UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________
FORM 10-K
(Mark One) | ||
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2010 | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to | ||
Commission File Number: 001-31911
______________________________________________
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa (State or other jurisdiction of Incorporation) | 42-1447959 (I.R.S. Employer Identification No.) | |
6000 Westown Parkway West Des Moines, Iowa (Address of principal executive offices) | 50266 (Zip Code) | |
Registrant's telephone number, including area code: (515) 221-0002 | ||
Securities registered pursuant to Section 12(b) of the Act: | ||
Title of each class | Name of each exchange on which registered | |
Common stock, par value $1 | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this From 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer x | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes o No x
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $554,052,926 based on the closing price of $10.32 per share, the closing price of the common stock on the New York Stock Exchange on June 30, 2010.
Shares of common stock outstanding as of February 28, 2011: 59,291,669
Documents incorporated by reference: Portions of the registrant's definitive proxy statement for the annual meeting of shareholders to be held June 9, 2011, which will be filed within 120 days after December 31, 2010, are incorporated by reference into Part III of this report.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2010
TABLE OF CONTENTS
Exhibit 12.1 | Ratio of Earnings to Fixed Charges | |
Exhibit 21.2 | Subsidiaries of American Equity Investment Life Holding Company | |
Exhibit 23.1 | Consent of Independent Registered Public Accounting Firm | |
Exhibit 31.1 | Certification | |
Exhibit 31.2 | Certification | |
Exhibit 32.1 | Certification | |
Exhibit 32.2 | Certification | |
PART I
Item 1. Business
Introduction
We are a leader in the development and sale of fixed index and fixed rate annuity products. We were incorporated in the state of Iowa on December 15, 1995. We are a full service underwriter of fixed annuity and life insurance products through our wholly-owned life insurance subsidiaries, American Equity Investment Life Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York, and Eagle Life Insurance Company ("Eagle Life"). Our business consists primarily of the sale of fixed index and fixed rate annuities and, accordingly, we have only one business segment. Our business strategy is to focus on our annuity business and earn predictable returns by managing investment spreads and investment risk. We are currently licensed to sell our products in 50 states and the District of Columbia. Throughout this report, unless otherwise specified or the context otherwise requires, all references to "American Equity", the "Company", "we", "our" and similar references are to American Equity Investment Life Holding Company and its consolidated subsidiaries.
Investor related information, including periodic reports filed on Forms 10-K, 10-Q and 8-K and all amendments to such reports may be found on our internet website at www.american-equity.com as soon as reasonably practicable after such reports are filed with the Securities and Exchange Commission ("SEC"). In addition, we have available on our website our: (i) code of business conduct and ethics; (ii) audit committee charter; (iii) compensation committee charter; (iv) nominating/corporate governance committee charter; and (v) corporate governance guidelines. The information incorporated herein by reference is also electronically accessible from the SEC's website at www.sec.gov.
Annuity Market Overview
Our target market includes the group of individuals ages 45-75 who are seeking to accumulate tax-deferred savings. We believe that significant growth opportunities exist for annuity products because of favorable demographic and economic trends. According to the U.S. Census Bureau, there were 35 million Americans age 65 and older in 2000, representing 12% of the U.S. population. By 2030, this sector of the population is expected to increase to 20% of the total population. Our fixed index and fixed rate annuity products are particularly attractive to this group as a result of the guarantee of principal with respect to those products, competitive rates of credited interest, tax-deferred growth and alternative payout options.
According to AnnuitySpecs.com, total industry sales of fixed index annuities increased 7% to $32.3 billion in 2010 from $30.1 billion in 2009. Our wide range of fixed index and fixed rate annuity products has enabled us to enjoy favorable growth during volatile equity and bond markets.
Strategy
Our business strategy is to grow our annuity business and earn predictable returns by managing investment spreads and investment risk. Key elements of this strategy include the following:
Enhance our Current Independent Agency Network. We believe that our successful relationships with approximately 50 national marketing organizations represent a significant competitive advantage. Our objective is to improve the productivity and efficiency of our core distribution channel by focusing our marketing and recruiting efforts on those independent agents capable of selling $1 million or more of annuity premium annually. This level of production qualifies them for our Gold Eagle program which was introduced at the beginning of 2007. We believe the Gold Eagle program has been effective as evidenced by the increase in Gold Eagle agents to 1,021 in 2010 as compared to 891 in 2009 and 566 in 2008, accounting for 57%, 57% and 56% of total production, respectively. Gold Eagle qualifiers receive a combination of cash and equity-based incentives as motivation for producing business for us. The equity-based incentive compensation component of our Gold Eagle program is unique in our industry and distinguishes us from our competitors. Our continuing focus on relationships and efficiency will ultimately reduce our independent agents to a core group of professional annuity producers. We will also be alert to opportunities to establish relationships with national marketing organizations and agents not presently associated with us and will continue to provide all of our marketers with the highest quality service possible.
Continue to Introduce Innovative and Competitive Products. We intend to be at the forefront of the fixed index and fixed rate annuity industry in developing and introducing innovative and new competitive products. We were one of the first companies to offer a fixed index annuity that allows a choice among interest crediting strategies which include both equity and bond indices as well as a traditional fixed rate strategy. We were also one of the first companies to include a living income benefit rider with our fixed index annuities. Most recently, we enhanced our living income benefit rider to provide policyholders with protection against inflation. We believe that our continued focus on anticipating and being responsive to the product needs of our independent agents and policyholders will lead to increased customer loyalty, revenues and profitability.
Use our Expertise to Achieve Targeted Spreads on Annuity Products. We have had a successful track record in achieving the targeted spreads on our annuity products. We intend to continue to leverage our experience and expertise in managing the investment spread during a range of interest rate environments to achieve our targeted spreads.
Maintain our Profitability Focus and Improve Operating Efficiency. We are committed to improving our profitability by advancing the scope and sophistication of our investment management and spread capabilities and continuously seeking out efficiencies within our operations. We have implemented competitive incentive programs for our national marketing organizations, agents and employees to stimulate performance.
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Take Advantage of the Growing Popularity of Index Products. We believe that the growing popularity of fixed index annuity products that allow equity and bond market participation without the risk of loss of the premium deposit presents an attractive opportunity to grow our business. We intend to capitalize on our reputation as a leading marketer of fixed index annuities in this expanding segment of the annuity market.
Focus on High Quality Service to Agents and Policyholders. We have maintained high quality personal service as one of our highest priorities since the inception of our business, and continue to strive for an unprecedented level of timely and accurate service to both our agents and policyholders. We believe this is one of our strongest competitive advantages.
Expand our Distribution Channels. We formed Eagle Life in 2008 with the vision of developing a network of affiliated and nonaffiliated broker-dealer firms to distribute a registered fixed index annuity product. We believe this to be the most effective means of building a core distribution channel of selling firms with registered representatives capable of selling $1 million or more of annuity premium annually.
Products
Annuities offer our policyholders a tax-deferred means of accumulating retirement savings, as well as a reliable source of income during the payout period. When our policyholders contribute cash to annuities, we account for these receipts as policy benefit reserves in the liability section of our consolidated balance sheet. The annuity deposits collected, by product type, during the three most recent fiscal years are as follows:
Year Ended December 31, | |||||||||||||||||||||
2010 | 2009 | 2008 | |||||||||||||||||||
Deposits Collected | Deposits as a % of Total | Deposits Collected | Deposits as a % of Total | Deposits Collected | Deposits as a % of Total | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Fixed index annuities: | |||||||||||||||||||||
Index strategies | $ | 2,401,891 | 52 | % | $ | 1,535,477 | 42 | % | $ | 1,303,871 | 57 | % | |||||||||
Fixed strategy | 1,551,007 | 33 | % | 1,849,833 | 50 | % | 937,227 | 41 | % | ||||||||||||
3,952,898 | 85 | % | 3,385,310 | 92 | % | 2,241,098 | 98 | % | |||||||||||||
Fixed rate annuities | 715,821 | 15 | % | 292,248 | 8 | % | 47,908 | 2 | % | ||||||||||||
$ | 4,668,719 | 100 | % | $ | 3,677,558 | 100 | % | $ | 2,289,006 | 100 | % | ||||||||||
Fixed Index Annuities
Fixed index annuities allow policyholders to earn index credits based on the performance of a particular index without the risk of loss of their principal. Most of these products allow policyholders to transfer funds once a year among several different crediting strategies, including one or more index based strategies and a traditional fixed rate strategy. Approximately 95%, 94% and 93% of our fixed index annuity sales for the years ended December 31, 2010, 2009 and 2008, respectively, were "premium bonus" products. The initial annuity deposit on these policies is increased at issuance by a specified premium bonus ranging from 3% to 10%. Generally, there is a compensating adjustment in the commission paid to the agent or the surrender charges on the policy to offset the premium bonus.
The annuity contract value is equal to the sum of premiums paid, premium bonuses and interest credited ("index credits"), which is based upon an overall limit (or "cap") or a percentage (the "participation rate") of the annual appreciation (based in certain situations on monthly averages or monthly point-to-point calculations) in a recognized index or benchmark. Caps and participation rates limit the amount of annual interest the policyholder may earn in any one contract year and may be adjusted by us annually subject to stated minimums. Caps generally range from 4% to 12% and participation rates generally range from 25% to 100%. In addition, some products have an "asset fee" ranging from 1.5% to 5%, which is deducted from annual interest to be credited. For products with asset fees, if the annual appreciation in the index does not exceed the asset fee, the policyholder's index credit is zero. The minimum guaranteed contract values are equal to 87.5% of the premium collected plus interest credited at an annual rate ranging from 1.5% to 3.5%.
Fixed Rate Annuities
Fixed rate deferred annuities include annual reset and multi-year rate guaranteed products. Our annual reset fixed rate annuities have an annual interest rate (the "crediting rate") that is guaranteed for the first policy year. After the first policy year, we have the discretionary ability to change the crediting rate once annually to any rate at or above a guaranteed minimum rate. Our multi-year rate guaranteed annuities are similar to our annual reset products except that the initial crediting rate is guaranteed for up to a seven-year period before it may be changed at our discretion. The guaranteed rate on our fixed rate deferred annuities ranges from 2% to 4% and the initial guaranteed rate on our multi-year rate guaranteed policies ranges from 2.65% to 5.10%.
The initial crediting rate is largely a function of the interest rate we can earn on invested assets acquired with new annuity deposits and the rates offered on similar products by our competitors. For subsequent adjustments to crediting rates, we take into account the yield on our investment portfolio, annuity surrender assumptions, competitive industry pricing and crediting rate history for particular groups of annuity policies with similar characteristics. As of December 31, 2010, crediting rates on our outstanding fixed rate deferred annuities generally ranged from 2.5% to 5%. The average crediting rate on our outstanding fixed rate deferred annuities at December 31, 2010 was 3.38%.
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We also sell single premium immediate annuities ("SPIAs"). Our SPIAs are designed to provide a series of periodic payments for a fixed period of time or for life, according to the policyholder's choice at the time of issue. The amounts, frequency and length of time of the payments are fixed at the outset of the annuity contract. SPIAs are often purchased by persons at or near retirement age who desire a steady stream of payments over a future period of years. The implicit interest rate on SPIAs is based on market conditions when the policy is issued. The implicit interest rate on our outstanding SPIAs averaged 2.94% at December 31, 2010.
Withdrawal Options—Fixed Index and Fixed Rate Annuities
Policyholders are typically permitted penalty-free withdrawals up to 10% of the contract value in each year after the first year, subject to limitations. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period which ranges from 5 to 17 years for fixed index annuities and 3 to 15 years for fixed rate annuities from the date the policy is issued. This surrender charge initially ranges from 4.7% to 20% for fixed index annuities and 8% to 25% for fixed rate annuities of the contract value and generally decreases by approximately one to two percentage points per year during the surrender charge period. Surrender charges are set at levels aimed at protecting us from loss on early terminations and reducing the likelihood of policyholders terminating their policies during periods of increasing interest rates. This practice lengthens the effective duration of the policy liabilities and enhances our ability to maintain profitability on such policies. The policyholder may elect to take the proceeds of the annuity either in a single payment or in a series of payments for life, for a fixed number of years or a combination of these payment options.
Beginning in July 2007, substantially all of our fixed index annuity policies were issued with a living income benefit rider. This rider provides an additional liquidity option to policyholders who elect to receive a guaranteed living income from their contract without requiring them to annuitize their contract value. The amount of the living income benefit available is determined by the growth in the policy's income account value as defined in the policy and the policyholder's age at the time the policyholder elects to begin receiving living income benefit payments. Living income benefit payments may be stopped and restarted at the election of the policyholder.
Life Insurance
These products include traditional ordinary and term, universal life and other interest-sensitive life insurance products. We have approximately $2.6 billion of life insurance in force as of December 31, 2010. We intend to continue offering a complete line of life insurance products for individual and group markets. Premiums related to this business accounted for 1% of revenues for the years ended December 31, 2010 and 2009 and 4% of revenues for the year ended December 31, 2008.
Investments
Investment activities are an integral part of our business, and net investment income is a significant component of our total revenues. Profitability of many of our products is significantly affected by spreads between interest yields on investments, the cost of options to fund the annual index credits on our fixed index annuities and rates credited on our fixed rate annuities. We manage the index-based risk component of our fixed index annuities by purchasing call options on the applicable indices to fund the annual index credits on these annuities and by adjusting the caps, participation rates and asset fees on policy anniversary dates to reflect the change in the cost of such options which varies based on market conditions. All options are purchased to fund the index credits on our fixed index annuities on their respective anniversary dates, and new options are purchased at each of the anniversary dates to fund the next annual index credits. All credited rates on non-multi-year rate guaranteed fixed rate deferred annuities may be changed annually, subject to minimum guarantees. Changes in caps, participation rates and asset fees on fixed index annuities and crediting rates on fixed rate annuities may not be sufficient to maintain targeted investment spreads in all economic and market environments. In addition, competition and other factors, including the potential for increases in surrenders and withdrawals, may limit our ability to adjust or to maintain caps, participation rates, asset fees and crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. For the year ended December 31, 2010, the weighted average yield, computed on the average amortized cost basis of our investment portfolio, was 6.06% and the weighted average cost of our liabilities, excluding amortization of deferred sales inducements, was 2.91%.
For additional information regarding the composition of our investment portfolio and our interest rate risk management, see Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Investments, Quantitative and Qualitative Disclosures About Market Risk and note 3 to our audited consolidated financial statements.
Marketing
We market our products through a variable cost brokerage distribution network of approximately 50 national marketing organizations and, through them, 37,000 independent agents as of December 31, 2010. We emphasize high quality service to our agents and policyholders along with the prompt payment of commissions to our agents. We believe this has been significant in building excellent relationships with our existing agency force.
Our independent agents and agencies range in profile from national sales organizations to personal producing general agents. We actively recruit new agents and terminate those agents who have not produced business for us in recent periods and are unlikely to sell our products in the future. In our recruitment efforts, we emphasize that agents have direct access to our executive officers, giving us an edge in recruiting over larger and foreign-owned competitors. We also emphasize our products and our Gold Eagle program which provides unique cash and equity-based incentives to those agents selling $1 million or more of annuity premium annually. We also have favorable relationships with our national marketing organizations, which have enabled us to efficiently sell through an expanded number of independent agents.
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The insurance distribution system is comprised of insurance brokers and marketing organizations. We are pursuing a strategy to increase the efficiency of our distribution network by strengthening our relationships with key national and regional marketing organizations and are alert for opportunities to establish relationships with organizations not presently associated with us. These organizations typically recruit agents for us by advertising our products and our commission structure through direct mail advertising or seminars for insurance agents and brokers. These organizations bear most of the cost incurred in marketing our products. We compensate marketing organizations by paying them a percentage of the commissions earned on new annuity policy sales generated by the agents recruited by such organizations. We also conduct incentive programs for marketing organizations and agents from time to time, including equity-based programs for our leading national marketers and those agents qualifying for our Gold Eagle program. We believe the Gold Eagle program has been effective as evidenced by the increase in Gold Eagle agents to 1,021 in 2010 as compared to 891 in 2009 and 566 in 2008, accounting for 57%, 57% and 56% of total production, respectively. For additional information regarding our equity-based programs for our leading national marketers and independent agents, see note 11 to our audited consolidated financial statements. We generally do not enter into exclusive arrangements with these marketing organizations.
One of our national marketing organizations accounted for more than 10% of the annuity deposits collected during 2010 and we expect this organization to continue as a marketer for American Equity Life with a focus on selling our products. The states with the largest share of direct premiums collected during 2010 were: Florida (11.5%), California (8.8%), Texas (7.0%), Illinois (6.1%) and Pennsylvania (5.2%).
Competition and Ratings
We operate in a highly competitive industry. Many of our competitors are substantially larger and enjoy substantially greater financial resources, higher ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships. Our annuity products compete with index, fixed rate and variable annuities sold by other insurance companies and also with mutual fund products, traditional bank investments and other investment and retirement funding alternatives offered by asset managers, banks, and broker-dealers. Our insurance products compete with products of other insurance companies, financial intermediaries and other institutions based on a number of features, including crediting rates, policy terms and conditions, service provided to distribution channels and policyholders, ratings, reputation and broker compensation.
The sales agents for our products use the ratings assigned to an insurer by independent rating agencies as one factor in determining which insurer's annuity to market. In recent years, the market for annuities has been dominated by those insurers with the highest ratings. Following is a summary of American Equity Life's financial strength ratings:
Financial Strength Rating | Outlook Statement | ||
A.M. Best Company | |||
January 2011—current | A- | Stable | |
November 2008—January 2011 | A- | Negative | |
August 2006—October 2008 | A- | Stable | |
July 2002—July 2006 | B++ | Stable | |
Standard & Poor's | |||
September 2010—current | BBB+ | Positive | |
July 2010—September 2010 | BBB+ | Stable | |
July 2008—July 2010 | BBB+ | Negative | |
July 2002—June 2008 | BBB+ | Stable |
The degree to which ratings adjustments have affected sales and persistency is unknown. We believe the rating upgrade from A.M. Best Company in 2006 enhanced our competitive position and improved our sales. However, the degree to which this rating will affect future sales and persistency is unknown.
Financial strength ratings generally involve quantitative and qualitative evaluations by rating agencies of a company's financial condition and operating performance. Generally, rating agencies base their ratings upon information furnished to them by the insurer and upon their own investigations, studies and assumptions. Ratings are based upon factors of concern to policyholders, agents and intermediaries and are not directed toward the protection of investors and are not recommendations to buy, sell or hold securities.
In addition to the financial strength ratings, rating agencies use an "outlook statement" to indicate a medium or long-term trend which, if continued, may lead to a rating change. A positive outlook indicates a rating may be raised and a negative outlook indicates a rating may be lowered. A stable outlook is assigned when ratings are not likely to be changed. Outlook statements should not be confused with expected stability of the issuer's financial or economic performance. A rating may have a "stable" outlook to indicate that the rating is not expected to change, but a "stable" outlook does not preclude a rating agency from changing a rating at any time without notice.
In July 2010, A.M. Best revised its rating outlook on the U.S. life/annuity sector to stable from negative. In December 2010, Standard & Poor's revised its outlook on the U.S. life insurance sector to stable from negative. Both agencies had their outlook on our industry stated as negative since late 2008. Strengthening balance sheets and recovering financial markets have been listed as reasons for the improved outlook. We believe the rating agencies think the economic recovery will continue to be slow, which may leave the potential for further credit losses. The rating agencies have heightened the level of scrutiny they apply to insurance companies, increased the frequency and scope of their credit reviews, and may adjust upward the capital and other requirements employed in the rating agency models for maintenance of certain ratings levels.
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A.M. Best Company ratings currently range from "A++" (Superior) to "F" (In Liquidation), and include 16 separate ratings categories. Within these categories, "A++" (Superior) and "A+" (Superior) are the highest, followed by "A" (Excellent) and "A-" (Excellent) then followed by "B++" (Good) and "B+" (Good). Publications of A.M. Best Company indicate that the "A-" rating is assigned to those companies that, in A.M. Best Company's opinion, have demonstrated an excellent ability to meet their ongoing obligations to policyholders.
Standard & Poor's insurer financial strength ratings currently range from "AAA (extremely strong)" to "R (under regulatory supervision)", and include 21 separate ratings categories, while "NR" indicates that Standard & Poor's has no opinion about the insurer's financial strength. Within these categories, "AAA" and "AA" are the highest, followed by "A" and "BBB". Publications of Standard & Poor's indicate that an insurer rated "BBB" is regarded as having good financial security characteristics, but is more likely to be affected by adverse business conditions than are higher rated insurers.
A.M. Best Company and Standard & Poor's review their ratings of insurance companies from time to time. There can be no assurance that any particular rating will continue for any given period of time or that it will not be changed or withdrawn entirely if, in their judgment, circumstances so warrant. If our ratings were to be negatively adjusted for any reason, we could experience a material decline in the sales of our products and the persistency of our existing business.
Reinsurance
Coinsurance
American Equity Life has two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of our fixed index and fixed rate annuities issued from August 1, 2001 through December 31, 2001, 40% of those contracts issued during 2002 and 2003, and 20% of those contracts issued from January 1, 2004 to July 31, 2004, when the agreement was suspended by mutual consent of the parties. As a result of the suspension, new business is no longer ceded to EquiTrust. The business reinsured under these agreements is not eligible for recapture before the expiration of 10 years. Coinsurance deposits (aggregate policy benefit reserves transferred to EquiTrust under these agreements) were $1.3 billion and $1.4 billion at December 31, 2010 and 2009, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to EquiTrust should EquiTrust fail to meet the obligations it has coinsured. EquiTrust has received a financial strength rating of "B+" (Good) with a stable outlook from A.M. Best Company. None of the coinsurance deposits with EquiTrust are deemed by management to be uncollectible.
