544 ) - 291,458
Services, media and other 105 939,021 (87,257 ) (46,622 ) 805,142
Residential mortgage backed
securities 53 239,616 (4,837 ) (777 ) 234,002
Commercial mortgage backed
securities 432 3,069,312 (266,949 ) (2,660 ) 2,799,703
Other asset backed
securities 824 5,304,363 (465,891 ) - 4,838,472
1,613 $ 11,501,512 $ (987,691 ) December 31, 2019 Fixed maturity securities, available for sale: United States Government full faith and credit 5$ 144,678 $ (96 ) $ -$ 144,582 United States Government sponsored agencies 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 The unrealized losses atJune 30, 2020 are principally related to the impacts the COVID-19 pandemic had on credit markets. Approximately 80% and 79% of the unrealized losses on fixed maturity securities shown in the above table forJune 30, 2020 andDecember 31, 2019 , respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. The increase in unrealized losses fromDecember 31, 2019 toJune 30, 2020 was primarily related to the impacts the COVID-19 pandemic had on credit markets. While treasury yields declined during the six months endedJune 30, 2020 , credit spreads have widened. The widening of credit spreads in most cases was driven by a flight to quality into treasury securities due to illiquidity and uncertainty of the impact of the COVID-19 pandemic on the economy. The 10-yearU.S. Treasury yields atJune 30, 2020 andDecember 31, 2019 were 0.66% and 1.92%, respectively. The 30-yearU.S. Treasury yields atJune 30, 2020 andDecember 31, 2019 were 1.41% and 2.39%, respectively. 39
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The following table sets forth the composition by credit quality (NAIC designation) of fixed maturity securities with gross unrealized losses:
Carrying Value of
Securities with Gross
Gross Unrealized Percent of Unrealized Percent of
NAIC Designation Losses Total Losses (1) Total
(Dollars in thousands)
June 30, 2020
1 $ 5,001,440 47.8 % $ (343,963 ) 34.8 %
2 4,136,595 39.5 % (441,530 ) 44.7 %
3 1,124,164 10.7 % (161,065 ) 16.3 %
4 143,697 1.4 % (32,929 ) 3.3 %
5 31,644 0.3 % (4,329 ) 0.5 %
6 26,095 0.3 % (3,875 ) 0.4 %
$ 10,463,635 100.0 % $ (987,691 ) 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 of June 30, 2020 of $50.2 million .
Our investments' gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities (consisting of
1,613 and 1,033 securities, respectively) have been in a continuous unrealized
loss position at June 30, 2020 and December 31, 2019 , along with a description
of the factors causing the unrealized losses is presented in Note 3 to our
unaudited consolidated financial statements in this Form 10-Q, which is
incorporated by reference in this Item 2.
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The amortized cost and fair value of fixed maturity securities in an unrealized
loss position and the number of months in a continuous unrealized loss position
(fixed maturity securities that carry an NRSRO rating of BBB/Baa or higher are
considered investment grade) were as follows:
Gross
Amortized Unrealized
Number of Cost, Net of Losses, Net of
Securities Allowance (1) Fair Value Allowance (1)
(Dollars in thousands)
June 30, 2020
Fixed maturity securities, available
for sale:
Investment grade:
Less than six months 962 $ 6,829,739 $ 6,391,626 $ (438,113 )
Six months or more and less than
twelve months 29 240,206 219,279 (20,927 )
Twelve months or greater 388 2,875,775 2,561,199 (314,576 )
Total investment grade 1,379 9,945,720 9,172,104 (773,616 )
Below investment grade:
Less than six months 109 751,445 659,535 (91,910 )
Six months or more and less than
twelve months 10 22,034 19,039 (2,995 )
Twelve months or greater 115 732,127 612,957 (119,170 )
Total below investment grade 234 1,505,606 1,291,531 (214,075 )
1,613 $ 11,451,326 $ 10,463,635 $ (987,691 )
December 31, 2019
Fixed maturity securities, available
for sale:
Investment grade:
Less than six months 352 $ 2,960,557 $ 2,911,909 $ (48,648 )
Six months or more and less than
twelve months 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
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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)
June 30, 2020
Investment grade:
Less than six months 57 $ 400,583 $ 282,437 $ (118,146 )
Six months or more and less than
twelve months - - - -
Twelve months or greater - - - -
Total investment grade 57 400,583 282,437 (118,146 )
Below investment grade:
Less than six months 38 262,422 186,330 (76,092 )
Six months or more and less than
twelve months 3 1,603 794 (809 )
Twelve months or greater 4 15,684 12,356 (3,328 )
Total below investment grade 45 279,709 199,480 (80,229 )
102 $ 680,292 $ 481,917 $ (198,375 )
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
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The amortized cost and fair value of fixed maturity securities, by contractual
maturity, that were in an unrealized loss position are shown below. Actual
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties. All of our mortgage and other asset backed securities provide for
periodic payments throughout their lives, and are shown below as a separate
line.