Effective July 1, 2009, we entered into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in Bermuda. One agreement ceded 20% of certain of our fixed index annuities issued from January 1, 2009 through March 31, 2010. The business reinsured under this agreement is not eligible for recapture until the end of the month following seven years after the date of issuance of the policy. The other agreement cedes 80% of our multi-year rate guaranteed annuities issued on or after July 1, 2009. The business reinsured under this agreement may not be recaptured. Coinsurance deposits (aggregate policy benefit reserves transferred to Athene under these agreements) were $1.3 billion and $834.2 million at December 31, 2010 and 2009, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to Athene should Athene fail to meet the obligations it has coinsured. The annuity deposits that have been ceded to Athene are being held in a trust on a funds withheld basis. American Equity Life is named as the sole beneficiary of the trust. The funds withheld are required to remain at a value that is sufficient to support the current balance of policy benefit liabilities of the ceded business on a statutory basis. If the value of the funds withheld account would ever reach a point where it is less than the amount of the ceded policy benefit liabilities on a statutory basis, Athene is required to either establish a letter of credit or deposit securities in a trust for the amount of any shortfall. At December 31, 2010, Athene has adequate capital reserves and a significant capital commitment from its equity investor. None of the coinsurance deposits with Athene are deemed by management to be uncollectible.
Financing Arrangements
American Equity Life has two reinsurance transactions with Hannover Life Reassurance Company of America, ("Hannover"), which are treated as reinsurance under statutory accounting practices and as financing arrangements under U.S. generally accepted accounting principles ("GAAP"). The statutory surplus benefits under these agreements are eliminated under GAAP and the associated charges are recorded as risk charges and included in other operating costs and expenses in the consolidated statements of operations. Hannover has received a financial strength rating of "A" (Excellent) with a positive outlook from A.M. Best Company. The transactions became effective October 1, 2005 (the "2005 Hannover Transaction") and December 31, 2008 (the "2008 Hannover Transaction").
The 2008 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided $29.5 million in net pretax statutory surplus benefit in 2008. Pursuant to the terms of this agreement, pretax statutory surplus was reduced by $6.7 million in 2010 and is expected to be reduced as follows: 2011—$6.7 million; 2012—$6.8 million; 2013—$6.9 million. These amounts include risk charges equal to 5.0% of the pretax statutory surplus benefit as of the end of each calendar quarter.
The 2005 Hannover Transaction is a yearly renewable term reinsurance agreement for statutory purposes covering 47% of waived surrender charges related to penalty free withdrawals and deaths on certain business. The agreement was amended in 2010 and 2009 to include policy forms that were not in existence at the time this agreement became effective. We may recapture the risks reinsured under this agreement as of the end of any quarter beginning October 1, 2008. The 2009 amendment includes a provision that makes it punitive for us not to recapture the business ceded prior to January 1, 2013. The reserve credit recorded on a statutory basis by American Equity Life was $135.2 million and $106.8 million at December 31, 2010 and 2009, respectively. We pay quarterly reinsurance premiums under this agreement with an experience refund calculated on a quarterly basis resulting in a risk charge equal to approximately 5.8% of the weighted average statutory reserve credit.
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Indemnity Reinsurance
Consistent with the general practice of the life insurance industry, American Equity Life enters into agreements of indemnity reinsurance with other insurance companies in order to reinsure portions of the coverage provided by its annuity, life and accident and health insurance products. Indemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to diversify its risks. Indemnity reinsurance does not discharge the original insurer's primary liability to the insured.
The maximum loss retained by us on all life insurance policies we have issued was $0.1 million or less as of December 31, 2010. American Equity Life's reinsured business under indemnity reinsurance agreements is primarily ceded to two reinsurers. Reinsurance related to life and accident and health insurance that was ceded by us to these reinsurers was immaterial.
During 2007, American Equity Life entered into reinsurance agreements with Ace Tempest Life Reinsurance Ltd and Hannover to cede to each 50% of the risk associated with our living income benefit rider on certain fixed index annuities issued in 2007. The amounts ceded under these agreements were immaterial as of and for the years ended December 31, 2010 and 2009.
We believe the assuming companies will be able to honor all contractual commitments, based on our periodic review of their financial statements, insurance industry reports and reports filed with state insurance departments.
Regulation
Life insurance companies are subject to regulation and supervision by the states in which they transact business. State insurance laws establish supervisory agencies with broad regulatory authority, including the power to:
• | grant and revoke licenses to transact business; |
• | regulate and supervise trade practices and market conduct; |
• | establish guaranty associations; |
• | license agents; |
• | approve policy forms; |
• | approve premium rates for some lines of business; |
• | establish reserve requirements; |
• | prescribe the form and content of required financial statements and reports; |
• | determine the reasonableness and adequacy of statutory capital and surplus; |
• | perform financial, market conduct and other examinations; |
• | define acceptable accounting principles for statutory reporting; |
• | regulate the type and amount of permitted investments; and |
• | limit the amount of dividends and surplus note payments that can be paid without obtaining regulatory approval. |
Our life subsidiaries are subject to periodic examinations by state regulatory authorities. In 2009, an examination of American Equity Life as of December 31, 2008, was performed for the Iowa Insurance Division by its examiners under the authority granted to the Iowa Insurance Commissioner. There were no adjustments to American Equity Life's 2008 statutory financial statements as a result of this examination. In 2009, the New York Insurance Department completed an examination of American Equity Investment Life Insurance Company of New York as of December 31, 2007. There were no adjustments to American Equity Investment Life Insurance Company of New York's 2007 statutory financial statements required as a result of this examination; however, it consented to a prospective change in its cash flow testing (asset adequacy) analysis which resulted in a $9.4 million increase in December 31, 2010 statutory reserves.
The payment of dividends or the distributions, including surplus note payments, by our life subsidiaries is subject to regulation by each subsidiary's state of domicile's insurance department. Currently, American Equity Life may pay dividends or make other distributions without the prior approval of the Iowa Insurance Commissioner, unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1) American Equity Life's statutory net gain from operations for the preceding calendar year, or (2) 10% of American Equity Life's statutory surplus at the preceding December 31. For 2011, up to $187.5 million can be distributed as dividends by American Equity Life without prior approval of the Iowa Insurance Commissioner. In addition, dividends and surplus note payments may be made only out of earned surplus, and all surplus note payments are subject to prior approval by regulatory authorities. American Equity Life had $493.6 million of statutory earned surplus at December 31, 2010.
Most states have also enacted regulations on the activities of insurance holding company systems, including acquisitions, extraordinary dividends, the terms of surplus notes, the terms of affiliate transactions and other related matters. We are registered pursuant to such legislation in Iowa. A number of state legislatures have also considered or have enacted legislative proposals that alter and, in many cases, increase the authority of state agencies to regulate insurance companies and holding company systems.
Most states, including Iowa and New York where our life subsidiaries are domiciled, have enacted legislation or adopted administrative regulations affecting the acquisition of control of insurance companies as well as transactions between insurance companies and persons controlling them. The nature and extent of such legislation and regulations currently in effect vary from state to state. However, most states require administrative approval of the direct or indirect acquisition of 10% or more of the outstanding voting securities of an insurance company incorporated in the state. The acquisition of 10% of such securities is generally deemed to be the acquisition of "control" for the purpose of the holding company statutes and requires not only the filing of detailed information concerning the acquiring parties and the plan of acquisition, but also administrative approval prior to the acquisition. In many states, the insurance authority may find that "control" in fact does not exist in circumstances in which a person owns or controls more than 10% of the voting securities.
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Although the federal government does not directly regulate the business of insurance, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation, securities regulation and federal taxation can significantly affect the insurance business.
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 989J of this Act, known as the "Harkin Amendment," provides a safe harbor exemption from securities registration requirements for fixed index annuities, effectively overturning SEC Rule 151A which the SEC adopted in January 2009, providing for the regulation of fixed index annuities as securities beginning in January 12, 2011. Subsequently, in July 2010, Rule 151A was successfully challenged in court and vacated by the U.S. Court of Appeals for the D.C. Circuit, which led to the SEC withdrawing Rule 151A under the Securities Act of 1933 on October 14, 2010.
State insurance regulators and the National Association of Insurance Commissioners ("NAIC") are continually reexamining existing laws and regulations and developing new legislation for the passage by state legislatures and new regulations for adoption by insurance authorities. Proposed laws and regulations or those still under development pertain to insurer solvency and market conduct and in recent years have focused on:
• | insurance company investments; |
• | risk-based capital ("RBC") guidelines, which consist of regulatory targeted surplus levels based on the relationship of statutory capital and surplus, with prescribed adjustments, to the sum of stated percentages of each element of a specified list of company risk exposures; |
• | the implementation of non-statutory guidelines and the circumstances under which dividends may be paid; |
• | principles-based reserving; |
• | product approvals; |
• | agent licensing; |
• | underwriting practices; and |
• | life insurance and annuity sales practices. |
The NAIC's RBC requirements are intended to be used by insurance regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies for the purpose of initiating regulatory action. The RBC formula defines a minimum capital standard which supplements low, fixed minimum capital and surplus requirements previously implemented on a state-by-state basis. Such requirements are not designed as a ranking mechanism for adequately capitalized companies.
The NAIC's RBC requirements provide for four levels of regulatory attention depending on the ratio of a company's total adjusted capital to its RBC. Adjusted capital is defined as the total of statutory capital and surplus, asset valuation reserve and certain other adjustments. Calculations using the NAIC formula at December 31, 2010, indicated that American Equity Life's ratio of total adjusted capital to the highest level at which regulatory action might be initiated was 339%.
Our life subsidiaries also may be required, under the solvency or guaranty laws of most states in which they do business, to pay assessments up to certain prescribed limits to fund policyholder losses or liabilities of insolvent insurance companies. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. Assessments related to business reinsured for periods prior to the effective date of the reinsurance are the responsibility of the ceding companies.
Federal Income Tax
The annuity and life insurance products that we market generally provide the policyholder with a federal income tax advantage, as compared to certain other savings investments such as certificates of deposit and taxable bonds, in that federal income taxation on any increases in the contract values (i.e., the "inside build-up") of these products is deferred until it is received by the policyholder. With other savings investments, the increase in value is generally taxed each year as it is realized. Additionally, life insurance death benefits are generally exempt from income tax.
From time to time, various tax law changes have been proposed that could have an adverse effect on our business, including the elimination of all or a portion of the income tax advantage described above for annuities and life insurance. If legislation were enacted to eliminate the tax deferral for annuities, such a change would have an adverse effect on our ability to sell non-qualified annuities. Non-qualified annuities are annuities that are not sold to an individual retirement account or other qualified retirement plan.
Nearly all of the tax cuts which were contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Act") and accelerated by the provisions of the Jobs and Growth Tax Reconciliation Act of 2003 (the "2003 Act") were due to expire at the end of 2010. These tax cuts include a temporary reduction in individual income tax rates which can lower the present value of the tax deferred advantage of annuities and life insurance products for some individuals. On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law which eliminated the expiration of many of the 2001 Act tax cuts and also maintained the current level of individual tax bracket rates.
Beginning in 2013, distributions from non-qualified annuity policies will be considered "investment income" for purposes of the newly enacted Medicare tax on investment income contained in the Health Care and Education Reconciliation Act of 2010. As a result, in certain circumstances a 3.8% tax ("Medicare Tax") may be applied to some or all of the taxable portion of distributions from non-qualified annuities to individuals whose income exceeds certain threshold amounts. This new tax may have an adverse effect on our ability to sell non-qualified annuities to individuals whose income exceeds these threshold amounts and could accelerate withdrawals due to additional tax. The constitutionality of the Health Care and Education Reconciliation Act of 2010 is currently the subject of multiple litigation actions initiated by various state attorneys general, and it is also the subject of several proposals in the U.S. Congress for amendment and/or repeal. The outcome of such litigation and
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legislative action as it relates to the Medicare Tax is unknown at this time.
Employees
As of December 31, 2010, we had approximately 360 full-time employees. We have experienced no work stoppages or strikes and consider our relations with our employees to be excellent. None of our employees are represented by a union.
ITEM 1A. RISK FACTORS
Although economic conditions both domestically and globally have continued to improve since the financial crisis in 2008, we remain vulnerable to market uncertainty and continued financial instability of national, state and local governments. Continued difficult conditions in the global capital markets and economy could deteriorate in the near future and affect our financial position and our level of earnings from our operations.
Markets in the United States and elsewhere experienced extreme volatility and disruption since the second half of 2007, due in part to the financial stresses affecting the liquidity of the banking system and the financial markets. This volatility and disruption reached unprecedented levels in late 2008 and early 2009. The United States entered a severe recession and recovery has proved to be slow and long-term. High unemployment rates and lower average household income levels have emerged as continued lagging indicators of a slow economic recovery. The continuing market uncertainty has directly and materially affected our investment portfolio. One of the strategies used by the U.S. government to stimulate the economy has been to keep interest rates low and increase the supply of United States dollars. While these strategies have appeared to be somewhat successful, any future economic downturn or market disruption could negatively impact our ability to reinvest these funds.
If market conditions deteriorate in 2011 or beyond it could result in additional other than temporary impairments and impairments on our commercial mortgage loans. This may result in us needing to raise additional capital to sustain our current business in force and new sales of our annuity products, which may be difficult under current market conditions. If capital is available, it may be at terms that are not favorable to us. If we are unable to raise adequate capital, we may be required to limit growth in sales of our annuity products.
Additionally, if market conditions occurred that would subsequently effect our liquidity we could be forced to limit our operations and our business could suffer. We need liquidity to pay our policyholder benefits, operating expenses, dividends on our capital stock, and to service our debt obligations. The principal sources of our liquidity are annuity deposits, investment income and proceeds from the sale, maturity and call of investments. Additional sources of liquidity in normal markets also include a variety of short and long-term instruments, including long-term debt and capital securities.
Governmental initiatives intended to improve global and local economies that have been adopted may not be effective and, in any event, may be accompanied by other initiatives, including new capital requirements or other regulations, that could materially affect our results of operations, financial condition and liquidity in ways that we cannot predict.
We are subject to extensive laws and regulations that are administered and enforced by a number of different regulatory authorities including state insurance regulators, the NAIC, the SEC and the New York Stock Exchange. Some of these authorities are or may in the future consider enhanced or new regulatory requirements intended to prevent future economic crises or otherwise assure the stability of institutions under their supervision. These authorities may also seek to exercise their supervisory or enforcement authority in new or more robust ways. All of these possibilities, if they occurred, could affect the way we conduct our business and manage our capital, and may require us to satisfy increased capital requirements, any of which in turn could materially affect our results of operations, financial condition and liquidity.
We are exposed to significant financial and capital risk, including changing interest rates, credit spreads and equity prices which may have an adverse affect on sales of our products, profitability, investment portfolio and reported book value per share.
Future changes in interest rates, credit spreads and equity and bond indices may result in fluctuations in the income derived from our investments. These and other factors due to the current economic uncertainty could have a material adverse effect on our financial condition, results of operations or cash flows.
Interest rate and credit spread risk
Our interest rate risk is related to market price and changes in cash flow. Substantial and sustained increases and decreases in market interest rates can materially and adversely affect the profitability of our products, our ability to earn predictable returns, the fair value of our investments and the reported value of stockholders' equity. A rise in interest rates, in the absence of other countervailing changes, will increase the unrealized loss position of our investment portfolio. With respect to our available for sale fixed maturity securities, such declines in value (net of income taxes and certain adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements) reduce our reported stockholders' equity and book value per share.
If interest rates rise dramatically within a short period of time, our business may be exposed to disintermediation risk. Disintermediation risk is the risk that our policyholders may surrender all or part of their contracts in a rising interest rate environment, which may require us to sell assets in an unrealized loss position. Alternatively, we may increase crediting rates to retain business and reduce the level of assets that may need to be sold at a loss. However, such action would reduce our investment spread and net income.
We hold a substantial amount of fixed maturity securities that are callable by the issuer prior to maturity, and since 2008, we have received significant amounts of redemption proceeds related to calls of securities issued by United States Government sponsored agencies. We have reinvested the proceeds from these redemptions into new securities issued by such agencies, corporate securities and securities issued by United
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States municipalities, states and territories. The callable United States Government sponsored agencies that we own / purchase typically provide for 12 months of call protection, after which they may be called on the first anniversary of the issue date, or any semi-annual or annual redemption date thereafter. As such, at any financial reporting date, substantially all of the securities we own issued by United States Government sponsored agencies that are not residential mortgage-backed securities all callable by the respective agency within 12 months.
Due to the long-term nature of our annuity liabilities, sustained declines in long-term interest rates may result in increased redemptions of our fixed maturity securities that are subject to call redemption prior to maturity by the issuer and expose us to reinvestment risk. If we are unable to reinvest the proceeds from such redemptions into investments with credit quality and yield characteristics of the redeemed securities, our net income and overall financial performance may be adversely affected. We have a certain ability to mitigate this risk by lowering crediting rates on our products subject to certain restrictions as discussed below.
Our exposure to credit spreads is related to market price and changes in cash flows related to changes in credit spreads. If credit spreads widen significantly it would probably lead to additional other than temporary impairments. If credit spreads tighten significantly it could result in reduced net investment income associated with new purchases of fixed maturity securities.
Credit risk
We are subject to the risk that the issuers of our fixed maturity securities and other debt securities and borrowers on our commercial mortgages, will default on principal and interest payments, particularly if a major downturn in economic activity occurs. An increase in defaults on our fixed maturity securities and commercial mortgage loan portfolios could harm our financial strength and reduce our profitability.
Credit and cash flow assumption risk is the risk that issuers of securities, mortgagees on mortgage loans or other parties, including reinsurers and derivatives counterparties, default on their contractual obligations or experience adverse changes to their contractual cash flow streams. We attempt to minimize the adverse impact of this risk by monitoring portfolio diversification by asset class, creditor, industry, and by complying with investment limitations governed by state insurance laws and regulations as applicable. We also consider all relevant objective information available in estimating the cash flows related to residential mortgage backed securities. We monitor and manage exposures to determine whether securities are impaired or loans are deemed uncollectible.
We use derivative instruments to fund the annual credits on our fixed index annuities. We purchase derivative instruments, consisting primarily of one-year call options, from a number of counterparties. Our policy is to acquire such options only from counterparties rated "A-"or better by a nationally recognized rating agency and the maximum credit exposure to any single counterparty is subject to concentration limits. In addition, we have entered into credit support agreements which allow us to require posting of collateral by our counterparties to secure their obligations to us under the derivative instruments. If our counterparties fail to honor their obligations under the derivative instruments, our revenues may not be sufficient to fund the annual index credits on our fixed index annuities. Any such failure could harm our financial strength and reduce our profitability.
Liquidity risk
We could have difficulty selling our commercial mortgage loans because they are less liquid than our publicly traded securities. If we require significant amounts of cash on short notice, we may have difficulty selling these loans at attractive prices or in a timely manner, or both.
Fluctuations in interest rates and investment spread could adversely affect our financial condition, results of operations and cash flows.
A key component of our net income is the investment spread. A narrowing of investment spreads may adversely affect operating results. Although we have the right to adjust interest crediting rates (cap, participation or asset fee rates for fixed index annuities) on most products, changes to crediting rates may not be sufficient to maintain targeted investment spreads in all economic and market environments. In general, our ability to lower crediting rates is subject to minimum crediting rates filed with and approved by state regulators. In addition, competition and other factors, including the potential for increases in surrenders and withdrawals, may limit our ability to adjust or maintain crediting rates at levels necessary to avoid the narrowing of spreads under certain market conditions. Our policy structure generally provides for resetting of policy crediting rates at least annually and imposes withdrawal penalties for withdrawals during the first 3 to 17 years a policy is in force.
Managing the investment spread on our fixed index annuities is more complex than it is for fixed rate annuity products. We manage the index-based risk component of our fixed index annuities by purchasing call options on the applicable indices to fund the annual index credits on these annuities and by adjusting the caps, participation rates and asset fees on policy anniversary dates to reflect changes in the cost of such options which varies based on market conditions. The price of such options generally increases with increases in the volatility in the indices and interest rates, which may either narrow the spread or cause us to lower caps or participation rates. Thus, the volatility of the indices adds an additional degree of uncertainty to the profitability of the index products. We attempt to mitigate this risk by resetting caps, participation rates and asset fees annually on the policy anniversaries.
Our valuation of fixed maturity and equity securities may include methodologies, estimates and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition.
Fixed maturity securities and equity securities are reported at fair value in our consolidated balance sheets. During periods of market disruption including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. Prices provided by independent broker quotes or independent pricing services that are used in the determination of fair value can vary significantly for a particular security. There may be
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certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. As such, valuations may include inputs and assumptions that are less observable or require greater judgment as well as valuation methods that require greater judgment. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported in our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.
Defaults on commercial mortgage loans and volatility in performance may adversely affect our business, financial condition and results of operations.
Commercial mortgage loans face heightened delinquency and default risk due to recent economic conditions which have had a negative impact on the performance of the underlying collateral, resulting in declining values and an adverse impact on the obligors of such instruments. An increase in the default rate of our commercial mortgage loan investments could have an adverse effect on our business, financial condition and results of operations.
In addition, the carrying value of commercial mortgage loans is negatively impacted by such factors. The carrying value of commercial mortgage loans is stated at outstanding principal less any loan loss allowances recognized. Considerations in determining allowances include, but are not limited to, the following: (i) declining debt service coverage ratios and increasing loan to value ratios; (ii) bankruptcy filings of major tenants or affiliates of the borrower on the property; (iii) catastrophic events at the property; and (iv) other subjective events or factors, including whether the terms of the debt will be restructured. There can be no assurance that management's assessment of loan loss allowances on commercial mortgage loans will not change in future periods, which could lead to investment losses.
We face competition from companies that have greater financial resources, broader arrays of products, higher ratings and stronger financial performance, which may impair our ability to retain existing customers, attract new customers and maintain our profitability and financial strength.
We operate in a highly competitive industry. Many of our competitors are substantially larger and enjoy substantially greater financial resources, higher ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships. Our annuity products compete with index, fixed rate and variable annuities sold by other insurance companies and also with mutual fund products, traditional bank investments and other retirement funding alternatives offered by asset managers, banks and broker-dealers. Our insurance products compete with those of other insurance companies, financial intermediaries and other institutions based on a number of factors, including premium rates, policy terms and conditions, service provided to distribution channels and policyholders, ratings by rating agencies, reputation and commission structures.
While we compete with numerous other companies, we view the following as our most significant competitors:
• | Allianz Life Insurance Company of North America; |
• | Aviva USA; |
• | Midland National Life Insurance Company; |
• | ING USA Annuity & Life Insurance Company; and |
• | North American Company for Life and Health Insurance. |
Our ability to compete depends in part on rates of interest credited to policyholder account balances or the parameters governing the determination of index credits which is driven by our investment performance. We will not be able to accumulate and retain assets under management for our products if our investment results under perform the market or the competition, since such under performance likely would result in asset withdrawals and reduced sales.
We compete for distribution sources for our products. We believe that our success in competing for distributors depends on factors such as our financial strength, the services we provide to, and the relationships we develop with these distributors and offering competitive commission structures. Our distributors are generally free to sell products from whichever providers they wish, which makes it important for us to continually offer distributors products and services they find attractive. If our products or services fall short of distributors' needs, we may not be able to establish and maintain satisfactory relationships with distributors of our annuity and life insurance products. Our ability to compete in the past has also depended in part on our ability to develop innovative new products and bring them to market more quickly than our competitors. In order for us to compete in the future, we will need to continue to bring innovative products to market in a timely fashion. Otherwise, our revenues and profitability could suffer.
Our reinsurance program involves risks because we remain liable with respect to the liabilities ceded to reinsurers if the reinsurers fail to meet the obligations assumed by them.
Our life insurance subsidiaries cede certain policies to other insurance companies through reinsurance agreements. American Equity Life has entered into two coinsurance agreements with EquiTrust covering $1.3 billion of policy benefit reserves at December 31, 2010 and into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in Bermuda, covering $1.3 billion of policy benefit reserves at December 31, 2010. Since Athene is an unauthorized reinsurer, the annuity deposits that have been ceded to Athene are held in a trust on a funds withheld basis. The funds withheld are required to remain at a value that is sufficient to support the current balance of policy benefit liabilities of the ceded business on a statutory basis. If the value of the funds withheld would ever reach a point where it is less than the amount of the ceded policy benefit liabilities on a statutory basis, Athene is required to either establish a letter of credit or deposit securities to the funds withheld for the amount of any shortfall. Athene has adequate capital reserves and a significant capital commitment from its equity investor. We remain liable with respect to the policy liabilities ceded to EquiTrust and Athene should either fail to
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meet the obligations assumed by them.
In addition, we have entered into other types of reinsurance contracts including indemnity reinsurance and financing arrangements. Should any of these reinsurers fail to meet the obligations assumed under such contracts, we remain liable with respect to the liabilities ceded.
We may experience volatility in net income due to the application of fair value accounting to our derivative instruments.
All of our derivative instruments, including certain derivative instruments embedded in other contracts, are recognized in the balance sheet at their fair values and changes in fair value are recognized immediately in earnings. This impacts certain revenues and expenses we report for our fixed index annuity business as follows:
• | We must present the call options purchased to fund the annual index credits on our fixed index annuity products at fair value. 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. We record the change in fair value of these options as a component of our revenues. The change in fair value of derivatives includes the gains or losses recognized at expiration of the option term or upon early termination and changes in fair value for open positions. |
• | The contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases in equity market performance and changes in the interest rates used to discount the excess of the projected policy contract values over the projected minimum guaranteed contract values. We record the change in fair value of these embedded derivatives as a component of our benefits and expenses in our consolidated statements of operations. |
The application of fair value accounting for derivatives and embedded derivatives in future periods to our fixed index annuity business may cause substantial volatility in our reported net income.
We may face unanticipated losses if there are significant deviations from our assumptions regarding the probabilities that our annuity contracts will remain in force from one period to the next.
The expected future profitability of our annuity products is based in part upon expected patterns of premiums, expenses and benefits using a number of assumptions, including those related to the probability that a policy or contract will remain in force, or persistency, and mortality. Since no insurer can precisely determine persistency or mortality, actual results could differ significantly from assumptions, and deviations from estimates and assumptions could have a material adverse effect on our business, financial condition or results of operations. For example actual persistency that is lower than our assumptions could have an adverse impact on future profitability, especially in the early years of a policy or contract primarily because we would be required to accelerate the amortization of expenses we deferred in connection with the acquisition of the policy.
In addition, we set initial crediting rates for our annuity products based upon expected claims and payment patterns, using assumptions for, among other factors, mortality rates of our policyholders. The long-term profitability of these products depends upon how our actual experience compares with our pricing assumptions. For example, if mortality rates are lower than our pricing assumptions, we could be required to make more payments under certain annuity contracts in addition to what we had projected.
If our estimated gross profits change significantly from initial expectations we may be required to expense our deferred policy acquisition costs and deferred sales inducements in an accelerated manner, which would reduce our profitability.
Deferred policy acquisition costs represent costs that vary with and primarily relate to the acquisition of new business. Deferred sales inducements are contract enhancements such as first-year premium and interest bonuses that are credited to policyholder account balances. These costs are capitalized when incurred and are amortized over the life of the contracts. Current amortization of these costs is generally in proportion to expected gross profits from interest margins and, to a lesser extent, from surrender charges. Unfavorable experience with regard to expected expenses, investment returns, mortality or withdrawals may cause acceleration of the amortization of these costs resulting in an increase of expenses and lower profitability.
If we do not manage our growth effectively, our financial performance could be adversely affected; our historical growth rates may not be indicative of our future growth.
We have experienced rapid growth since our formation in December 1995. For the year ended December 31, 2010, our deposits from sales of new annuities were $4.7 billion. We intend to continue to grow by recruiting new independent agents, increasing the productivity of our existing agents, expanding our insurance distribution network, developing new products, expanding into new product lines, and continuing to develop new incentives for our sales agents. Future growth will impose significant added responsibilities on our management, including the need to identify, recruit, maintain and integrate additional employees, including management. There can be no assurance that we will be successful in expanding our business or that our systems, procedures and controls will be adequate to support our operations as they expand. In addition, due to our rapid growth and resulting increased size, it may be necessary to expand the scope of our investing activities to asset classes in which we historically have not invested or have not had significant exposure. If we are unable to adequately manage our investments in these classes, our financial condition or operating results in the future could be less favorable than in the past. Further, we have utilized reinsurance in the past to support our growth. The future availability and cost of reinsurance is uncertain. Our failure to manage growth effectively, or our inability to recruit, maintain and integrate additional qualified employees and independent agents, could have a material adverse effect on our business, financial condition or results of operations. In addition, due to our rapid growth, our historical growth rates are not likely to accurately reflect
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our future growth rates or our growth potential. We cannot assure you that our future revenues will increase or that we will continue to be profitable.
If we are unable to attract and retain national marketing organizations and independent agents, sales of our products may be reduced.
We distribute our annuity products through a variable cost distribution network which included over 50 national marketing organizations and 37,000 independent agents as of December 31, 2010. We must attract and retain such marketers and agents to sell our products. Insurance companies compete vigorously for productive agents. We compete with other life insurance companies for marketers and agents primarily on the basis of our financial position, support services, compensation and product features. Such marketers and agents may promote products offered by other life insurance companies that may offer a larger variety of products than we do. Our competitiveness for such marketers and agents also depends upon the long-term relationships we develop with them. If we are unable to attract and retain sufficient marketers and agents to sell our products, our ability to compete and our revenues would suffer.
We may require additional capital to support our business and sustained future growth which may not be available when needed or may be available only on unfavorable terms.
Our long-term strategic capital requirements will depend on many factors including the accumulated statutory earnings of our life insurance subsidiaries and the relationship between the statutory capital and surplus of our life insurance subsidiaries and various elements of required capital. To support long-term capital requirements, we may need to increase or maintain the statutory capital and surplus of our life insurance subsidiaries through additional financings, which could include debt, equity, financing arrangements and/or other surplus relief transactions. Adverse market conditions have affected and continue to affect the availability and cost of capital. Such financings, if available at all, may be available only on terms that are not favorable to us. If we cannot maintain adequate capital, we may be required to limit growth in sales of new annuity products, and such action could adversely affect our business, financial condition or results of operations.
Changes in state and federal regulation may affect our profitability.
We are subject to regulation under applicable insurance statutes, including insurance holding company statutes, in the various states in which our life insurance subsidiaries transact business. Our life insurance subsidiaries are domiciled in New York and Iowa. We are currently licensed to sell our products in 50 states and the District of Columbia. Insurance regulation is intended to provide safeguards for policyholders rather than to protect shareholders of insurance companies or their holding companies. As increased scrutiny has been placed upon the insurance regulatory framework, a number of state legislatures have considered or enacted legislative proposals that alter, and in many cases increase, state authority to regulate insurance companies and holding company systems.
Regulators oversee matters relating to trade practices, policy forms, claims practices, guaranty funds, types and amounts of investments, reserve adequacy, insurer solvency, minimum amounts of capital and surplus, transactions with related parties, changes in control and payment of dividends.
State insurance regulators and the NAIC continually reexamine existing laws and regulations and may impose changes in the future.
Our life insurance subsidiaries are subject to the NAIC's risk-based capital requirements which are intended to be used by insurance regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies for the purpose of initiating regulatory action. Our life insurance subsidiaries also may be required, under solvency or guaranty laws of most states in which they do business, to pay assessments up to certain prescribed limits to fund policyholder losses or liabilities for insolvent insurance companies.
Although the federal government does not directly regulate the insurance business, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation, securities regulation and federal taxation, can significantly affect the insurance business. In addition, legislation has been introduced in Congress which could result in the federal government assuming some role in the regulation of the insurance industry.
On July 21, 2010, President Obama signed into law the Dodd-Frank Act which, among other things, imposes a comprehensive new regulatory regime on the over-the-counter ("OTC") derivatives marketplace. The derivatives legislation is set forth in Title VII of the Dodd-Frank Act entitled "Wall Street Transparency and Accountability" (the "Derivatives Title"). With limited exceptions, the provisions of the Derivatives Title become effective on the later of 360 days following enactment and, to the extent a provision requires rulemaking, not less than 60 days after publication of the final rule. Once effective, this legislation will subject swap dealers and "major swap participants" (as defined in the legislation and further clarified by the rulemaking) to substantial supervision and regulation, including capital standards, margin requirements, business conduct standards, recordkeeping and reporting requirements. It also requires central clearing for certain derivatives transactions that the U.S. Commodities Futures Trading Commission ("CFTC") determines must be cleared and are accepted for clearing by a "derivatives clearing organization" (subject to certain exceptions) and provides the CFTC with authority to impose position limits across markets. Many key concepts, processes and issues under the Derivatives Title have been left to the relevant regulators to define and address. Although it is not possible at this time to assess the impact of the Dodd-Frank Act and any future regulations implementing the new legislation, the Dodd-Frank Act and any such regulations may subject us to additional restrictions on our hedging positions which may have an adverse effect on our ability to hedge risks associated with our business, including our fixed index annuity business, or on the cost of our hedging activity.
The Dodd-Frank Act also created a Financial Stability and Oversight Council. The Council may designate by a 2/3 vote whether certain insurance companies and insurance holding companies pose a grave threat to the financial stability of the United States, in which case such companies would become subject to prudential regulation by the Board of Governors of the U.S. Federal Reserve (the "Federal Reserve Board") (including capital requirements, leverage limits, liquidity requirements and examinations). The Federal Reserve Board may limit such company's ability
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to enter into merger transactions, restrict its ability to offer financial products, require it to terminate one or more activities, or impose conditions on the manner in which it conducts activities. The Dodd-Frank Act also established a Federal Insurance Office under the U.S. Treasury Department to monitor all aspects of the insurance industry and of lines of business other than certain health insurance, certain long-term care insurance and crop insurance. The director of the Federal Insurance Office will have the ability to recommend that an insurance company or an insurance holding company be subject to heightened prudential standards. The Dodd-Frank Act also provides for the pre-emption of state laws in certain instances involving the regulation of reinsurance and other limited insurance matters. The Dodd-Frank Act requires extensive rule-making and other future regulatory action, which in some cases will take a period of years to implement.
The regulatory framework at the state and federal level applicable to our insurance products is evolving. The changing regulatory framework could affect the design of such products and our ability to sell certain products. Any changes in these laws and regulations could materially and adversely affect our business, financial condition or results of operations.
Changes in federal income taxation laws, including any reduction in individual income tax rates, may affect sales of our products and profitability.
The annuity and life insurance products that we market generally provide the policyholder with certain federal income tax advantages. For example, federal income taxation on any increases in non-qualified annuity contract values (i.e. the "inside build-up") is deferred until it is received by the policyholder. With other savings investments, such as certificates of deposit and taxable bonds, the increase in value is generally taxed each year as it is realized. Additionally, life insurance death benefits are generally exempt from income tax.
From time to time, various tax law changes have been proposed that could have an adverse effect on our business, including the elimination of all or a portion of the income tax advantages described above for annuities and life insurance. If legislation were enacted to eliminate the tax deferral for annuities, such a change would have an adverse effect on our ability to sell non-qualified annuities. Non-qualified annuities are annuities that are not sold to a qualified retirement plan.
Beginning in 2013, distributions from non-qualified annuity policies will be considered "investment income" for purposes of the newly enacted Medicare tax on investment income contained in the Health Care and Education Reconciliation Act of 2010. As a result, in certain circumstances a 3.8% tax (“Medicare Tax”) may be applied to some or all of the taxable portion of distributions from non-qualified annuities to individuals whose income exceeds certain threshold amounts. This new tax may have an adverse effect on our ability to sell non-qualified annuities to individuals whose income exceeds these threshold amounts and could accelerate withdrawals due to additional tax. The constitutionality of the Health Care and Education Reconciliation Act of 2010 is currently the subject of multiple litigation actions initiated by various state attorneys general, and the Act is also the subject of several proposals in the US Congress for amendment and/or repeal. The outcome of such litigation and legislative action as it relates to the 3.8% Medicare tax is unknown at this time.
We face risks relating to litigation, including the costs of such litigation, management distraction and the potential for damage awards, which may adversely impact our business.
We are occasionally involved in litigation, both as a defendant and as a plaintiff. In addition, state regulatory bodies, such as state insurance departments, the SEC, the Financial Industry Regulatory Authority, Inc. ("FINRA"), the Department of Labor and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, the Employee Retirement Income Security Act of 1974, as amended, and laws governing the activities of broker-dealers. Companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims. We are currently a defendant in a class action and a purported class action lawsuit alleging improper sales practices. In these lawsuits, the plaintiffs are seeking returns of premiums and other compensatory and punitive damages.
In February 2011, we entered into a settlement with the plaintiffs in the class action lawsuit. Preliminary approval of the settlement was issued by the court on March 1, 2011, and although we anticipate final court approval of the settlement, there can be no assurance of such final approval. The pending purported class action lawsuit is in the pre-litigation and discovery stages. Although we do not believe this lawsuit will have a material adverse effect on our business, financial condition or results of operations, there can be no assurance that such litigation, or any other pending or future litigation, will not have such an effect, whether financially, through distraction of management or otherwise.
A downgrade in our credit or financial strength ratings may increase our future cost of capital and may reduce new sales, adversely affect relationships with distributors and increase policy surrenders and withdrawals.
Currently, our senior unsecured indebtedness carries a "bbb-" rating from A.M. Best Company and a "BB+" rating from Standard & Poor's. Our ability to maintain such ratings is dependent upon the results of operations of our subsidiaries and our financial strength. If we fail to preserve the strength of our balance sheet and to maintain a capital structure that rating agencies deem suitable, it could result in a downgrade of the ratings applicable to our senior unsecured indebtedness. A downgrade would likely reduce the fair value of the common stock and may increase our future cost of capital.
Financial strength ratings are important factors in establishing the competitive position of life insurance and annuity companies. In recent years, the market for annuities has been dominated by those insurers with the highest ratings. A ratings downgrade, or the potential for a ratings downgrade, could have a number of adverse effects on our business. For example, distributors and sales agents for life insurance and annuity products use the ratings as one factor in determining which insurer's annuities to market. A ratings downgrade could cause those distributors and agents to seek alternative carriers. In addition, a ratings downgrade could materially increase the number of policy or contract surrenders we experience, as well as our ability to obtain reinsurance or obtain reasonable pricing on reinsurance.
Financial strength ratings are measures of an insurance company's ability to meet contractholder and policyholder obligations and generally
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involve quantitative and qualitative evaluations by rating agencies of a company's financial condition and operating performance. Generally, rating agencies base their ratings upon information furnished to them by the insurer and upon their own investigations, studies and assumptions. Ratings are based upon factors of concern to agents, policyholders and intermediaries and are not directed toward the protection of investors and are not recommendations to buy, sell or hold securities.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease commercial office space in one building in West Des Moines, Iowa, for our principal offices under an operating lease that expires on November 21, 2021. We also lease our office in Pell City, Alabama, pursuant to an operating lease that expires on December 31, 2011. We are fully utilizing these facilities and believe both locations to be sufficient to house our operations for the foreseeable future.
Item 3. Legal Proceedings
We are occasionally involved in litigation, both as a defendant and as a plaintiff. In addition, state regulatory bodies, such as state insurance departments, the SEC, FINRA, the Department of Labor, and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, the Employee Retirement Income Security Act of 1974, as amended, and laws governing the activities of broker-dealers.
In recent years, companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims. We are currently a defendant in two lawsuits, one class action and one purported class action, involving allegations of improper sales practices and similar claims as described below. In February 2011, we entered into a settlement with the plaintiffs in the class action lawsuit, which is subject to final court approval and is more fully described below. The pending purported class action lawsuit referred to below is in the pre-litigation and discovery stages and we do not have sufficient information to make an assessment of the plaintiffs' claims for liability or damages. The plaintiffs are seeking undefined amounts of damages or other relief, including punitive damages, which are difficult to quantify and cannot be estimated based on the information currently available. While we are uncertain as to the ultimate outcome of the pending purported class action lawsuit, there can be no assurance that such litigation, or any other pending or future litigation, will not have a material adverse effect on our business, financial condition, or results of operations.
We are a defendant in two cases, including (i) Stephens v. American Equity Investment Life Insurance Company, et. al., in the San Luis Obispo Superior Court, San Francisco, California (complaint filed November 29, 2004) (the "SLO Case") and (ii) McCormack, et al. v. American Equity Investment Life Insurance Company, et al., in the United States District Court for the Central District of California, Western Division and Anagnostis v. American Equity, et al., coordinated in the Central District, entitled, In Re: American Equity Annuity Practices and Sales Litigation, in the United States District Court for the Central District of California, Western Division (complaint filed September 7, 2005) (the "Los Angeles Case").
The plaintiffs in the SLO Case represent a class of individuals who are California residents age 65 and older and who either purchased their annuity from us through a co-defendant marketing organization or who purchased one of a defined set of particular annuities issued by us. The named plaintiffs in this case are: Chalys M. Stephens and John P. Stephens. Following a mediation conducted on January 21, 2011, we reached a settlement in principal with the plaintiffs. Preliminary approval of the settlement was issued by the court on March 1, 2011, and although we anticipate final court approval of the settlement, there can be no assurance of such final approval. The settlement, if final court approval is received, will provide a total settlement benefit of $36 million to past and present policyholders who are members of the class and, if awarded by the court, will provide for attorneys' fees payable to the plaintiffs' counsel of up to $11 million, litigation expenses in an amount up to $950,000, and incentives of $25,000 payable to each of the two class representatives. The net charge to operations for the settlement (after related reductions in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes) was $27.3 million and is included in our consolidated financial statements for the year ended December 31, 2010.
The Los Angeles Case is a consolidated action involving several lawsuits filed by individuals, and the individuals are seeking class action status for a national class of purchasers of annuities issued by us. The named plaintiffs in this consolidated case are Bernard McCormack, Gust Anagnostis by and through Gary S. Anagnostis and Robert C. Anagnostis, Regina Bush by and through Sharon Schipiour, Lenice Mathews by and through Mary Ann Maclean and George Miller. The allegations generally attack the suitability of sales of deferred annuity products to persons over the age of 65. The plaintiffs seek recessionary and injunctive relief including restitution and disgorgement of profits on behalf of all class members under California Business & Professions Code section 17200 et seq. and Racketeer Influenced and Corrupt Organizations Act; compensatory damages for breach of fiduciary duty and aiding and abetting of breach of fiduciary duty; unjust enrichment and constructive trust; and other pecuniary damages under California Civil Code section 1750 and California Welfare & Institutions Codes section 15600 et seq. We are vigorously defending against both class action status as well as the underlying claims.