Available for sale
Amortized
Cost Fair Value
(Dollars in thousands)
June 30, 2020
Due in one year or less $ 5,177 $ 5,058 Due after one year through five years 508,870 469,413 Due after five years through ten years 1,084,846 980,602 Due after ten years through twenty years 569,854 506,516 Due after twenty years
719,474 629,869
2,888,221 2,591,458
Residential mortgage backed securities 239,616 234,002
Commercial mortgage backed securities 3,069,312 2,799,703
Other asset backed securities 5,304,363 4,838,472
$ 11,501,512 $ 10,463,635
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 June 30,
2020 , 25% 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:
June 30, 2020
Percent
of Total
Amortized Carrying Amount/ Carrying
Cost Fair Value Amount
(Dollars in thousands)
GIIPS (1) $ 251,477 $ 273,003 0.5 %
Asia/Pacific 436,587 495,818 1.0 %
Non-GIIPS Europe 3,043,061 3,337,126 6.6 %
Latin America 268,867 291,746 0.6 %
Non-U.S. North America 1,415,331 1,546,324 3.1 %
Australia & New Zealand 1,114,659 1,182,517 2.3 %
Other 5,629,293 5,296,541 10.4 %
$ 12,159,275 $ 12,423,075 24.5 %
(1)
GIIPS are corporate securities with issuers domiciled in these countries.
None of our foreign government obligations were held in any of these
countries.
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All of the securities presented in the table above are investment grade (NAIC designation of either 1 or 2), except for the following:
June 30, 2020
Carrying Amount/
Amortized Cost Fair Value
(Dollars in thousands)
GIIPS $ 14,544 $ 16,271
Asia/Pacific 11,000 10,860
Non-GIIPS Europe 145,635 128,521
Latin America 81,913 81,634
Non-U.S. North America 84,630 77,096
Other 524,486 443,300
$ 862,208 $ 757,682
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 June 30, 2020 , the amortized cost and fair value of securities on the
watch list (all fixed maturity securities) are as follows:
Amortized Net Unrealized
Number of Amortized Allowance for Cost, Net of Losses, General Description Securities Cost Credit Losses Allowance Net of Allowance Fair Value
(Dollars in thousands)
Corporate securities -
Public securities 6 $ 59,078 $ (46,622 ) $ 12,456 $ (1,718 ) $ 10,738
Corporate securities -
Private placement
securities 34 359,141 (127 ) 359,014 (25,933 ) 333,081
Residential mortgage
backed securities 16 35,860 (777 ) 35,083 (458 ) 34,625
Commercial mortgage
backed securities 16 137,801 (2,660 ) 135,141 (19,966 ) 115,175
Other asset backed
securities 5 83,892 - 83,892 (12,200 ) 71,692
77 $ 675,772 $ (50,186 ) $ 625,586 $ (60,275 ) $ 565,311
We expect to recover the unrealized losses, net of allowances, as we did not
have the intent to sell and it was not more likely than not that we would be
required to sell these securities prior to recovery of the amortized cost basis,
net of allowances. Our analysis of these securities and their credit performance
at June 30, 2020 is as follows:
Corporate securities - public securities: The decline in the values of these
securities, which are all securities related to domestic oil drillers, relates
to the continuing low level of oil prices, which has caused credit metrics to
continue to be under pressure. As a result of our process for identifying
securities that could potentially have credit losses we recognized credit losses
of $18.4 million and $46.7 million , respectively, on these securities for the
three and six months ended June 30, 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. While there is a heightened level of credit risk for the
private placement 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 $0.1 million on these securities for
the three and six months ended June 30, 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 $0.8 million on these securities for the three and six months ended
June 30, 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. For the three and six
months ended June 30, 2020 we recognized credit losses of $5.8 million and $8.3
million , respectively, on these securities.