Item 4. Reserved
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange ("NYSE") under the symbol AEL. The following table sets forth the high and low prices of our common stock as quoted on the NYSE.
2010 | High | Low | ||||||
First Quarter | $ | 10.99 | $ | 6.65 | ||||
Second Quarter | $ | 11.64 | $ | 8.53 | ||||
Third Quarter | $ | 11.19 | $ | 9.19 | ||||
Fourth Quarter | $ | 13.01 | $ | 10.11 | ||||
2009 | ||||||||
First Quarter | $ | 7.40 | $ | 2.96 | ||||
Second Quarter | $ | 8.86 | $ | 4.01 | ||||
Third Quarter | $ | 8.65 | $ | 5.24 | ||||
Fourth Quarter | $ | 8.40 | $ | 6.10 | ||||
As of March 2, 2011, there were approximately 7,700 holders of our common stock. In 2010 and 2009, we paid an annual cash dividend of $0.10 and $0.08, respectively, per share on our common stock. We intend to continue to pay an annual cash dividend on such shares so long as we have sufficient capital and/or future earnings to do so. However, we anticipate retaining most of our future earnings, if any, for use in our operations and the expansion of our business. Any further determination as to dividend policy will be made by our board of directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition and future prospects and such other factors as our board of directors may deem relevant.
Since we are a holding company, our ability to pay cash dividends depends in large measure on our subsidiaries' ability to make distributions of cash or property to us. Iowa insurance laws restrict the amount of distributions American Equity Life can pay to us without the approval of the Iowa Insurance Commissioner. See Management's Discussion and Analysis of Financial Condition and Results of Operations and note 12 to our audited consolidated financial statements.
Issuer Purchases of Equity Securities
There were no issuer purchases of equity securities for the quarter ended December 31, 2010.
We have a Rabbi Trust, the NMO Deferred Compensation Trust, which purchases our common shares to fund the amount of shares earned by our agents and vested under the NMO Deferred Compensation Plan. At December 31, 2010, agents had earned 81,745 shares which had vested but had not yet been purchased and contributed to the Rabbi Trust.
In addition, we have a share repurchase program under which we are authorized to purchase up to 10,000,000 shares of our common stock. As of December 31, 2010 we have repurchased 3,845,296 shares of our common stock under this program. We suspended the repurchase of our common stock under this program in August of 2008.
The maximum number of shares that may yet be purchased under these plans is 6,236,449 at December 31, 2010.
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Item 6. Selected Consolidated Financial Data
The summary consolidated financial and other data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our audited consolidated financial statements and related notes appearing elsewhere in this report. The results for past periods are not necessarily indicative of results that may be expected for future periods.
Year ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||||||
Consolidated Statements of Operations Data: | ||||||||||||||||||||
Revenues | ||||||||||||||||||||
Annuity product charges | $ | 69,075 | $ | 63,358 | $ | 52,671 | $ | 45,828 | $ | 39,472 | ||||||||||
Net investment income | 1,036,106 | 932,172 | 822,077 | 719,916 | 677,638 | |||||||||||||||
Change in fair value of derivatives | 168,862 | 216,896 | (372,009 | ) | (59,985 | ) | 183,783 | |||||||||||||
Net realized gains on investments, excluding other than temporary impairment ("OTTI") losses | 23,726 | 51,279 | 5,555 | 501 | 2,682 | |||||||||||||||
Net OTTI losses recognized in operations | (23,867 | ) | (86,771 | ) | (192,648 | ) | (4,383 | ) | (1,337 | ) | ||||||||||
Total revenues | 1,285,592 | 1,188,913 | 337,904 | 714,500 | 915,860 | |||||||||||||||
Benefits and expenses | ||||||||||||||||||||
Interest sensitive and index product benefits | 733,218 | 347,883 | 205,131 | 560,209 | 404,269 | |||||||||||||||
Change in fair value of embedded derivatives | 130,950 | 529,508 | (210,753 | ) | (67,902 | ) | 151,057 | |||||||||||||
Amortization of deferred sales inducements and policy acquisition costs | 192,261 | 128,008 | 157,443 | 68,038 | 119,716 | |||||||||||||||
Interest expense on notes payable and subordinated debentures | 37,031 | 30,672 | 39,218 | 43,436 | 42,632 | |||||||||||||||
Interest expense on amounts due under repurchase agreements | — | 534 | 8,207 | 15,926 | 32,931 | |||||||||||||||
Other operating costs and expenses | 114,615 | 57,255 | 52,633 | 48,230 | 40,418 | |||||||||||||||
Total benefits and expenses | 1,220,326 | 1,102,749 | 260,851 | 676,356 | 799,831 | |||||||||||||||
Income before income taxes | 65,266 | 86,164 | 77,053 | 38,144 | 116,029 | |||||||||||||||
Income tax expense | 22,333 | 17,634 | 61,106 | 11,914 | 41,068 | |||||||||||||||
Net income | 42,933 | 68,530 | 15,947 | 26,230 | 74,961 | |||||||||||||||
Per Share Data: | ||||||||||||||||||||
Earnings per common share | $ | 0.73 | $ | 1.22 | $ | 0.30 | $ | 0.46 | $ | 1.33 | ||||||||||
Earnings per common share—assuming dilution | 0.68 | 1.18 | 0.30 | 0.46 | 1.26 | |||||||||||||||
Dividends declared per common share | 0.10 | 0.08 | 0.07 | 0.06 | 0.05 | |||||||||||||||
Non-GAAP Financial Measure (a): | ||||||||||||||||||||
Operating income | $ | 108,947 | $ | 101,778 | $ | 72,472 | $ | 61,532 | $ | 69,977 | ||||||||||
Reconciliation to net income: | ||||||||||||||||||||
Net income | $ | 42,933 | $ | 68,530 | $ | 15,947 | $ | 26,229 | $ | 74,961 | ||||||||||
Net realized gains and net OTTI losses on investments, net of offsets | 379 | (1,339 | ) | 92,524 | 1,688 | (427 | ) | |||||||||||||
Convertible debt extinguishment, net of income taxes | 171 | 687 | (5,702 | ) | — | — | ||||||||||||||
Net effect of derivatives, embedded derivatives and other index annuity, net of offsets | 38,167 | 29,952 | (31,038 | ) | 33,615 | (4,557 | ) | |||||||||||||
Effect of counterparty default, net of offsets | — | 3,948 | 741 | — | — | |||||||||||||||
Litigation settlement, net of offsets | 27,297 | — | — | — | — | |||||||||||||||
Operating income | $ | 108,947 | $ | 101,778 | $ | 72,472 | $ | 61,532 | $ | 69,977 | ||||||||||
Operating income per common share | $ | 1.86 | $ | 1.81 | $ | 1.35 | $ | 1.08 | $ | 1.24 | ||||||||||
Operating income per common share—assuming dilution | 1.70 | 1.75 | 1.30 | 1.05 | 1.18 | |||||||||||||||
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As of and for the Year Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||
Total investments | $ | 19,816,931 | $ | 15,374,110 | $ | 12,719,605 | $ | 12,610,895 | $ | 11,385,464 | ||||||||||
Total assets | 26,426,763 | 21,312,004 | 17,081,740 | 16,384,690 | 14,979,198 | |||||||||||||||
Policy benefit reserves | 23,655,807 | 19,336,221 | 15,809,539 | 14,711,780 | 13,207,931 | |||||||||||||||
Notes payable | 330,835 | 316,468 | 247,750 | 248,968 | 243,022 | |||||||||||||||
Subordinated debentures | 268,435 | 268,347 | 268,209 | 268,330 | 268,489 | |||||||||||||||
Accumulated other comprehensive income (loss) ("AOCI") | 81,820 | (30,456 | ) | (147,376 | ) | (38,929 | ) | (38,769 | ) | |||||||||||
Total stockholders' equity | 938,047 | 754,623 | 496,844 | 621,324 | 607,502 | |||||||||||||||
Other Data: | ||||||||||||||||||||
Life subsidiaries' statutory capital and surplus and asset valuation reserve | 1,456,679 | 1,239,651 | 1,011,682 | 1,013,845 | 1,009,192 | |||||||||||||||
Life subsidiaries' statutory net gain from operations before income taxes and realized capital gains (losses) | 322,133 | 253,146 | 129,046 | 41,473 | 95,217 | |||||||||||||||
Life subsidiaries' statutory net income (loss) | 172,865 | 116,895 | (7,073 | ) | 17,010 | 89,875 | ||||||||||||||
Book value per share (b) | $ | 16.07 | $ | 13.08 | $ | 9.46 | $ | 11.11 | $ | 10.82 | ||||||||||
Book value per share, excluding AOCI (b) | 14.67 | 13.61 | 12.27 | 11.81 | 11.51 | |||||||||||||||
____________________
(a) | In addition to net income, we have consistently utilized operating income, operating income per common share and operating income per common share—assuming dilution, non-GAAP financial measures commonly used in the life insurance industry, as economic measures to evaluate our financial performance. Operating income equals net income adjusted to eliminate the impact of net realized gains on investments including net OTTI losses recognized in operations and related deferred tax asset valuation allowance, (gain) loss on extinguishment of convertible debt, fair value changes in derivatives and embedded derivatives, the Lehman counterparty default on expired call options and the net charge to settle a class action lawsuit. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of operating income together with net income, provides information that may enhance an investor's understanding of our underlying results and profitability. |
(b) | Book value per share and book value per share excluding AOCI is calculated as total stockholders' equity and total stockholders' equity excluding AOCI divided by the total number of shares of common stock outstanding. AOCI fluctuates from year to year due to unrealized changes in the fair value of available for sale investments. Shares outstanding include shares held by the NMO Deferred Compensation Trust and exclude unallocated shares held by our employee stock ownership plan—see note 11 to our audited consolidated financial statements. |
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's discussion and analysis reviews our consolidated financial position at December 31, 2010 and 2009, and our consolidated results of operations for the three years in the period ended December 31, 2010, and where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with our audited consolidated financial statements, notes thereto and selected consolidated financial data appearing elsewhere in this report.
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 the SEC, 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 impairments and other than temporary impairments, and certain liabilities, and the lapse rate and profitability of policies; |
• | customer response to new products and marketing initiatives; |
• | changes in the Federal income tax laws and regulations which may affect the relative income tax advantages of our products; |
• | increasing competition in the sale of 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 SEC. |
For a detailed discussion of these and other factors that might affect our performance, see Item 1A of this report.
Executive Summary
Since our formation in 1995, we have emphasized industry leading customer service to both our distribution force and our policyholders. We believe this to be a major part of our ability to attract production from our independent agent network as well as a low rate of policy surrenders. Excellent customer service teamed with our ability to design innovative insurance products that provide principal protection and tax deferred growth have continued to result in significant sales of our annuity products year over year. High sales levels has driven us to industry leading growth rates and to cash and investments in excess of $20 billion at December 31, 2010, in only 15 years of operations. We have applied a conservative investment strategy to the annuity deposits we continue to manage which has provided reliable returns on our invested assets. Our profitability has also been driven by maintaining an efficient operation.
In 2010, we issued $200 million principal amount of convertible senior notes. We used the proceeds from issuance of the convertible senior notes to fully repay the $150 million line of credit. Subsequent to the end of 2010, we obtained a new three year $160 million revolving line of credit and have terminated the $150 million line. We have $74.5 million principal amount of convertible notes that holders may require us to redeem in 2011 and at December 31, 2010, the parent company had cash and cash equivalents totaling $62.3 million available to extinguish this debt.
Over the past several years we have steadily grown our invested assets, investment spread and operating income (a non-GAAP financial measurement - see Item 6. Selected Consolidated Financial Data) despite the challenging economic conditions and interest rate environment. Our business model contemplates continued growth in invested assets and operating income while maintaining a high quality investment portfolio that will not experience significant losses from impairments of invested assets. Growth in invested assets is predicated on a continuation of our high sales achievements of the last two years while at the same time maintaining a high level of retention of the funds received. The economic and personal investing environments continue to be conducive for high sales levels as retirees and others look to put their money in instruments that will protect their principal and provide them with consistent cash flow sources in their retirement years. We expect to continue to grow our operating income by maintaining a reliable investment spread of 2.90% or more through effective management of our investment portfolio and the cost of money for our annuity business. We are committed to maintaining a high quality investment portfolio with limited exposure to below investment grade securities and other riskier assets.
Overview
We specialize in the sale of individual annuities (primarily deferred annuities) and, to a lesser extent, we also sell life insurance policies. Under U.S. generally accepted accounting principles ("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 and other charges deducted from the account balances of policyholders, 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), 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.
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Earnings from products accounted for as deposit liabilities are primarily generated from the excess of net investment income earned over the interest credited or the cost of providing index credits to the policyholder, or the "investment spread." Our investment spread is summarized as follows:
Year Ended December 31, | |||||||||
2010 | 2009 | 2008 | |||||||
Average yield on invested assets | 6.06 | % | 6.30 | % | 6.20 | % | |||
Cost of money: | |||||||||
Aggregate | 2.91 | % | 3.26 | % | 3.43 | % | |||
Cost of money for fixed index annuities | 2.86 | % | 3.24 | % | 3.43 | % | |||
Average crediting rate for fixed rate annuities: | |||||||||
Annually adjustable | 3.26 | % | 3.26 | % | 3.26 | % | |||
Multi-year rate guaranteed | 3.74 | % | 3.88 | % | 3.88 | % | |||
Investment spread: | |||||||||
Aggregate | 3.15 | % | 3.04 | % | 2.77 | % | |||
Fixed index annuities | 3.20 | % | 3.06 | % | 2.77 | % | |||
Fixed rate annuities: | |||||||||
Annually adjustable | 2.80 | % | 3.04 | % | 2.94 | % | |||
Multi-year rate guaranteed | 2.32 | % | 2.42 | % | 2.32 | % | |||
The cost of money for fixed index annuities and average crediting rates for fixed rate annuities are computed based upon policyholder account balances and do not include the impact of amortization of deferred sales inducements. See Critical Accounting Policies—Deferred Policy Acquisition Costs and Deferred Sales Inducements. With respect to our fixed index annuities, the cost of money includes the average crediting rate on amounts allocated to the fixed rate strategy, expenses we incur to fund the annual index credits and where applicable, minimum guaranteed interest credited. Proceeds received upon expiration or early termination 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.
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 impairment of investments, 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 to agents and bonuses credited to policyholders) and our ability to manage our operating expenses.
Results of Operations for the Three Years Ended December 31, 2010
Annuity deposits by product type collected during 2010, 2009 and 2008, were as follows:
Year Ended December 31, | ||||||||||||
Product Type | 2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | ||||||||||||
Fixed index annuities: | ||||||||||||
Index strategies | $ | 2,401,891 | $ | 1,535,477 | $ | 1,303,871 | ||||||
Fixed strategy | 1,551,007 | 1,849,833 | 937,227 | |||||||||
3,952,898 | 3,385,310 | 2,241,098 | ||||||||||
Fixed rate annuities: | ||||||||||||
Single-year rate guaranteed | 331,705 | 113,511 | 28,930 | |||||||||
Multi-year rate guaranteed | 384,116 | 178,737 | 18,978 | |||||||||
715,821 | 292,248 | 47,908 | ||||||||||
Total before coinsurance ceded | 4,668,719 | 3,677,558 | 2,289,006 | |||||||||
Coinsurance ceded | 478,963 | 749,259 | 1,310 | |||||||||
Net after coinsurance ceded | $ | 4,189,756 | $ | 2,928,299 | $ | 2,287,696 | ||||||
Annuity deposits before coinsurance ceded increased 27% during 2010 compared to 2009 and 61% during 2009 compared to 2008. We attribute these increases to factors including the highly competitive rates of our products, our continued strong relationships with our national marketing organizations and field force of licensed, independent insurance agents the increased attractiveness of safe money products in volatile markets, lower interest rates on competing products such as bank certificates of deposit and product enhancements including a new generation of guaranteed income withdrawal benefit riders. In addition, we continue to benefit from the actions of several significant competitors who have been less aggressive in marketing their products than in prior periods. The extent to which this trend will be sustained in future periods is uncertain.
19
As reported in our 2009 filings, we undertook several actions in 2009 to manage our statutory capital position to facilitate growth. These actions included a restructuring of commission payments to agents, an amendment to a reinsurance agreement to expand such agreement to cover certain policy forms that were not in existence when the agreement was executed and the entry into two funds withheld coinsurance agreements to reinsure a portion of our 2009 sales. Under the 2009 coinsurance agreements, we ceded to the reinsurer 20% of annuity deposits received in 2009 and the first quarter of 2010 from our two top selling fixed index annuity products and 80% of the annuity deposits received after June 30, 2009 from a multi-year rate guaranteed fixed annuity product. The agreement to cede 80% of the annuity deposits from the multi-year rate guaranteed fixed annuity product is ongoing. Effective April 1, 2010, we are retaining 100% of our fixed index annuity deposits and are no longer ceding any portion of those annuity deposits to the reinsurer. We believe our existing statutory capital and surplus and the statutory surplus we expect to generate internally through statutory earnings will support a higher level of new business growth than in previous years. However, while we have the capital resources to accept more business than was sold in 2009, our capacity is not unlimited and sales growth must be matched with available resources to maintain desired financial strength ratings from credit rating agencies and in particular, A.M. Best Company. Should sales growth accelerate to levels that cannot be supported by internal capital generation, we would intend to obtain capital from external sources to facilitate such growth. Given the prospects for higher levels of new business in 2011, in February 2011 we entered into a binding letter of intent to complete an additional surplus relief reinsurance transaction on or before March 31, 2011 that will provide an initial pretax statutory surplus benefit of $49.2 million.
Net income decreased 37% to $42.9 million in 2010 and increased 330% to $68.5 million in 2009 from $15.9 million in 2008. Net income for 2008 does not include the impact of applying the FASB guidance for recognition and presentation of other than temporary impairments that was released in April 2009 as discussed below. Net income for 2008 includes the impact of the adoption of fair value measurement accounting standards as discussed below.
Net income has been positively impacted by the growth in the volume of business in force and the investment spread earned on this business. Average annuity account values outstanding increased 18% for the year ended December 31, 2010 compared to 2009 and 14% for the year ended December 31, 2009 compared to 2008. Our investment spread measured on a percentage basis was 3.15%, 3.04% and 2.77% for the years ended December 31, 2010, 2009 and 2008, respectively. The increase in investment spread in 2010 resulted from a lower aggregate cost of money on our fixed index annuities, offset in part, by a smaller decline in the yield on invested assets. The lower cost of money for fixed index annuities during 2010 was due to lower costs of options purchased to fund the annual index credits on fixed index annuities and lower rates for the fixed rate strategy in fixed index annuities. The 2010 decrease in the average yield on invested assets was primarily attributable to a lag in reinvestment of proceeds from bonds called for redemption during the year into new assets resulting in high levels of low yielding short-term investments and interest earning cash and cash equivalents. The 2010 decrease in average yield on invested assets was also effected by lower yields on investments purchased in 2010. The increase in investment spread in 2009 resulted from a higher investment yield earned in 2009 on average assets due to higher yields on investments purchased subsequent to 2007 and a lower aggregate cost of money on our fixed index annuities for 2010 and 2009. The lower cost of money for fixed index annuities during 2009 was due to adjustments we made throughout 2007 to caps, participation rates and asset fees to manage the cost of options purchased to fund the annual index credits. The benefit from these adjustments was not fully recognized until the fourth quarter of 2008.
Operating income, a non-GAAP financial measure (see reconciliation to net income in Item 6 - Selected Consolidated Financial Data) increased 7% to $108.9 million in 2010 and increased 40% to $101.8 in 2009 from $72.5 million in 2008.
In addition to net income, we have consistently utilized operating income, a non-GAAP financial measure commonly used in the life insurance industry, as an economic measure to evaluate our financial performance. Operating income equals net income adjusted to eliminate the impact of net realized gains on investments, including net other than temporary impairment ("OTTI") losses recognized in operations and related deferred tax asset valuation allowance, (gain) loss on retirement of debt, fair value changes in derivatives and embedded derivatives, the Lehman counterparty default on expired call options and the cost to settle a class action lawsuit. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of operating income together with net income, provides information that may enhance an investor's understanding of our underlying results and profitability.
Operating income is not a substitute for net income determined in accordance with GAAP. The adjustments made to derive adjusted operating income are important to understanding our overall results from operations and, if evaluated without proper context, operating income possesses material limitations. As an example, we could produce a low level of net income in a given period, despite strong operating performance, if in that period we generate significant net realized losses from our investment portfolio. We could also produce a high level of net income 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 operating income, it does not include the decrease in cash flows expected to be collected as a result of credit loss OTTI. Therefore, our management and board of directors also separately review net realized investment gains (losses) and analyses of our net investment income, including impacts related to OTTI write-downs, in connection with their review of our investment portfolio. In addition, our management and board of directors examine net income as part of their review of our overall financial results.
Net realized gains on investments and net impairment losses recognized in operations fluctuate from year to year based upon changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments. We adopted the FASB guidance for recognition and presentation of other than temporary impairments that was released in April 2009 on January 1, 2009, which amended the determination of the amount of other than temporary impairments recognized in the statement of operations resulting in the noncredit portion of other than temporary impairments being recognized in other comprehensive income for debt securities that we do not intend to sell and it is not more likely than not we will be required to sell but also do not expect to recover the entire amortized cost basis of the security. The amounts disclosed in the non-GAAP reconciliation in Item 6-Selected Consolidated Financial Data are net of related reductions in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes. Income tax benefits related to net realized
20
gains on investments and net other than temporary impairment losses recognized in operations were reduced by $34.5 million in 2008 for the establishment of a deferred tax valuation allowance related to the other than temporary impairments and capital loss carryforwards. Net income for 2009 includes a benefit of $11.9 million for the reduction of the deferred tax valuation allowance related to other than temporary impairments and capital loss carryforwards.
Amounts attributable to the fair value accounting for derivatives and embedded derivatives primarily fluctuate from year to year based upon changes in the fair values of call options purchased to fund the annual index credits for fixed index annuities and changes in the interest rates used to discount the embedded derivative liability. The amounts disclosed in the non-GAAP reconciliation in Item 6-Selected Consolidated Financial Data are net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and income taxes. The significant changes in the impact from the item disclosed in the non-GAAP reconciliation in Item 6-Selected Consolidated Financial Data relate primarily to changes in the interest rates used to discount the embedded derivative liabilities. Pursuant to fair value measurements accounting standards adopted prospectively on January 1, 2008, the discount rates are based on risk-free interest rates adjusted for our nonperformance risk. These rates decreased during the years ended December 31, 2010 and 2009 resulting in decreases in net income for those years. Prior to the adoption of the fair value measurements accounting standards, the discount rates used were risk-free interest rates without adjustment for our nonperformance risk. The change to discount rates including our nonperformance risk resulted in a decrease in policy benefit reserves on January 1, 2008 of $150.6 million. The net income impact of this decrease in reserves net of the related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and income taxes was $40.7 million.
See note 13 in our audited consolidated financial statements for further discussion of the litigation settlement.
Annuity product charges (surrender charges assessed against policy withdrawals and fees deducted from policyholder account balances for living income benefit riders) increased 9% to $69.1 million in 2010 and 20% to $63.4 million in 2009 from $52.7 million in 2008. These increases were principally attributable to increases in the amount of fees assessed for lifetime income benefit riders which were $13.5 million and $4.5 million for the years ended December 31, 2010 and 2009, respectively. Withdrawals from annuity and single premium universal life policies subject to surrender charges were $418.9 million, $432.1 million and $420.8 million for the years ended December 31, 2010, 2009 and 2008, respectively. The average surrender charge collected on withdrawals subject to a surrender charge was 13.2%, 13.5% and 12.4% for the year ended December 31, 2010, 2009 and 2008, respectively.
Net investment income increased 11% to $1,036.1 million in 2010 and 13% to $932.2 million in 2009 from $822.1 million in 2008. These increases were principally attributable to the growth in our annuity business and corresponding increases in our invested assets. Average invested assets excluding derivative instruments (on an amortized cost basis) increased 15% to $17.1 billion in 2010 and 12% to $14.8 billion in 2009 compared to $13.2 billion in 2008. The average yield earned on invested assets was 6.06%, 6.30% and 6.20% for 2010, 2009 and 2008, respectively. The decrease in yield earned on average invested assets in 2010 was attributable to a lag in reinvestment of proceeds from bonds called for redemption during 2010 into new assets causing excess liquidity. The 2010 decrease yield on invested assets was also effected by lower yields on investments purchased in 2010. Based on yields received for purchases of fixed maturity securities in 2010, we estimate that approximately $27.9 million in net investment income was foregone during 2010, as a result of the excess liquidity, and the average yield on invested assets would have been 6.23% for 2010 if such income had been earned. The increase in yield earned on average invested assets in 2009 was attributable to higher yields on investments purchased in 2009 and 2008.
Change in fair value of derivatives (principally call options purchased to fund annual index credits on fixed index annuities) is affected by the performance of the indices upon which our options are based and the aggregate cost of options purchased. The components of change in fair value of derivatives are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Call options: | |||||||||||
Gain (loss) on option expiration | $ | 208,881 | $ | (196,000 | ) | $ | (270,361 | ) | |||
Change in unrealized gain (loss) | (67,078 | ) | 415,276 | (100,453 | ) | ||||||
2015 notes hedges | 29,595 | — | — | ||||||||
Interest rate swaps | (2,536 | ) | (2,380 | ) | (1,195 | ) | |||||
$ | 168,862 | $ | 216,896 | $ | (372,009 | ) | |||||
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The differences between the change in fair value of derivatives between years for call options are primarily due to the performance of the indices upon which our call options are based. 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 for options expiring during the years ended December 31, 2010, 2009 and 2008 is as follows:
Year Ended December 31, | |||||
2010 | 2009 | 2008 | |||
S&P 500 Index | |||||
Point-to-point strategy | 1.9% - 68.6% | 0.0% - 45.1% | 0.0% - 2.6% | ||
Monthly average strategy | 0.4% - 51.2% | 0.0% - 22.9% | 0.0% - 6.4% | ||
Monthly point-to-point strategy | 0.0% - 23.7% | 0.0% - 9.9% | 0.0% - 0.0% | ||
Fixed income (bond index) strategies | 0.0% - 13.5% | 0.0% - 13.8% | 0.3% - 7.0% | ||
Actual amounts credited to policyholder account balances may be less than the index appreciation due to contractual features in the fixed index annuity policies (caps, participation rates, and asset fees) which allow us to manage the cost of the options purchased to fund the annual index credits. The change in fair value of derivatives is also influenced by the aggregate costs of options purchased. The aggregate cost of options has increased primarily due to an increased amount of fixed index annuities in force. 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. Costs for options purchased during the year ended December 31, 2010 and 2009 decreased compared to prior years due to lower volatility in equity markets and adjustments to caps, participation rates, and asset fees.
We had unsecured counterparty exposure in connection with options purchased from affiliates of Lehman Brothers ("Lehman") which declared bankruptcy during the third quarter of 2008. All options purchased from affiliates of Lehman had expired as of June 30, 2010. The amount of option proceeds due on expired options purchased from affiliates of Lehman that we did not receive payment on was $12.0 million and $2.1 million for the years ended December 31, 2009 and 2008, respectively. No amount has been recognized for any recovery of these amounts that may result from our claim in Lehman's bankruptcy proceedings.
Concurrently with the issuance of the 2015 notes, we entered into hedge transactions (the “2015 notes hedges”) to provide the cash needed to meet our cash obligations in excess of the principal amount of the 2015 notes upon conversion of the 2015 notes. The fair value of the 2015 notes hedges changes based upon changes in the price of our common stock which increased in 2010 subsequent to the date of origination. Similarly, the fair value of the conversion option obligation to the holders of the 2015 notes changes based upon changes in the price of our common stock and the conversion option obligation is accounted for as an embedded derivative liability with changes in fair value reported in the Change in fair value of embedded derivatives. The amount for the change in fair value of the 2015 notes hedges equals the amount for the change in the related embedded derivative liabilities and there is an offsetting expense in the change in fair value of embedded derivatives. See note 9 to our audited consolidated financial statements for a discussion of the 2015 notes hedges.
Net realized gains on investments, excluding OTTI losses include gains and losses on the sale of securities and impairment losses on mortgage loans on real estate which fluctuate from year to year due to changes in the interest rate and economic environment and the timing of the sale of investments. The components of net realized gains on investments for the years ended December 31, 2010, 2009 and 2008 are set forth in the table that follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Available for sale fixed maturity securities: | |||||||||||
Gross realized gains | $ | 27,755 | $ | 54,401 | $ | 5,852 | |||||
Gross realized losses | (2,575 | ) | (2,162 | ) | (589 | ) | |||||
25,180 | 52,239 | 5,263 | |||||||||
Equity securities: | |||||||||||
Gross realized gains | 14,384 | 5,620 | 292 | ||||||||
Gross realized losses | (71 | ) | (96 | ) | — | ||||||
14,313 | 5,524 | 292 | |||||||||
Other investments: | |||||||||||
Impairment losses | (542 | ) | — | — | |||||||
Mortgage loans on real estate: | |||||||||||
Impairment losses | (15,225 | ) | (6,484 | ) | — | ||||||
$ | 23,726 | $ | 51,279 | $ | 5,555 | ||||||
Gross realized gains have increased in 2010 due to tax planning strategies to generate taxable capital gains that will permit deduction of capital losses for income tax purposes. Gross realized losses in 2010 primarily relate to securities that experienced credit events during 2010 resulting in the decision to sell the securities at a loss. See Financial Condition—Investments for additional discussion of impairment losses recognized on mortgage loans on real estate.
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Net OTTI losses recognized in operations decreased to $23.9 million in 2010 and decreased to $86.8 million in 2009 from $192.6 million in 2008. See Financial Condition—Investments for additional discussion of write downs of securities for other than temporary impairments.
Gain (loss) on extinguishment of debt includes a $0.3 million loss on an extinguishment of $6.7 million principal amount of our 5.25% convertible senior notes due in December 2024 (the "2024 notes") during the year ended December 31, 2010. The $0.7 million loss on extinguishment of debt in 2009 includes a $3.1 million gain on an exchange of five million shares of our common stock for $37.2 million principal amount of our 2024 notes and a $3.8 million loss on an exchange of $63.6 million principal amount of our 5.25% convertible senior notes due in December 2029 for the same principal amount of the 2024 notes. The fair value of the common stock issued was $31.3 million. The $9.7 million gain on extinguishment of debt in 2008 resulted from the purchase of $78.1 million principal amount of the 2024 notes for $61.4 million in cash, of which $0.4 million was assigned to the reacquisition of the equity component of the 2024 notes.
Interest sensitive and index product benefits increased 111% to $733.2 million in 2010 and 70% to $347.9 million in 2009 from $205.1 million in 2008. The components of interest credited to account balances are summarized as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Index credits on index policies | $ | 454,660 | $ | 94,601 | $ | 33,337 | |||||
Interest credited (including changes in minimum guaranteed interest for fixed index annuities) | 265,539 | 249,015 | 171,794 | ||||||||
Living income benefit rider | 13,019 | 4,267 | — | ||||||||
$ | 733,218 | $ | 347,883 | $ | 205,131 | ||||||
The changes in index credits were attributable to changes in the 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 $438.4 million, $70.6 million and $26.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. Proceeds for 2009 and 2008 were adversely affected by the Lehman defaults as discussed above. The increases in interest credited for 2010 and 2009 were due to an increase in the average amount of annuity liabilities outstanding receiving a fixed rate of interest. The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 18% to $18.1 billion in 2010 and 14% to $15.4 billion in 2009 from $13.5 billion in 2008.
Amortization of deferred sales inducements increased 50% to $59.9 million in 2010 and 30% to $40.0 million in 2009 from $30.7 million in 2008. The 2010 increase includes the $0.3 million impact of unlocking in 2010 and the 2009 decrease includes the $1.3 million impact of unlocking in 2008. See Critical Accounting Policies - Deferred Acquisition Costs and Deferred Sales Inducements. In general, amortization of deferred sales inducements has been increasing each year due to growth in our annuity business and the deferral of sales inducements incurred with respect to sales of premium bonus annuity products. Bonus products represented 95%, 94% and 93% of our total annuity deposits during 2010, 2009 and 2008, respectively. The anticipated increase in amortization from these factors has been affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business, amortization associated with the net realized gains on investments and net OTTI losses recognized in operations and, in 2010, amortization associated with the litigation settlement.
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 life of the contracts which typically exceeds ten years. The gross profit adjustments resulting from fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business increased (decreased) amortization by ($39.2) million, ($29.2) million and $13.9 million in 2010, 2009 and 2008, respectively. The gross profit adjustments from net realized gains on investments and net OTTI losses recognized in operations increased (decreased) amortization by $0.5 million, ($6.8) million and ($35.6) million in 2010, 2009 and 2008, respectively. The gross profit adjustments from the litigation settlement decreased amortization in 2010 by $1.3 million. Excluding the amortization amounts attributable to fair value accounting for derivatives and embedded derivatives, realized gains on investments and net OTTI losses recognized in operations, and the litigation settlement, amortization would have been $99.9 million, $76.0 million and $52.4 million for 2010, 2009 and 2008, respectively. See Critical Accounting Policies - Deferred Policy Acquisition Costs and Deferred Sales Inducements.
Change in fair value of embedded derivatives was an increase of $131.0 million during 2010 and $529.5 million in 2009 and a decrease of $210.8 million in 2008. The 2010 increase includes $29.6 million for the increase in the fair value of the 2015 notes embedded conversion derivative. As discussed previously, this amount was offset by an increase in the fair value of the 2015 notes hedges. The remainder of the 2010 increase and the 2009 and 2008 changes relate to the fixed index annuity embedded derivatives and 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 these index credits discussed above in change in fair value of derivatives; (ii) changes in discount rates used in estimating our liability for policy growth; (iii) changes in estimates of expected costs of annual call options that will be purchased in the future to fund index credits beyond the next policy anniversary; and (iv) the growth in the host component of the policy liability. See Critical Accounting Policies - Policy Liabilities for Fixed Index Annuities. The primary reason for the increase in the change in fair value of fixed index annuity embedded derivatives in 2010 was decreases in the discount rates used in estimating our liability for policy growth offset in part by decreases in the expected index credits which correlated with the decrease in the change in fair value of derivatives for 2010 discussed above. The primary reasons for the significant increase
23
in the change in fair value of fixed index annuity embedded derivatives in 2009 were decreases in the discount rates used in estimating our liability for policy growth and increases in the expected index credits which correlated with the increase in the change in fair value of derivatives for 2009 discussed above. The primary reasons for the significant decrease in the change in fair value of fixed index annuity embedded derivatives in 2008 were increases in the discount rates used in estimating our liability for policy growth, a decrease in the expected index credits which correlated with a decrease in the change in fair value of derivatives for 2008 and a decrease in our estimate of the expected future cost of annual call options. The increase in the discount rates to reflect our nonperformance risk upon the adoption of the fair value measurements accounting requirements on January 1, 2008 as discussed previously decreased the fair value of embedded derivatives by $150.6 million and the decrease in the estimate of future option costs decreased the fair value of the embedded derivatives for 2008 by $51.6 million.
Interest expense on notes payable increased 49% to $22.1 million in 2010 and decreased 25% to $14.9 million in 2009 from $19.8 million in 2008. The 2010 increase was primarily due to the December 2009 issuance of an additional $52.2 million of 5.25% convertible senior notes and a higher effective rate of interest on $63.6 million principal amount of 5.25% convertible senior notes that were issued in December 2009 in exchange for the same principal amount of another issue of 5.25% convertible senior notes. The 2010 increase was also due to additional interest associated with the September 2010 issuance of $200 million principal amount of 3.50% convertible senior notes. The decrease in 2009 was primarily attributable to the extinguishment of $78.1 million principal amount of our 2024 notes during 2008 and extinguishment of $37.2 million principal amount of our 2024 notes through the exchange of five million shares of our common stock in the second quarter of 2009. The 2010 increase and 2009 decrease in interest expense on the convertible notes were partially offset by a decrease in 2010 and an increase in 2009 in interest expense on borrowings under our revolving line of credit with banks. The weighted average interest rates were 1.10%, 1.49% and 4.15% and the average borrowings outstanding were $108.5 million, $113.3 million and $35.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. Interest expense on notes payable is expected to increase in 2011 due to the September 2010 issuance of the 2015 notes that carry an effective interest rate of 8.9%. See note 9 to our audited consolidated financial statements.
Interest expense on subordinated debentures decreased 6% to $14.9 million in 2010 and 19% to $15.8 million in 2009 from $19.4 million in 2008. These decreases were primarily due to decreases in the weighted average interest rates on the outstanding subordinated debentures which were 5.47%, 5.82% and 7.15% for 2010, 2009 and 2008, respectively. The weighted average interest rates have decreased because $149 million principal amount of the subordinated debentures have a floating rate of interest based upon the three month London Interbank Offered Rate plus an applicable margin. See Financial Condition—Liabilities.
Interest expense on amounts due under repurchase agreements decreased 93% $0.5 million in 2009 and $8.2 million in 2008. There were no amounts outstanding during the year ended December 31, 2010. Weighted average interest rates were 0.35% and 2.28% for 2009 and 2008, respectively, and average borrowings outstanding were $150.7 million and $359.9 million during 2009 and 2008, respectively. Repurchase agreements were not utilized during 2010 due to the high level of calls on investment securities during the year. See Financial Condition—Investments.
Amortization of deferred policy acquisition costs increased 55% to $136.4 million in 2010 and decreased 31% to $88.0 million in 2009 from $126.7 million in 2008. The 2010 increase includes the $1.4 million impact of unlocking in 2010 and the 2009 decrease includes the $14.6 million impact of unlocking in 2008. See Critical Accounting Policies - Deferred Acquisition Costs and Deferred Sales Inducements. In general, amortization of deferred policy acquisition costs has been increasing each year due to the growth in our annuity business and the deferral of policy acquisition costs incurred with respect to sales of annuity products. The anticipated increase in amortization from these factors has been affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business, amortization associated with net realized gains on investments and net OTTI losses recognized in operations and, in 2010, the amortization associated with the litigation settlement.
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. The gross profit adjustments resulting from fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business increased (decreased) amortization by ($48.3) million, ($60.6) million and $44.2 million in 2010, 2009 and 2008, respectively. The gross profit adjustments from net realized gains on investments and net OTTI losses recognized in operations decreased amortization by $0.0 million, $12.2 million and $61.6 million in 2010, 2009 and 2008, respectively. The gross profit adjustments from the litigation settlement decreased amortization in 2010 by $4.4 million. Excluding the amortization amounts attributable to fair value accounting for derivatives and embedded derivatives, realized gains on investments and net OTTI losses recognized in operations, and the litigation settlement, amortization would have been $189.1 million, $160.9 million and $144.2 million for 2010, 2009 and 2008, respectively.
Other operating costs and expenses increased 100% to $114.6 million in 2010 and 9% to $57.3 million in 2009 from $52.6 million in 2008. The increase in 2010 was principally attributable to the litigation settlement accrual of $48.0 million, a $6.8 million increase in salaries and benefits and a $2.2 million increase in legal costs. See note 13 in our audited consolidated financial statements for a discussion of the litigation settlement. The increase in salaries and benefits for 2010 was due to an increase in incentive bonuses incurred for employees including the implementation of a short-term incentive plan for senior management and an increase in the number of employees due to growth in our business. The increase in litigation expense during 2010 was related to the defense of a class action lawsuit which we entered into a settlement with the plaintiffs in February 2011. The increase in 2009 was principally attributable to an increase in salaries and benefits of $3.3 million, an increase in risk charges on reinsurance of $3.7 million, and an increase in general overhead of $1.0 million offset by a decrease in legal expense of $3.1 million. The increase in salaries and benefits for 2009 was primarily due to an increase in the number of employees due to the growth in our business. Also, we recorded post employment benefit expense of $1.2 million during the second quarter of 2009 related to a post employment benefit agreement with our Executive Chairman, David J. Noble which was approved by our board of directors on June 4, 2009. The increase in risk charges on reinsurance was due to a reinsurance treaty entered into on December 31, 2008 and the expansion of the in-force business covered under an existing reinsurance treaty during the second quarter of 2009. The increase in general overhead costs was due to the growth
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in our business from increased sales. The decreases in legal expense were primarily related to a decrease in the cost of defense related to ongoing litigation.
Income tax expense increased 27% to $22.3 million in 2010 and decreased 71% to $17.6 million in 2009 from $61.1 million in 2008. These changes were primarily related to changes in income before income taxes and the impact of changes in the valuation allowance for deferred income tax assets related to capital loss carryforwards and other than temporary impairments on investment securities. The effective tax rates were 34.2%, 20.5% and 79.3% for 2010, 2009 and 2008, respectively. The effective tax rate for 2010 was less than the applicable statutory federal income tax rate of 35% primarily due to state income tax benefits attributable to losses in the non-life subgroup. The effective tax rate for 2009 was less than the applicable statutory federal income tax rate of 35% primarily due to a decrease in the deferred income tax asset valuation allowance established in 2008 for capital loss carryforwards and other than temporary impairments which decreased income tax expense in 2009 by $11.9 million. This decrease was primarily due to current year taxable income from capital gain sources which resulted from the recognition of net realized gains on available for sale fixed maturity and equity securities that were sold as part of a tax planning strategy to generate capital gains to offset capital losses as discussed above. The effective tax rate for 2008 was more than the applicable statutory federal income tax rate of 35% primarily due to the establishment of a valuation allowance for deferred income tax assets related to capital loss carryforwards and other than temporary impairments on investment securities. See note 8 to our consolidated financial statements.
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 in United States government and government-sponsored agency securities and corporate securities rated investment grade by established nationally recognized statistical rating organizations ("NRSRO's") or in securities of comparable investment quality, if not rated and commercial mortgage loans on real estate.