Other asset backed securities: The decline the value of these securities, which
are all securities related to the auto rental industry, is primarily a result of
the impact COVID-19 has had on the travel industry. We have not taken any credit
losses on these securities as of June 30, 2020 as we do not expect any credit
losses on the securities based on our current analyses.
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Credit Losses We have a policy and process to identify securities in our investment portfolio for which we recognize credit loss. See Note 3 to our unaudited consolidated financial statements. During the three and six months endedJune 30, 2020 , we recognized credit losses of$18.4 million and$46.7 million , respectively, on corporate securities with exposure to the offshore drilling industry as discussed above and$5.8 million and$8.3 million , respectively, on commercial mortgage backed securities due to the impact of COVID-19 on the performance of the underlying collateral or our intent to sell the securities. In addition, during both the three and six months endedJune 30, 2020 , we recognized credit losses of$0.8 million on residential mortgage backed securities due to the performance of the underlying collateral and$0.1 million on a private placement security with exposure to the airlines industry. During the six months endedJune 30, 2020 we recognized a credit loss of$0.5 million on an asset backed security due to our intent to sell such security. We recognized other than temporary impairments of$1.2 million during the three and six months endedJune 30, 2019 related to residential mortgage backed securities and an other asset backed security for which we have previously recognized OTTI and an other than temporary impairment related to a commercial mortgage backed security due to our intent to sell the security. 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 to our unaudited consolidated financial statements in this Form 10-Q, which is incorporated by reference in this Item 2. Mortgage Loans on Real Estate Our financing receivables consist of two mortgage loan portfolio segments: commercial 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 residential mortgage loan portfolio consists of loans with an outstanding principal balance of$153.9 million that were purchased onJune 25, 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. AtJune 30, 2020 andDecember 31, 2019 , the largest principal amount outstanding for any single commercial mortgage loan was$35.0 million and$28.5 million , respectively, and the average loan size was$4.7 million and$4.4 million , respectively. In addition, the average loan to value ratio for commercial mortgage loans was 54.0% and 54.3% atJune 30, 2020 andDecember 31, 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 to our unaudited consolidated financial statements in this Form 10-Q, incorporated by reference in this Item 2. In the normal course of business, we commit to fund commercial mortgage loans up to 90 days in advance. AtJune 30, 2020 , we had commitments to fund commercial mortgage loans totaling$65.1 million , with interest rates ranging from 3.20% to 7.00%. 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 six months endedJune 30, 2020 , we received$67.5 million in cash for loans being paid in full compared to$83.3 million for the six months endedJune 30, 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 to our unaudited 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 commercial mortgage loans. This process utilizes each loan's loan-to-value and debt service coverage ratios as primary metrics. See Note 4 to our unaudited consolidated financial statements, incorporated by reference, for a summary of our portfolio by loan-to-value and debt service coverage ratios. We closely monitor loan performance for both our commercial and residential mortgage loan portfolios. Commercial 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 past 60-89
days past Over 90 days
Current due due past due Total
As of June 30, 2020: (Dollars in thousands)
Commercial mortgage loans $ 3,827,114 $ - $ - $ - $ 3,827,114
Residential mortgage loans 151,208 - - - 151,208
Total mortgage loans $ 3,978,322 $ - $ - $ - $ 3,978,322
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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 to our unaudited consolidated financial statements in this Form 10-Q, which is incorporated by reference in this Item 2. Liquidity and Capital Resources 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$(518.4) million for the six months endedJune 30, 2020 compared to$1.1 billion for the six months endedJune 30, 2019 , with the decrease attributable to a$1.4 billion decrease in net annuity deposits after coinsurance and a$203 million (after coinsurance) increase in funds returned to policyholders. As a result of funds returned to policyholders being in excess cash flows from annuity deposits for the six months endedJune 30, 2020 , we experienced a net cash outflow related to policyholder activity which was funded primarily by cash flows from investment income. We may continue to experience net cash outflows related to policyholder activity due to lower sales as a result of social distancing due to COVID-19. We continue to invest the net proceeds from policyholder transactions and investment activities in high quality fixed maturity securities and mortgage loans. 