The composition of our investment portfolio is summarized as follows:
December 31, | ||||||||||||||
2010 | 2009 | |||||||||||||
Carrying Amount | Percent | Carrying Amount | Percent | |||||||||||
(Dollars in thousands) | ||||||||||||||
Fixed maturity securities: | ||||||||||||||
United States Government full faith and credit | $ | 4,388 | — | % | $ | 3,310 | — | % | ||||||
United States Government sponsored agencies | 3,750,065 | 18.9 | % | 5,557,971 | 36.2 | % | ||||||||
United States municipalities, states and territories | 2,367,003 | 12.0 | % | 355,634 | 2.3 | % | ||||||||
Corporate securities | 7,652,850 | 38.6 | % | 3,933,198 | 25.6 | % | ||||||||
Residential mortgage backed securities | 2,878,557 | 14.5 | % | 2,489,101 | 16.2 | % | ||||||||
Total fixed maturity securities | 16,652,863 | 84.0 | % | 12,339,214 | 80.3 | % | ||||||||
Equity securities | 65,961 | 0.4 | % | 93,086 | 0.6 | % | ||||||||
Mortgage loans on real estate | 2,598,641 | 13.1 | % | 2,449,778 | 15.9 | % | ||||||||
Derivative instruments | 479,786 | 2.4 | % | 479,272 | 3.1 | % | ||||||||
Other investments | 19,680 | 0.1 | % | 12,760 | 0.1 | % | ||||||||
$ | 19,816,931 | 100.0 | % | $ | 15,374,110 | 100.0 | % | |||||||
During 2010 and 2009, we received $5.2 billion and $4.2 billion, respectively, in net redemption proceeds related to calls of our callable United States Government sponsored agency securities, of which $1.6 billion and $2.1 billion, respectively, were classified as held for investment. We reinvested the proceeds from these redemptions primarily in United States Government sponsored agencies, corporate securities and United States municipalities, states, and territories classified as available for sale. At December 31, 2010, 36% of our fixed income securities have call features and 1% ($0.1 billion) of those securities were subject to call redemption. Another 21% ($3.4 billion) of our fixed income securities will become subject to call redemption during 2011.
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. Historically, we have had a high percentage of our fixed maturity securities in U.S. Government sponsored agency securities (for the most part Federal Home Loan Mortgage Corporation and Federal National Mortgage Association). While U.S. Government sponsored agency securities are of high credit quality, the call features have resulted in our excess cash position in 2010. These calls resulted from the low interest rate and tight agency spread environment experienced in 2010. Since 2007, when we had almost 80% of our
25
fixed maturity portfolio invested in callable agencies, we have reallocated a significant portion of our fixed maturities from the callable agency securities to other highly rated, long-term securities. The largest portion of our fixed maturity securities are now in investment grade (NAIC designation 1 or 2) publicly traded or privately placed corporate securities. We have also built a portfolio of residential mortgage backed securities ("RMBS") that provide our investment portfolio a source of regular cash flow and higher yielding assets than our agency securities. Additionally, in 2009 we began building a portfolio of taxable bonds issued by municipalities, states and territories of the United States that provide us with attractive yields while consistent with our aversion to credit risk.
A summary of our fixed maturity securities by NRSRO ratings is as follows:
December 31, | |||||||||||||
2010 | 2009 | ||||||||||||
Rating Agency Rating | Carrying Amount | Percent | Carrying Amount | Percent | |||||||||
(Dollars in thousands) | |||||||||||||
Aaa/Aa/A | $ | 11,599,255 | 69.6 | % | $ | 8,666,467 | 70.2 | % | |||||
Baa | 3,725,920 | 22.4 | % | 2,442,897 | 19.8 | % | |||||||
Total investment grade | 15,325,175 | 92.0 | % | 11,109,364 | 90.0 | % | |||||||
Ba | 294,200 | 1.8 | % | 367,427 | 3.0 | % | |||||||
B | 69,033 | 0.4 | % | 358,288 | 2.9 | % | |||||||
Caa and lower | 959,437 | 5.8 | % | 481,389 | 3.9 | % | |||||||
In or near default | 5,018 | — | % | 22,746 | 0.2 | % | |||||||
Total below investment grade | 1,327,688 | 8.0 | % | 1,229,850 | 10.0 | % | |||||||
$ | 16,652,863 | 100.0 | % | $ | 12,339,214 | 100.0 | % | ||||||
The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day credit quality assessment and valuation of securities owned by state regulated insurance companies. Insurance companies report ownership of securities to the SVO when such securities are eligible for regulatory filings. The SVO conducts credit analysis on these securities for the purpose of assigning an NAIC designation and/or unit price. Typically, if a security has been rated by an NRSRO, the SVO utilizes that rating and assigns 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 and lower | |
6 | In or near default |
In November 2010, the NAIC membership approved continuation of a process developed in 2009 to assess non-agency RMBS for the 2010 filing year that does not rely on NRSRO ratings. The NAIC retained the services of PIMCO Advisory to model each non-agency RMBS owned by U.S. insurers at year-end 2010 and 2009. PIMCO Advisory has provided 5 prices for each security for life insurance companies to utilize in determining the NAIC designation for each RMBS based on each insurer's statutory book value price. This process is used to determine the level of RBC requirements for non-agency RMBS.
A summary of our fixed maturity securities by NAIC designation is as follows:
December 31, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||
NAIC Designation | Amortized Cost | Fair Value | Carrying Amount | Percentage of Total Carrying Amount | Amortized Cost | Fair Value | Carrying Amount | Percentage of Total Carrying Amount | ||||||||||||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||||||||||||||||
1 | $ | 12,152,552 | $ | 12,246,954 | $ | 12,262,263 | 73.6 | % | $ | 9,495,015 | $ | 9,370,647 | $ | 9,374,900 | 76.0 | % | ||||||||||||||
2 | 3,892,680 | 4,012,076 | 4,012,076 | 24.1 | % | 2,571,815 | 2,555,826 | 2,555,826 | 20.7 | % | ||||||||||||||||||||
3 | 368,680 | 323,113 | 348,256 | 2.1 | % | 409,860 | 315,948 | 344,914 | 2.8 | % | ||||||||||||||||||||
4 | 19,820 | 19,178 | 19,178 | 0.1 | % | 24,375 | 20,799 | 20,799 | 0.2 | % | ||||||||||||||||||||
5 | 6,089 | 6,262 | 6,262 | 0.1 | % | 21,013 | 20,749 | 20,749 | 0.1 | % | ||||||||||||||||||||
6 | 4,273 | 4,828 | 4,828 | — | % | 25,685 | 22,026 | 22,026 | 0.2 | % | ||||||||||||||||||||
$ | 16,444,094 | $ | 16,612,411 | $ | 16,652,863 | 100.0 | % | $ | 12,547,763 | $ | 12,305,995 | $ | 12,339,214 | 100.0 | % | |||||||||||||||
26
A summary of our RMBS by collateral type and split by NAIC designation, as well as a separate summary of securities for which we have recognized OTTI and those which we have not yet recognized any OTTI is as follows as of December 31, 2010:
Collateral Type | NAIC Designation | Principal Amount | Amortized Cost | Fair Value | ||||||||||
(Dollars in thousands) | ||||||||||||||
OTTI has not been recognized | ||||||||||||||
Government agency | 1 | $ | 341,430 | $ | 308,917 | $ | 307,939 | |||||||
Prime | 1 | 1,661,865 | 1,573,960 | 1,634,953 | ||||||||||
2 | 1,500 | 1,480 | 1,363 | |||||||||||
3 | 52,677 | 51,239 | 45,499 | |||||||||||
Alt-A | 1 | 55,022 | 54,512 | 56,072 | ||||||||||
2 | 5,123 | 5,216 | 4,708 | |||||||||||
$ | 2,117,617 | $ | 1,995,324 | $ | 2,050,534 | |||||||||
OTTI has been recognized | ||||||||||||||
Prime | 1 | $ | 135,747 | $ | 123,053 | $ | 115,519 | |||||||
2 | 331,762 | 304,578 | 279,488 | |||||||||||
3 | 62,145 | 58,765 | 52,738 | |||||||||||
Alt-A | 1 | 260,021 | 224,492 | 212,030 | ||||||||||
2 | 183,992 | 146,413 | 125,259 | |||||||||||
3 | 49,314 | 43,343 | 40,287 | |||||||||||
6 | 4,709 | 4,060 | 2,702 | |||||||||||
$ | 1,027,690 | $ | 904,704 | $ | 828,023 | |||||||||
Total by collateral type | ||||||||||||||
Government agency | $ | 341,430 | $ | 308,917 | $ | 307,939 | ||||||||
Prime | 2,245,696 | 2,113,075 | 2,129,560 | |||||||||||
Alt-A | 558,181 | 478,036 | 441,058 | |||||||||||
$ | 3,145,307 | $ | 2,900,028 | $ | 2,878,557 | |||||||||
Total by NAIC designation | ||||||||||||||
1 | $ | 2,454,085 | $ | 2,284,934 | $ | 2,326,513 | ||||||||
2 | 522,377 | 457,687 | 410,818 | |||||||||||
3 | 164,136 | 153,347 | 138,524 | |||||||||||
6 | 4,709 | 4,060 | 2,702 | |||||||||||
$ | 3,145,307 | $ | 2,900,028 | $ | 2,878,557 | |||||||||
The amortized cost and fair value of fixed maturity securities at December 31, 2010, by contractual maturity 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 residential mortgage backed securities provide for periodic payments throughout their lives and are shown below as a separate line.
Available for sale | Held for investment | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
Due in one year or less | $ | 26,033 | $ | 26,284 | $ | — | $ | — | |||||||
Due after one year through five years | 401,008 | 440,698 | — | — | |||||||||||
Due after five years through ten years | 1,647,988 | 1,816,850 | — | — | |||||||||||
Due after ten years through twenty years | 2,895,065 | 2,910,182 | — | — | |||||||||||
Due after twenty years | 7,751,772 | 7,758,092 | 822,200 | 781,748 | |||||||||||
12,721,866 | 12,952,106 | 822,200 | 781,748 | ||||||||||||
Residential mortgage backed securities | 2,900,028 | 2,878,557 | — | — | |||||||||||
$ | 15,621,894 | $ | 15,830,663 | $ | 822,200 | $ | 781,748 | ||||||||
27
Unrealized Losses
At December 31, 2010 and 2009, the amortized cost and fair value of fixed maturity securities and equity securities that were in an unrealized loss position were as follows:
Number of Securities | Amortized Cost | Unrealized Losses | Fair Value | |||||||||||
(Dollars in thousands) | ||||||||||||||
December 31, 2010 | ||||||||||||||
Fixed maturity securities, available for sale: | ||||||||||||||
United States Government full faith and credit | 2 | $ | 566 | $ | (18 | ) | $ | 548 | ||||||
United States Government sponsored agencies | 1 | 111,747 | (1,646 | ) | 110,101 | |||||||||
United States municipalities, states and territories | 289 | 1,571,263 | (53,384 | ) | 1,517,879 | |||||||||
Corporate securities: | ||||||||||||||
Finance, insurance and real estate | 79 | 784,844 | (44,353 | ) | 740,491 | |||||||||
Manufacturing, construction and mining | 111 | 1,102,886 | (36,226 | ) | 1,066,660 | |||||||||
Utilities and related sectors | 145 | 987,093 | (39,209 | ) | 947,884 | |||||||||
Wholesale/retail trade | 25 | 169,125 | (6,251 | ) | 162,874 | |||||||||
Services, media and other | 18 | 206,317 | (10,801 | ) | 195,516 | |||||||||
Residential mortgage backed securities | 98 | 1,470,836 | (108,421 | ) | 1,362,415 | |||||||||
768 | $ | 6,404,677 | $ | (300,309 | ) | $ | 6,104,368 | |||||||
Fixed maturity securities, held for investment: | ||||||||||||||
United States Government sponsored agencies | 3 | $ | 746,414 | $ | (15,309 | ) | $ | 731,105 | ||||||
Corporate security: | ||||||||||||||
Finance, insurance and real estate | 1 | 75,786 | (25,143 | ) | 50,643 | |||||||||
4 | $ | 822,200 | $ | (40,452 | ) | $ | 781,748 | |||||||
Equity securities, available for sale: | ||||||||||||||
Finance, insurance and real estate | 8 | $ | 32,782 | $ | (1,946 | ) | $ | 30,836 | ||||||
December 31, 2009 | ||||||||||||||
Fixed maturity securities, available for sale: | ||||||||||||||
United States Government full faith and credit | 2 | $ | 338 | $ | (6 | ) | $ | 332 | ||||||
United States Government sponsored agencies | 27 | 3,026,593 | (118,388 | ) | 2,908,205 | |||||||||
United States municipalities, states and territories | 32 | 114,232 | (2,263 | ) | 111,969 | |||||||||
Corporate securities: | ||||||||||||||
Finance, insurance and real estate | 68 | 443,859 | (50,555 | ) | 393,304 | |||||||||
Manufacturing, construction and mining | 28 | 178,642 | (10,462 | ) | 168,180 | |||||||||
Utilities and related sectors | 36 | 226,604 | (13,156 | ) | 213,448 | |||||||||
Wholesale/retail trade | 17 | 80,599 | (5,423 | ) | 75,176 | |||||||||
Services, media and other | 17 | 113,308 | (5,324 | ) | 107,984 | |||||||||
Residential mortgage backed securities | 109 | 1,719,481 | (306,372 | ) | 1,413,109 | |||||||||
336 | $ | 5,903,656 | $ | (511,949 | ) | $ | 5,391,707 | |||||||
Fixed maturity securities, held for investment: | ||||||||||||||
United States Government sponsored agencies | 4 | $ | 365,000 | $ | (5,900 | ) | $ | 359,100 | ||||||
Corporate security: | ||||||||||||||
Finance, insurance and real estate | 1 | 75,649 | (28,966 | ) | 46,683 | |||||||||
5 | $ | 440,649 | $ | (34,866 | ) | $ | 405,783 | |||||||
Equity securities, available for sale: | ||||||||||||||
Finance, insurance and real estate | 14 | $ | 41,948 | $ | (3,269 | ) | 38,679 | |||||||
Unrealized losses decreased $207.4 million from $550.1 million at December 31, 2009 to $342.7 million at December 31, 2010. We decreased unrealized losses by recognizing $23.9 million of credit OTTI losses on debt securities for the year ended December 31, 2010. The remaining decrease in unrealized losses was due to improving market and economic conditions and tightening of credit spreads resulting in higher fair values for many of our fixed maturity securities. The increase in fair value of RMBS is also due to an increased demand in the market for these types of securities.
28
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 Unrealized Losses | Percent of Total | Gross Unrealized Losses | Percent of Total | ||||||||||
(Dollars in thousands) | |||||||||||||
December 31, 2010 | |||||||||||||
1 | $ | 5,017,596 | 72.4 | % | $ | (186,066 | ) | 54.6 | % | ||||
2 | 1,619,437 | 23.4 | % | (102,931 | ) | 30.2 | % | ||||||
3 | 269,555 | 3.9 | % | (49,764 | ) | 14.6 | % | ||||||
4 | 17,278 | 0.2 | % | (642 | ) | 0.2 | % | ||||||
5 | — | — | % | — | — | % | |||||||
6 | 2,702 | 0.1 | % | (1,358 | ) | 0.4 | % | ||||||
$ | 6,926,568 | 100.0 | % | $ | (340,761 | ) | 100.0 | % | |||||
December 31, 2009 | |||||||||||||
1 | $ | 4,577,573 | 78.5 | % | $ | (295,280 | ) | 54.0 | % | ||||
2 | 904,027 | 15.5 | % | (147,214 | ) | 26.9 | % | ||||||
3 | 302,630 | 5.2 | % | (94,679 | ) | 17.3 | % | ||||||
4 | 20,799 | 0.4 | % | (3,576 | ) | 0.7 | % | ||||||
5 | 14,499 | 0.2 | % | (467 | ) | 0.1 | % | ||||||
6 | 12,828 | 0.2 | % | (5,599 | ) | 1.0 | % | ||||||
$ | 5,832,356 | 100.0 | % | $ | (546,815 | ) | 100.0 | % | |||||
29
The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 780 and 355 securities, respectively) have been in a continuous unrealized loss position, at December 31, 2010 and 2009:
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
December 31, 2010 | |||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||
Available for sale: | |||||||||||||||||||||||
United States Government full faith and credit | $ | 548 | $ | (18 | ) | $ | — | $ | — | $ | 548 | $ | (18 | ) | |||||||||
United States Government sponsored agencies | 110,101 | (1,646 | ) | — | — | 110,101 | (1,646 | ) | |||||||||||||||
United States municipalities, states and territories | 1,510,354 | (51,989 | ) | 7,525 | (1,395 | ) | 1,517,879 | (53,384 | ) | ||||||||||||||
Corporate securities: | |||||||||||||||||||||||
Finance, insurance and real estate | 626,363 | (31,352 | ) | 114,128 | (13,001 | ) | 740,491 | (44,353 | ) | ||||||||||||||
Manufacturing, construction and mining | 1,032,170 | (33,893 | ) | 34,490 | (2,333 | ) | 1,066,660 | (36,226 | ) | ||||||||||||||
Utilities and related sectors | 933,727 | (34,657 | ) | 14,157 | (4,552 | ) | 947,884 | (39,209 | ) | ||||||||||||||
Wholesale/retail trade | 153,699 | (4,947 | ) | 9,175 | (1,304 | ) | 162,874 | (6,251 | ) | ||||||||||||||
Services, media and other | 195,516 | (10,801 | ) | — | — | 195,516 | (10,801 | ) | |||||||||||||||
Residential mortgage backed securities | 396,083 | (14,100 | ) | 966,332 | (94,321 | ) | 1,362,415 | (108,421 | ) | ||||||||||||||
$ | 4,958,561 | $ | (183,403 | ) | $ | 1,145,807 | $ | (116,906 | ) | $ | 6,104,368 | $ | (300,309 | ) | |||||||||
Held for investment: | |||||||||||||||||||||||
United States Government sponsored agencies | $ | 731,105 | $ | (15,309 | ) | $ | — | $ | — | $ | 731,105 | $ | (15,309 | ) | |||||||||
Corporate security: | |||||||||||||||||||||||
Finance, insurance and real estate | — | — | 50,643 | (25,143 | ) | 50,643 | (25,143 | ) | |||||||||||||||
$ | 731,105 | $ | (15,309 | ) | $ | 50,643 | $ | (25,143 | ) | $ | 781,748 | $ | (40,452 | ) | |||||||||
Equity securities, available for sale: | |||||||||||||||||||||||
Finance, insurance and real estate | $ | 14,583 | $ | (1,199 | ) | $ | 16,253 | $ | (747 | ) | $ | 30,836 | $ | (1,946 | ) | ||||||||
December 31, 2009 | |||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||
Available for sale: | |||||||||||||||||||||||
United States Government full faith and credit | $ | 332 | $ | (6 | ) | $ | — | $ | — | $ | 332 | $ | (6 | ) | |||||||||
United States Government sponsored agencies | 2,908,205 | (118,388 | ) | — | — | 2,908,205 | (118,388 | ) | |||||||||||||||
United States municipalities, states and territories | 111,969 | (2,263 | ) | — | — | 111,969 | (2,263 | ) | |||||||||||||||
Corporate securities: | |||||||||||||||||||||||
Finance, insurance and real estate | 154,093 | (10,560 | ) | 239,211 | (39,995 | ) | 393,304 | (50,555 | ) | ||||||||||||||
Manufacturing, construction and mining | 93,922 | (2,032 | ) | 74,258 | (8,430 | ) | 168,180 | (10,462 | ) | ||||||||||||||
Utilities and related sectors | 149,515 | (5,046 | ) | 63,933 | (8,110 | ) | 213,448 | (13,156 | ) | ||||||||||||||
Wholesale/retail trade | 35,629 | (623 | ) | 39,547 | (4,800 | ) | 75,176 | (5,423 | ) | ||||||||||||||
Services, media and other | 46,625 | (512 | ) | 61,359 | (4,812 | ) | 107,984 | (5,324 | ) | ||||||||||||||
Residential mortgage backed securities | 226,567 | (22,781 | ) | 1,186,542 | (283,591 | ) | 1,413,109 | (306,372 | ) | ||||||||||||||
$ | 3,726,857 | $ | (162,211 | ) | $ | 1,664,850 | $ | (349,738 | ) | $ | 5,391,707 | $ | (511,949 | ) | |||||||||
Held for investment: | |||||||||||||||||||||||
United States Government sponsored agencies | $ | 359,100 | $ | (5,900 | ) | $ | — | $ | — | $ | 359,100 | $ | (5,900 | ) | |||||||||
Corporate security: | |||||||||||||||||||||||
Finance, insurance and real estate | — | — | 46,683 | (28,966 | ) | 46,683 | (28,966 | ) | |||||||||||||||
$ | 359,100 | $ | (5,900 | ) | $ | 46,683 | $ | (28,966 | ) | $ | 405,783 | $ | (34,866 | ) | |||||||||
Equity securities, available for sale: | |||||||||||||||||||||||
Finance, insurance and real estate | $ | 9,802 | $ | (147 | ) | $ | 28,877 | $ | (3,122 | ) | $ | 38,679 | $ | (3,269 | ) | ||||||||
30
The following is a description of the factors causing the unrealized losses by investment category as of December 31, 2010:
United States municipalities, states and territories: These securities are relatively long in duration, making the value of such securities sensitive to changes in market interest rates. These securities carry yields less than those available at December 31, 2010 as the result of rising interest rates in 2010.
Corporate securities: The unrealized losses in these securities are due partially to the continuation of wider than historic credit spreads in certain sectors of the corporate bond market. While credit spreads have narrowed, several sectors remain at spreads wider than levels prior to the 2008 financial crisis, such as financials and select economic sensitive issuers. As the result of wider spreads, these issues carry yields less than those available in the market as of December 31, 2010.
Residential mortgage backed securities: At December 31, 2010, we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $478.0 million and a fair value of $441.1 million. Despite recent improvements in the capital markets, the fair values of RMBS continue at prices below amortized cost. RMBS prices will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Equity securities: The unrealized loss on equity securities, which are primarily investment grade perpetual preferred stocks with exposure to REITS, investment banks and finance companies, are due to the ongoing concerns relating to capital, asset quality and earnings stability due to the financial crisis. All of the equity securities in an unrealized loss position for 12 months or more are investment grade perpetual preferred stocks that are absent credit deterioration. A continued difficult housing market has raised concerns in regard to earnings and dividend stability in many companies which directly affect the values of these securities.
Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these securities before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until a recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis based upon consideration of all the evidence available to us, including the magnitude of an unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security. For equity securities we measure other than temporary impairment charges based upon the difference between the book value of a security and its fair value.
Approximately 85% and 81% of the unrealized losses on fixed maturity securities shown in the above table for December 31, 2010 and 2009, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity securities with unrealized losses are current with respect to the payment of principal and interest.
31
At December 31, 2010 and 2009, the amortized cost and fair value of fixed maturity securities and equity 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:
Number of Securities | Amortized Cost | Fair Value | Gross Unrealized Losses | |||||||||||
(Dollars in thousands) | ||||||||||||||
December 31, 2010 | ||||||||||||||
Fixed maturity securities: | ||||||||||||||
Investment grade: | ||||||||||||||
Less than six months | 656 | $ | 5,805,583 | $ | 5,611,000 | $ | (194,583 | ) | ||||||
Six months or more and less than twelve months | 1 | 7,874 | 7,848 | (26 | ) | |||||||||
Twelve months or greater | 34 | 313,127 | 292,173 | (20,954 | ) | |||||||||
Total investment grade | 691 | 6,126,584 | 5,911,021 | (215,563 | ) | |||||||||
Below investment grade: | ||||||||||||||
Less than six months | 5 | 65,359 | 61,296 | (4,063 | ) | |||||||||
Six months or more and less than twelve months | 1 | 9,562 | 9,522 | (40 | ) | |||||||||
Twelve months or greater | 75 | 1,025,372 | 904,277 | (121,095 | ) | |||||||||
Total below investment grade | 81 | 1,100,293 | 975,095 | (125,198 | ) | |||||||||
Equity securities: | ||||||||||||||
Less than six months | 1 | 3,000 | 2,995 | (5 | ) | |||||||||
Six months or more and less than twelve months | 2 | 12,782 | 11,588 | (1,194 | ) | |||||||||
Twelve months or greater | 5 | 17,000 | 16,253 | (747 | ) | |||||||||
Total equity securities | 8 | 32,782 | 30,836 | (1,946 | ) | |||||||||
780 | $ | 7,259,659 | $ | 6,916,952 | $ | (342,707 | ) | |||||||
December 31, 2009 | ||||||||||||||
Fixed maturity securities | ||||||||||||||
Investment grade: | ||||||||||||||
Less than six months | 120 | $ | 2,516,264 | $ | 2,463,732 | $ | (52,532 | ) | ||||||
Six months or more and less than twelve months | 26 | 1,591,620 | 1,500,847 | (90,773 | ) | |||||||||
Twelve months or greater | 95 | 883,552 | 777,079 | (106,473 | ) | |||||||||
Total investment grade | 241 | 4,991,436 | 4,741,658 | (249,778 | ) | |||||||||
Below investment grade: | ||||||||||||||
Less than six months | 3 | 60,580 | 57,220 | (3,360 | ) | |||||||||
Six months or more and less than twelve months | 12 | 85,605 | 64,159 | (21,446 | ) | |||||||||
Twelve months or greater | 85 | 1,206,684 | 934,453 | (272,231 | ) | |||||||||
Total below investment grade | 100 | 1,352,869 | 1,055,832 | (297,037 | ) | |||||||||
Equity securities: | ||||||||||||||
Less than six months | 2 | 7,291 | 7,242 | (49 | ) | |||||||||
Six months or more and less than twelve months | 1 | 2,658 | 2,561 | (97 | ) | |||||||||
Twelve months or greater | 11 | 32,000 | 28,877 | (3,123 | ) | |||||||||
Total equity securities | 14 | 41,949 | 38,680 | (3,269 | ) | |||||||||
355 | $ | 6,386,254 | $ | 5,836,170 | $ | (550,084 | ) | |||||||
32
At December 31, 2010 and 2009, 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 and equity securities that had unrealized losses greater than 20% and the number of months in a continuous unrealized loss position greater than 20% were as follows:
Number of Securities | Amortized Cost | Carrying Value | Gross Unrealized Losses | |||||||||||
(Dollars in thousands) | ||||||||||||||
December 31, 2010 | ||||||||||||||
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 | 2 | 24,645 | 19,648 | (4,997 | ) | |||||||||
Six months or more and less than twelve months | — | — | — | — | ||||||||||
Twelve months or greater | 7 | 104,129 | 71,368 | (32,761 | ) | |||||||||
Total below investment grade | 9 | 128,774 | 91,016 | (37,758 | ) | |||||||||
9 | $ | 128,774 | $ | 91,016 | $ | (37,758 | ) | |||||||
December 31, 2009 | ||||||||||||||
Investment grade: | ||||||||||||||
Less than six months | 2 | $ | 34,271 | $ | 30,198 | $ | (4,073 | ) | ||||||
Six months or more and less than twelve months | — | — | — | — | ||||||||||
Twelve months or greater | 2 | 11,940 | 8,601 | (3,339 | ) | |||||||||
Total investment grade | 4 | 46,211 | 38,799 | (7,412 | ) | |||||||||
Below investment grade: | ||||||||||||||
Less than six months | 13 | 118,198 | 101,805 | (16,393 | ) | |||||||||
Six months or more and less than twelve months | 9 | 158,359 | 111,878 | (46,481 | ) | |||||||||
Twelve months or greater | 27 | 365,706 | 252,062 | (113,644 | ) | |||||||||
Total below investment grade | 49 | 642,263 | 465,745 | (176,518 | ) | |||||||||
53 | $ | 688,474 | $ | 504,544 | $ | (183,930 | ) | |||||||
33
The amortized cost and fair value of fixed maturity securities at December 31, 2010 and 2009, 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 residential mortgage backed securities provide for periodic payments throughout their lives, and are shown below as a separate line.
Available for sale | Held for investment | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
December 31, 2010 | |||||||||||||||
Due in one year of less | $ | — | $ | — | $ | — | $ | — | |||||||
Due after one year through five years | 30,367 | 29,858 | — | — | |||||||||||
Due after five years through ten years | 257,793 | 249,838 | — | — | |||||||||||
Due after ten years through twenty years | 1,274,273 | 1,224,989 | — | — | |||||||||||
Due after twenty years | 3,371,408 | 3,237,268 | 822,200 | 781,748 | |||||||||||
4,933,841 | 4,741,953 | 822,200 | 781,748 | ||||||||||||
Residential mortgage backed securities | 1,470,836 | 1,362,415 | — | — | |||||||||||
$ | 6,404,677 | $ | 6,104,368 | $ | 822,200 | $ | 781,748 | ||||||||
December 31, 2009 | |||||||||||||||
Due in one year or less | $ | 12,000 | $ | 11,707 | $ | — | $ | — | |||||||
Due after one year through five years | 82,754 | 75,462 | — | — | |||||||||||
Due after five years through ten years | 100,597 | 95,678 | — | — | |||||||||||
Due after ten years through twenty years | 707,824 | 682,247 | 365,000 | 359,100 | |||||||||||
Due after twenty years | 3,281,000 | 3,113,504 | 75,649 | 46,683 | |||||||||||
4,184,175 | 3,978,598 | 440,649 | 405,783 | ||||||||||||
Residential mortgage backed securities | 1,719,481 | 1,413,109 | — | — | |||||||||||
$ | 5,903,656 | $ | 5,391,707 | $ | 440,649 | $ | 405,783 | ||||||||
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 an other than temporary impairment. 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. Specifically 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. A security which has a 25% or greater change in market price relative to its amortized cost and a possibility of a loss of principal will be included on a list which is referred to as our watch list. We exclude from this list securities with unrealized losses which are related to market movements in interest rates and which have no factors indicating that such unrealized losses may be other than temporary as we do not intend to sell these securities and it is more likely than not we will not have to sell these securities before a recovery is realized. In addition, we exclude our RMBS as we monitor all of our RMBS on a quarterly basis for changes in default rates, loss severities and expected cash flows for the purpose of assessing potential other than temporary impairments and related credit losses to be recognized in operations. At December 31, 2010, the amortized cost and fair value of securities on the watch list are as follows:
General Description | Number of Securities | Amortized Cost | Unrealized Gains/ (Losses) | Fair Value | Months in Continuous Unrealized Loss Position | Months Unrealized Losses Greater Than 20% | |||||||||||
(Dollars in thousands) | |||||||||||||||||
Investment grade | |||||||||||||||||
Corporate fixed maturity securities: | |||||||||||||||||
Finance and insurance | 2 | 6,011 | (660 | ) | 5,351 | 38-45 | — | ||||||||||
Below investment grade | |||||||||||||||||
Corporate fixed maturity securities: | |||||||||||||||||
Finance | 1 | 4,249 | — | 4,249 | — | — | |||||||||||
Retail | 1 | 10,479 | (1,304 | ) | 9,175 | 67 | — | ||||||||||
4 | 20,739 | (1,964 | ) | 18,775 | |||||||||||||
34
Our analysis of these securities that we have determined are temporarily impaired and their credit performance at December 31, 2010 is as follows:
Finance and Insurance: The decline in value of these securities is due to the continued wide spreads as a result of the ongoing concerns relating to capital, asset quality and earnings stability due to the financial events of the past two years. While these issuers have had their financial position and profitability weakened by the credit and liquidity crisis, we have determined that these securities were not other than temporarily impaired due to our evaluation of the operating performance and the credit worthiness of each individual issuer.
Retail: The decline in value of this bond relates to a debt-financed share repurchase combined with a weakening economy which has led to a decrease in sales. We have determined that this security was not other than temporarily impaired due to the issuer's very strong market position and a consistent history of strong operating performance, improving economic conditions and rising security prices.
We do not intend to sell these securities and it is more likely than not we will not have to sell these securities before recovery of their amortized cost and, as such, there were no other than temporary impairments on these securities at December 31, 2010.
Other Than Temporary Impairments
We have a policy and process in place to identify securities in our investment portfolio for which we should recognize impairments. See Critical Accounting Policies—Evaluation of Other Than Temporary Impairments. We recognized other than temporary impairments and additional credit losses on a number of securities for which we have previously recognized OTTI as set forth in the following table:
General Description | Number of Securities | Other Than Temporary Impairments | Portion Recognized In Comprehensive Income | Net Impairment Losses Recognized in Operations | |||||||||||
(Dollars in thousands) | |||||||||||||||
Year Ended December 31, 2010 | |||||||||||||||
Corporate bonds: | |||||||||||||||
Finance | 1 | $ | (822 | ) | $ | — | $ | (822 | ) | ||||||
Retail | 1 | (1,576 | ) | — | (1,576 | ) | |||||||||
Residential mortgage backed securities | 30 | (17,146 | ) | (4,323 | ) | (21,469 | ) | ||||||||
32 | $ | (19,544 | ) | $ | (4,323 | ) | $ | (23,867 | ) | ||||||
Year Ended December 31, 2009 | |||||||||||||||
United States Government full faith and credit | 1 | $ | (245 | ) | $ | — | $ | (245 | ) | ||||||
Corporate bonds: | |||||||||||||||
Finance | 3 | (8,388 | ) | (1,521 | ) | (9,909 | ) | ||||||||
Insurance | 2 | (766 | ) | (421 | ) | (1,187 | ) | ||||||||
Home building | 3 | (5,242 | ) | (814 | ) | (6,056 | ) | ||||||||
Residential mortgage backed securities | 54 | (184,590 | ) | 136,400 | (48,190 | ) | |||||||||
Common & preferred stocks: | |||||||||||||||
Finance | 7 | (18,292 | ) | — | (18,292 | ) | |||||||||
Insurance | 2 | (1,492 | ) | — | (1,492 | ) | |||||||||
Real estate | 2 | (1,400 | ) | — | (1,400 | ) | |||||||||
74 | $ | (220,415 | ) | $ | 133,644 | $ | (86,771 | ) | |||||||
Year Ended December 31, 2008 | |||||||||||||||
Corporate bonds: | |||||||||||||||
Finance | 3 | $ | (13,462 | ) | |||||||||||
Insurance | 2 | (10,662 | ) | ||||||||||||
Home building | 3 | (7,009 | ) | ||||||||||||
Media | 1 | (5,325 | ) | ||||||||||||
Residential mortgage backed securities | 15 | (76,171 | ) | ||||||||||||
Common & preferred stocks: | |||||||||||||||
Finance | 9 | (49,763 | ) | ||||||||||||
Insurance | 3 | (7,093 | ) | ||||||||||||
Real estate | 14 | (23,163 | ) | ||||||||||||
50 | $ | (192,648 | ) | ||||||||||||
The presentation for the year ended December 31, 2008, is prior to the adoption of FASB guidance issued in April 2009 which separates OTTI for debt securities into credit component that is recognized in operations and a non-credit component that is recognized in other comprehensive income.
35
Several factors led us to believe that full recovery of amortized cost will not be expected. These include, but are not limited to: (i) a significant change in the operating performance of a company; (ii) a material change in the expected contractual obligation of an issuer; (iii) a significant change in ratings as defined by the NRSRO; and (iv) the time frame in which a recovery to amortized cost may occur. We recognized OTTI of $2.4 million on two corporate fixed maturity securities during the year ended December 31, 2010, because we changed from a position of holding these securities until price recovery to intending to sell them prior to price recovery.
Deterioration of the issuers’ credit worthiness and liquidity profile were major factors in leading us to make the determination that other than temporary impairments were present in our corporate bonds and preferred stocks. Our analysis demonstrated that we could not expect a recovery of our cost basis within our expected holding period for debt securities or within a reasonable period of time for equity securities.
In the case of residential mortgage backed securities, we considered the ratings downgrades, increased default and loss severity projections, actual defaults, and expected cash flow projections to determine that other than temporary impairments were present. We continue to monitor the cash flows and economics surrounding these securities to determine changes in expected future cash flows.
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments we have recognized on residential mortgage backed securities which are all senior level tranches within the structure of the securities:
Discount Rate | Default Rate | Loss Severity | ||||||||||||||||||
Sector | Vintage | Min | Max | Min | Max | Min | Max | |||||||||||||
December 31, 2010 | ||||||||||||||||||||
Prime | 2005 | 7.5 | % | 7.5 | % | 11 | % | 11 | % | 45 | % | 45 | % | |||||||
2006 | 6.5 | % | 7.6 | % | 7 | % | 11 | % | 45 | % | 60 | % | ||||||||
2007 | 5.8 | % | 6.7 | % | 11 | % | 28 | % | 40 | % | 60 | % | ||||||||
2008 | 6.6 | % | 6.6 | % | 5 | % | 5 | % | 50 | % | 50 | % | ||||||||
Alt-A | 2005 | 6.0 | % | 7.4 | % | 12 | % | 27 | % | 45 | % | 50 | % | |||||||
2006 | 6.5 | % | 7.3 | % | 30 | % | 36 | % | 50 | % | 60 | % | ||||||||
2007 | 6.5 | % | 7.0 | % | 35 | % | 51 | % | 50 | % | 60 | % | ||||||||
December 31, 2009 | ||||||||||||||||||||
Prime | 2005 | 7.7 | % | 7.7 | % | 7 | % | 7 | % | 50 | % | 50 | % | |||||||
2006 | 6.5 | % | 9.2 | % | 7 | % | 14 | % | 35 | % | 55 | % | ||||||||
2007 | 5.8 | % | 7.9 | % | 8 | % | 31 | % | 35 | % | 50 | % | ||||||||
Alt-A | 2004 | 5.8 | % | 5.8 | % | 11 | % | 11 | % | 40 | % | 40 | % | |||||||
2005 | 5.6 | % | 8.7 | % | 10 | % | 25 | % | 10 | % | 55 | % | ||||||||
2006 | 6.0 | % | 7.3 | % | 16 | % | 31 | % | 40 | % | 60 | % | ||||||||
2007 | 6.2 | % | 7.5 | % | 15 | % | 52 | % | 45 | % | 70 | % | ||||||||
In making the decisions to write down the securities described above, we considered whether the factors leading to those write downs impacted any other securities held in our portfolio. In cases where we determined that a decline in value was related to an industry-wide concern, we considered the impact of such concern on all securities we held within that industry classification.
36
Mortgage Loans on Real Estate
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 commercial mortgage loans on real estate are reported at cost, adjusted for amortization of premiums and accrual of discounts net of allowances for loan loss. At December 31, 2010 and 2009, the largest principal amount outstanding for any single mortgage loan was $10.7 million and $11.2 million, respectively, and the average loan size was $2.4 million for both 2010 and 2009. We have the contractual ability to pursue full personal recourse on 13.3% of the loans and partial personal recourse on 32.5% of the loans, and master leases provide us recourse against the principals of the borrowing entity on 5.6% of the loans. In addition, the average loan to value ratio for the overall portfolio was 54.7% and 56.3% at December 31, 2010 and 2009, 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 may obtain a current appraisal of the underlying collateral. The commercial mortgage loan portfolio is summarized by geographic region and property type as follows:
December 31, | |||||||||||||
2010 | 2009 | ||||||||||||
Carrying Amount | Percent | Carrying Amount | Percent | ||||||||||
(Dollars in thousands) | |||||||||||||
Geographic distribution | |||||||||||||
East | $ | 618,250 | 23.6 | % | $ | 560,256 | 22.8 | % | |||||
Middle Atlantic | 172,443 | 6.6 | % | 168,246 | 6.9 | % | |||||||
Mountain | 402,965 | 15.4 | % | 388,940 | 15.9 | % | |||||||
New England | 42,695 | 1.6 | % | 44,541 | 1.8 | % | |||||||
Pacific | 247,254 | 9.5 | % | 216,382 | 8.8 | % | |||||||
South Atlantic | 496,606 | 19.0 | % | 464,077 | 18.9 | % | |||||||
West North Central | 419,002 | 16.0 | % | 410,883 | 16.7 | % | |||||||
West South Central | 215,650 | 8.3 | % | 201,719 | 8.2 | % | |||||||
$ | 2,614,865 | 100.0 | % | $ | 2,455,044 | 100.0 | % | ||||||
Loan loss allowance | (16,224 | ) | (5,266 | ) | |||||||||
2,598,641 | 2,449,778 | ||||||||||||
Property type distribution | |||||||||||||
Office | $ | 683,404 | 26.1 | % | $ | 664,701 | 27.1 | % | |||||
Medical Office | 166,930 | 6.4 | % | 145,390 | 5.9 | % | |||||||
Retail | 589,369 | 22.5 | % | 564,023 | 23.0 | % | |||||||
Industrial/Warehouse | 666,908 | 25.5 | % | 610,279 | 24.9 | % | |||||||
Hotel | 151,516 | 5.8 | % | 155,594 | 6.3 | % | |||||||
Apartment | 131,682 | 5.1 | % | 122,854 | 5.0 | % | |||||||
Mixed use/other | 225,056 | 8.6 | % | 192,203 | 7.8 | % | |||||||
$ | 2,614,865 | 100.0 | % | $ | 2,455,044 | 100.0 | % | ||||||
Loan loss allowance | (16,224 | ) | (5,266 | ) | |||||||||
2,598,641 | 2,449,778 | ||||||||||||
In the normal course of business, we commit to fund commercial mortgage loans up to 90 days in advance. At December 31, 2010, we had commitments to fund commercial mortgage loans totaling $96.2 million, with fixed interest rates ranging from 5.25% to 6.00%.
During 2010, five mortgage loans were satisfied by taking ownership of the real estate serving as collateral the loans. These loans had an aggregate principal amount outstanding of $11.7 million, for which specific loan loss allowances totaling $4.3 million were established and recognized in 2010. Additional impairment of $0.6 million was recognized on two properties after ownership of the real estate was taken in 2010 as the fair value of each property was revalued by a third party appraiser and the fair value less the estimated costs to sell was lower due to new facts discovered after ownership was obtained.
At December 31, 2010, we have seven mortgage loans that are in the process of being satisfied by taking ownership of the real estate serving as collateral on the loan. These seven loans have a total outstanding principal balance of $24.1 million for which we have recorded specific loan loss allowances totaling $11.1 million in 2010. We also have 23 commercial mortgage loans at December 31, 2010 with a total outstanding principal balance of $68.5 million that have been given "workout" terms which generally allow for interest only payments or the capitalization of interest for a specified period of time. We have recorded a specific loan loss allowance on one of the "workout" loans (principal balance of
37
$5.7 million) of $1.9 million ($0.9 million in 2010 and $1.0 million in 2009). At December 31, 2010, we have six commercial mortgage loans with a total outstanding principal balance of $20.5 million that were delinquent (60 days or more at the reporting date) in their principal and interest payments and we recorded a specific loan loss allowance on one of these loans (principal balance of $1.3 million) of $0.2 million in 2010. The total outstanding principal balance of these 36 loans is $113.0 million, which represents less than 5% of our total mortgage loan portfolio.