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 subsidiary trusts), 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. 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 Investment Life Insurance Company ("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 2020, up to$349.0 million can be distributed as dividends byAmerican Equity Life without prior approval of theIowa 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 atJune 30, 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 ofJune 30, 2020 , we estimateAmerican Equity Life has sufficient statutory capital and surplus, combined with capital available to the holding company, to maintain this 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 RBC 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 RBC ratio was 372% atDecember 31, 2019 . Under this agreement, we are also required to maintain a maximum ratio of adjusted debt to total adjusted capital of 0.35. OnJune 10, 2020 , we issued 12,000 shares of 6.625% Fixed-Rate Reset Non-Cumulative Preferred Stock, Series B ("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 . 46
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OnNovember 21, 2019 we issued$400 million of 5.95% fixed-rate reset non-cumulative preferred stock and received 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. Cash and cash equivalents of the parent holding company atJune 30, 2020 , were$349.0 million which includes the$290.3 million of net proceeds from the Series B preferred issuance described above. In addition, we have a$150 million revolving line of credit, with no borrowings outstanding, available throughSeptember 2021 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. New Accounting Pronouncements See Note 1 to our unaudited consolidated financial statements in this Form 10-Q, which is incorporated by reference in this Item 2. Item 3. 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% (14 basis points) from levels atJune 30, 2020 , we estimate that the fair value of our fixed maturity securities would decrease by approximately$519.8 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$239.9 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 included in Management's Discussion and Analysis in our Annual Report on Form 10-K for the year endedDecember 31, 2019 for a further discussion of liquidity risk. 47
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The amortized cost of fixed maturity securities that are callable at the option of the issuer, excluding securities with a make-whole provision, was$7.6 billion as ofJune 30, 2020 . 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$4.9 billion of floating rate fixed maturity securities as ofJune 30, 2020 . Generally, interest rates on these floating rate fixed maturity securities are based on the 3 month LIBOR rate and are reset quarterly. Should rates decline to levels which tighten the spread between our average portfolio yield and average cost of interest credited on annuity liabilities, we have the ability to reduce crediting rates (caps, participation rates or asset fees for fixed index annuities) on most of our annuity liabilities to maintain the spread at our targeted level. AtJune 30, 2020 , approximately 99% of our annuity liabilities were subject to annual adjustment of the applicable crediting rates at our discretion, limited by minimum guaranteed crediting rates specified in the policies. AtJune 30, 2020 , approximately 19% of our annuity liabilities were at minimum guaranteed crediting rates. We purchase call options on the applicable indices to fund the annual index credits on our fixed index annuities. These options are primarily one-year instruments purchased to match the funding requirements of the underlying policies. Fair value changes associated with those investments are substantially offset by an increase or decrease in the amounts added to policyholder account balances for fixed index products. The difference between proceeds received at expiration of these options and index credits, as shown in the following table, is primarily due to under or over-hedging as a result of policyholder behavior being different than our expectations. Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Proceeds received at expiration of options related to such credits$ 97,015 $ 166,430 $ 382,278 $ 224,890 Annual index credits to policyholders on their anniversaries 97,875 161,752 376,815 217,677 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 fixed 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 4. Controls and Procedures 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-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded the design and operation of our disclosure controls and procedures were effective as ofJune 30, 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. There were no changes in our internal control over financial reporting that occurred during the quarter endedJune 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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