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the measurement of an estimated loss for each individual loan identified and an analysis of the mortgage loan portfolio for the need for a general loan allowance for probable losses on all other loans. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell that collateral. The amount of the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience, delinquencies, credit concentrations, underwriting standards and national and local economic conditions. Based upon this process and analysis, we established a general loan loss allowance of $3.0 million during the year ended December 31, 2010. No general loan loss allowance was considered necessary at December 31, 2009, and the 2010 activity reflects our ongoing evaluation of historical experience and current market conditions.
Mortgage loans summarized in the following table represent all loans that we are either not currently collecting or those we feel it is probable we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the borrower to alleviate short-term cash flow issues and loans delinquent for 60 days or more at the reporting date).
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Impaired mortgage loans with allowances | $ | 31,027 | $ | 15,869 | |||
Impaired mortgage loans with no allowance for losses | 81,994 | 70,214 | |||||
Allowance for probable loan losses | (13,224 | ) | (5,266 | ) | |||
Net carrying value of impaired mortgage loans | $ | 99,797 | $ | 80,817 | |||
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.
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. 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.
The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts, presented in the consolidated balance sheets are as follows:
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Assets | |||||||
Derivative instruments | |||||||
Call options | $ | 479,786 | $ | 479,272 | |||
Other Assets | |||||||
2015 notes hedges | 66,595 | — | |||||
$ | 546,381 | $ | 479,272 | ||||
Liabilities | |||||||
Policy benefit reserves—annuity products | |||||||
Fixed index annuities—embedded derivatives | $ | 1,971,383 | $ | 1,375,866 | |||
Other liabilities | |||||||
2015 notes embedded conversion derivative | 66,595 | — | |||||
Interest rate swaps | 1,976 | 1,891 | |||||
$ | 2,039,954 | $ | 1,377,757 | ||||
38
The change in fair value of derivatives included in the consolidated statements of operations are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Change in fair value of derivatives: | |||||||||||
Call options | $ | 141,803 | $ | 219,275 | $ | (370,814 | ) | ||||
2015 notes hedges | 29,595 | — | — | ||||||||
Interest rate swaps | (2,536 | ) | (2,379 | ) | (1,195 | ) | |||||
$ | 168,862 | $ | 216,896 | $ | (372,009 | ) | |||||
Change in fair value of embedded derivatives: | |||||||||||
2015 notes embedded derivatives | $ | 29,595 | $ | — | $ | — | |||||
Fixed index annuities | 101,355 | 529,508 | (210,753 | ) | |||||||
$ | 130,950 | $ | 529,508 | $ | (210,753 | ) | |||||
We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps, participation rates, or asset fees, we can generally manage option costs except in cases where the contractual features would prevent further modifications.
Our strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process which evaluates the program's effectiveness. We do not purchase call options that would require payment or collateral to another institution and our call options do not contain counterparty credit-risk-related contingent features. We are exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, we purchase our option contracts from multiple counterparties and evaluate the creditworthiness of all counterparties prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's credit rating of A- or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. We also have credit support agreements that allow us to request the counterparty to provide collateral to us when the fair value of our exposure to the counterparty exceeds specified amounts.
The notional amount and maximum amount of loss due to credit risk that we would incur if parties to the call options failed completely to perform according to the terms of the contracts are as follows:
December 31, | ||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||
Counterparty | Credit Rating (S&P) | Credit Rating (Moody's) | Notional Amount | Fair Value | Notional Amount | Fair Value | ||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Bank of America | A+ | Aa3 | $ | 588,650 | $ | 25,704 | $ | 796 | $ | — | ||||||||||
BNP Paribas | AA | Aa2 | 786,561 | 34,772 | 1,647,627 | 101,888 | ||||||||||||||
Lehman | NR | NR | — | — | 1,437 | — | ||||||||||||||
Bank of New York | AA- | Aa2 | 18,082 | 111 | 112,193 | 6,153 | ||||||||||||||
Credit Suisse | A+ | Aa1 | 2,462,920 | 95,910 | 2,711,027 | 163,321 | ||||||||||||||
Barclays | AA- | Aa3 | 1,728,218 | 72,751 | 258,853 | 10,082 | ||||||||||||||
SunTrust | BBB+ | A3 | 50,540 | 3,164 | 427,572 | 27,735 | ||||||||||||||
Wells Fargo (Wachovia) | NR | Aa2 | 1,745,775 | 76,250 | 1,189,234 | 70,746 | ||||||||||||||
J.P. Morgan | AA- | Aa1 | 2,858,902 | 133,368 | 1,648,394 | 99,347 | ||||||||||||||
UBS | A+ | Aa3 | 921,596 | 37,756 | — | — | ||||||||||||||
$ | 11,161,244 | $ | 479,786 | $ | 7,997,133 | $ | 479,272 | |||||||||||||
As of December 31, 2010 and 2009 we held $381.2 and $346.5 million, respectively, of cash and cash equivalents received from counterparties for derivative collateral, which is included in other liabilities on our consolidated balance sheets. This derivative collateral limits the maximum amount of economic loss due to credit risk that we would incur if parties to the call options failed completely to perform according to the terms of the contracts to $108.1 million and $149.6 million at December 31, 2010 and 2009, respectively.
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We had unsecured counterparty exposure in connection with options purchased from affiliates of Lehman Brothers ("Lehman") which declared bankruptcy during the third quarter of 2008. All options purchased from affiliates of Lehman had expired as of June 30, 2010. The amount of option proceeds due on expired options purchased from affiliates of Lehman that we did not receive payment on was $12.0 million and $2.1 million for the years ended December 31, 2009 and 2008, respectively. No amount has been recognized for any recovery of these amounts that may result from our claim in Lehman's bankruptcy proceedings.
Concurrently with the issuance of our 3.5% Convertible Senior Notes due in 2015 (the "2015 notes"), we entered into hedge transactions (the "2015 notes hedges") with various parties whereby we have the option to receive the cash equivalent of the conversion spread on approximately 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. These options expire on September 15, 2015 and must be settled in cash. The aggregate cost of the 2015 notes hedges was $37.0 million. The 2015 notes hedges are accounted for as derivative assets, and are included in Other assets in our Consolidated Balance Sheets. The estimated fair value of the 2015 notes hedges was $66.6 million as of December 31, 2010.
The conversion option of the 2015 notes (the "2015 notes embedded conversion derivative") is an embedded derivative that requires bifurcation from the 2015 notes and is accounted for as a derivative liability, which is included in Other liabilities in our Consolidated Balance Sheets. The fair value of the 2015 notes embedded conversion derivative at the time of issuance of the 2015 notes was $37.0 million, and was recorded as the original debt discount for purposes of accounting for the debt component of the 2015 notes. This discount will be recognized as interest expense using the effective interest method over the term of the 2015 notes. The estimated fair value of the 2015 notes embedded conversion derivative was $66.6 million as of December 31, 2010.
Liabilities
Our liability for policy benefit reserves increased to $23.7 billion at December 31, 2010 compared to $19.3 billion at December 31, 2009, primarily due to additional annuity sales as discussed above. Substantially all of our annuity products have a surrender charge feature designed to reduce the risk of early withdrawal or surrender of the policies and to compensate us for our costs if policies are withdrawn early. Notwithstanding these policy features, the withdrawal rates of policyholder funds may be affected by changes in interest rates and other factors.
As part of our investment strategy, we enter into securities repurchase agreements (short-term collateralized borrowings). We had no borrowings under repurchase agreements during 2010. The maximum amount borrowed during 2009 and 2008 was $440.0 million and $641.1 million, respectively. When we do borrow cash on these repurchase agreements, we pledge collateral in the form of debt securities with fair values approximately equal to the amount due and we use the cash to purchase debt securities ahead of the time we collect the cash from selling annuity policies to avoid a lag between the investment of funds and the obligation to credit interest to policyholders. We earn investment income on the securities purchased with these borrowings at a rate in excess of the cost of these borrowings. Such borrowings averaged $150.7 million and $359.9 million for the years ended December 31, 2009 and 2008, respectively. The weighted average interest rate on amounts due under repurchase agreements was 0.35% and 2.28% for the years ended December 31, 2009 and 2008, respectively.
In December 2004, we issued $260.0 million principal amount of convertible senior notes due December 6, 2024 (the "2024 notes"). The 2024 notes are unsecured and bear interest at a fixed rate of 5.25% per annum. Interest is payable semi-annually in arrears on June 6 and December 6 of each year. In addition to regular interest on the 2024 notes, beginning with the six-month interest period ending June 6, 2012, we will also pay contingent interest under certain conditions at a rate of 0.5% per annum based on the average trading price of the 2024 notes during a specified period.
We extinguished $78.1 million principal amount of the 2024 notes during 2008 at a discount and recognized a gain of $9.7 million. In 2009, we issued five million shares of our common stock with a fair value of $31.3 million in exchange for $37.2 million principal amount of the 2024 notes and recognized a gain of $3.1 million. In 2010, we extinguished $6.7 million principal amount of the outstanding 2024 notes for $6.6 million in cash and recognized a loss of $0.3 million.
In December 2009, we issued $115.8 million principal amount of convertible senior notes due December 6, 2029 (the "2029 notes"). The 2029 notes are unsecured and bear interest at a fixed rate of 5.25% per annum. Interest is payable semi-annually in arrears on June 6 and December 6 of each year. In addition to regular interest on the 2029 notes, beginning with the six-month interest period ending June 6, 2015, we will also pay contingent interest under certain conditions at a rate of 0.5% per annum based on the average trading price of the 2029 notes during a specified period. $52.2 million of these notes were issued for cash. The remaining $63.6 million were issued in exchange for the same amount of the 2024 notes, for which a loss of $3.8 million was recognized.
In September 2010, we issued $200.0 million principal amount of the 2015 notes. The 2015 notes have a stated interest rate of 3.5%, mature on September 15, 2015, and are intended to be settled in cash; however, in certain limited circumstances we have the discretion to settle in shares of our common stock or a combination of cash and shares of our common stock. Contractual interest payable on the 2015 notes began accruing in September 2010 and is payable semi-annually in arrears on March 15 and September 15. We used $150 million of the proceeds to pay off our fully drawn bank line of credit.
The 2024 notes and 2029 notes are convertible at the holders' option prior to the maturity date into cash and shares of our common stock under certain conditions. The conversion price per share of the 2024 notes is $14.03, which represents a conversion rate of 71.3 shares of our common stock per $1,000 in principal amount of notes. The conversion price per share of the 2029 notes is $9.69, which represents a conversion rate of 103.2 shares of our common stock per $1,000 in principal amount of notes. Upon conversion, we will deliver to the holder cash equal to the aggregate principal amount of the notes to be converted and shares of our common stock for the amount by which the conversion value exceeds the aggregate principal amount of the notes to be converted (commonly referred to as "net share settlement"). See note 9 to the audited consolidated financial statements for additional details concerning the conversion features of the notes and the dilutive effect of the notes in our diluted
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earnings per share calculation.
The initial conversion rate for the 2015 notes is 80 shares of our common stock per $1,000 principal amount of 2015 notes, equivalent to a conversion price of approximately $12.50 per share of our common stock, with the amount due on conversion. Upon conversion, a holder will receive a cash payment equal to the sum of the daily settlement amounts, calculated on a proportionate basis for each day, during a specified observation period following the conversion date.
At December 31, 2010, $74.5 million principal amount of the 2024 notes remains outstanding which we may redeem at any time on or after December 15, 2011. The holders of the 2024 notes may require us to repurchase their notes on December 15, 2011, 2014, and 2019 and for a certain period of time following a change in control. We may redeem the 2029 notes at any time on or after December 15, 2014. The holders of the 2029 notes may require us to repurchase their notes on December 15, 2014, 2019 and 2024 and for a certain period of time following a change in control. The redemption price or the repurchase price shall be payable in cash and equal to 100% of the principal amount of the notes, plus accrued and unpaid interest (including contingent interest and liquidated damages, if any) up to but not including the date of redemption or repurchase.
Our convertible notes are senior unsecured obligations and rank equally in the right of payment with all existing and future senior indebtedness and senior to any existing and future subordinated indebtedness. Our convertible notes effectively rank junior in the right of payment to any existing and future secured indebtedness to the extent of the value of the assets securing such secured indebtedness. Our convertible notes are structurally subordinated to all liabilities of our subsidiaries.
Our subsidiary trusts have issued fixed rate and floating rate trust preferred securities and the trusts have used the proceeds from these offerings to purchase subordinated debentures from us. We also issued subordinated debentures to the trusts in exchange for all of the common securities of each trust. The sole assets of the trusts are the subordinated debentures and any interest accrued thereon. The terms of the preferred securities issued by each trust parallel the terms of the subordinated debentures. Our obligations under the subordinated debentures and related agreements provide a full and unconditional guarantee of payments due under the trust preferred securities. Accounting standards for consolidation of variable interest entities, specifically exempts qualifying special purpose entities from consolidation; therefore, we do not consolidate our subsidiary trusts and record our subordinated debt obligations to the trusts and our equity investments in the trusts. See note 10 to our audited consolidated financial statements for additional information concerning our subordinated debentures payable to, and the preferred securities issued by, the subsidiary trusts.
Following is a summary of subordinated debt obligations to the trusts at December 31, 2010 and 2009:
December 31, | |||||||||||
2010 | 2009 | Interest Rate | Due Date | ||||||||
(Dollars in thousands) | |||||||||||
American Equity Capital Trust I | $ | 22,893 | $ | 22,953 | 8% | September 30, 2029 | |||||
American Equity Capital Trust II | 75,932 | 75,784 | 5% | June 1, 2047 | |||||||
American Equity Capital Trust III | 27,840 | 27,840 | *LIBOR + 3.90% | April 29, 2034 | |||||||
American Equity Capital Trust IV | 12,372 | 12,372 | *LIBOR + 4.00% | January 8, 2034 | |||||||
American Equity Capital Trust VII | 10,830 | 10,830 | *LIBOR + 3.75% | December 14, 2034 | |||||||
American Equity Capital Trust VIII | 20,620 | 20,620 | *LIBOR + 3.75% | December 15, 2034 | |||||||
American Equity Capital Trust IX | 15,470 | 15,470 | *LIBOR + 3.65% | June 15, 2035 | |||||||
American Equity Capital Trust X | 20,620 | 20,620 | *LIBOR + 3.65% | September 15, 2035 | |||||||
American Equity Capital Trust XI | 20,620 | 20,620 | *LIBOR + 3.65% | December 15, 2035 | |||||||
American Equity Capital Trust XII | 41,238 | 41,238 | *LIBOR + 3.50% | April 7, 2036 | |||||||
$ | 268,435 | $ | 268,347 | ||||||||
*—three month London Interbank Offered Rate
The interest rate for Trust XI was fixed at 8.595% for 5 years until December 15, 2010.
American Equity Capital Trust I issued 865,671 shares of 8% trust preferred securities, of which 2,000 shares are held by one of our subsidiaries, and we issued $26.8 million of our 8% subordinated debentures. During 2010 and 2008, 2,010 and 8,333 shares of these trust preferred securities converted into 7,444 and 30,862 shares of our common stock, respectively. There were no conversions during 2009. The remaining 736,328 shares of these trust preferred securities not held by a subsidiary are convertible into 2,727,084 shares of our common stock.
American Equity Capital Trust II issued 97,000 shares of 5% trust preferred securities, and we issued $100 million of our 5% subordinated debentures. The consideration received by American Equity Capital Trust II in connection with the issue of its trust preferred securities consisted of fixed income trust preferred securities of equal value issued by FBL Financial Group, Inc.
At December 31, 2010, we had a $150 million revolving line of credit with eight banks. The applicable interest rate is floating at LIBOR plus 0.80% or the greater of prime rate or federal funds rate plus 0.50%, as elected by us. As noted above, we used $150 million of the 2015 notes proceeds to pay off the amount drawn on this revolving line of credit. No amount was outstanding at December 31, 2010. The amount outstanding under this revolving line of credit at December 31, 2009 was $150.0 million. Subsequent to December 31, 2010, we terminated the $150 million
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revolving line of credit agreement and entered into a $160 million revolving line of credit agreement with seven banks. The revolving period of the $160 million facility will be three years. The interest rate will be floating at a rate based on our election that will be equal to the applicable base rate (highest of the rate of interest publicly announced by JPMorgan Chase Bank as its prime rate in effect at its principal office in New York City, the federal funds effective rate from time to time plus 0.50% and the adjusted LIBOR for a one month interest period on such day plus 1.00%) plus the applicable margin or the adjusted LIBOR plus the applicable margin. The applicable margin and commitment fee rate are based on our credit rating and can change throughout the period of the credit facility. Based on our current credit rating the applicable margin is 2.00% and the commitment fee is 0.50% on the unused portion of credit available. Under this agreement, we are required to maintain a minimum risk-based capital ratio at American Equity Life, a maximum ratio of debt to total capital, a minimum cash coverage ratio, and a minimum level of statutory surplus at American Equity Life.
We entered into interest rate swaps to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures and our revolving line of credit. The terms of the interest rate swaps provide that we pay a fixed rate of interest and receive a floating rate of interest. The interest rate swaps are not effective hedges under accounting guidance for derivative instruments and hedging activities. Therefore, we record the interest rate swaps at fair value with the changes in fair value and any net cash payments received or paid included in the change in fair value of derivatives in our consolidated statements of operations.
Details regarding the interest rate swaps are as follows:
December 31, | ||||||||||||||||||
Notional Amount | Receive Rate | Pay Rate | 2010 | 2009 | ||||||||||||||
Maturity Date | Counterparty | Fair Value | Fair Value | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||
September 15, 2010 | 20,000 | *LIBOR(a) | 5.19 | % | Bank of America | — | (142 | ) | ||||||||||
April 7, 2011 | 20,000 | *LIBOR(a) | 5.23 | % | Bank of America | (99 | ) | (290 | ) | |||||||||
October 15, 2011 | 15,000 | **LIBOR | 1.54 | % | SunTrust | (193 | ) | (144 | ) | |||||||||
October 31, 2011 | 30,000 | **LIBOR | 1.51 | % | SunTrust | (374 | ) | (241 | ) | |||||||||
October 31, 2011 | 30,000 | **LIBOR | 1.61 | % | SunTrust | (405 | ) | (301 | ) | |||||||||
October 31, 2011 | 75,000 | **LIBOR | 1.77 | % | SunTrust | (905 | ) | (773 | ) | |||||||||
$ | (1,976 | ) | $ | (1,891 | ) | |||||||||||||
*—three month London Interbank Offered Rate
**—one month London Interbank Offered Rate
(a)—subject to a floor of 4.25%
Liquidity and Capital Resources
Liquidity for Insurance Operations
Our insurance subsidiaries' primary sources of cash flow are annuity deposits, investment income, and proceeds from the sale, maturity and calls of investments. The primary uses of funds are investment purchases, payments to policyholders in connection with surrenders and withdrawals, policy acquisition costs and other operating expenses.
Liquidity requirements are met primarily by funds provided from operations. Our life subsidiaries generally receive adequate cash flow from annuity deposits and investment income to meet their obligations. Annuity and life insurance liabilities are generally long-term in nature. However, a primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our annuity policies, such as surrender charges, that help limit and discourage early withdrawals. At December 31, 2010, approximately 97% of our annuity liabilities were subject to penalty upon surrender, with a weighted average remaining surrender charge period of 10.3 years and a weighted average surrender charge rate of 15.2%.
Our insurance subsidiaries continue to 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 $2.8 billion for the year ended December 31, 2010 compared to $1.7 billion for the year ended December 31, 2009 with the increase primarily attributable to a $1.3 billion increase in net annuity deposits after coinsurance and a $200.7 million (after coinsurance) increase in funds returned to policyholders. We continue to invest the net proceeds from policyholder transactions and investment activities in high quality fixed maturity securities and fixed rate commercial mortgage loans. As reported above under Financial Condition - Investments, during 2010 we experienced a significant amount of calls of United States Government sponsored agency securities. As a result we have had elevated levels of short-term investments and cash and cash equivalents during 2010. We have been reinvesting the proceeds from the called securities in United States Government sponsored agency securities, investment grade corporate fixed maturity securities and United States municipalities, states and territories securities with yields that meet our investment spread objectives. The accelerated pace of these calls may continue in 2011. At December 31, 2010, 36% of our fixed income securities have call features and 1% ($0.1 billion) of those securities were subject to call redemption. Another 21% ($3.4 billion) of our fixed income securities will become subject to call redemption during 2011. If interest rates remain unchanged from December 31, 2010 levels we expect many of the securities callable in 2011 to be called. Our ability to continue to reinvest the proceeds from called securities in assets with acceptable credit quality and yield characteristics similar to the called securities will be dependent on future
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market conditions.
Liquidity of Parent Company
We, as the parent company, are a legal entity separate and distinct from our subsidiaries, and have no business operations. We need liquidity primarily to service our debt, including the convertible senior notes and subordinated debentures issued to subsidiary trusts, pay operating expenses and pay dividends to 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 to us to meet our current and reasonably foreseeable future obligations and we expect they will be adequate to fund our parent company cash flow requirements in 2011. During 2011, we may redeem and holders may require us to repurchase the $74.5 million principal amount outstanding of the 2024 notes. At December 31, 2010, we have cash and cash equivalents totaling $62.3 million on hand available to extinguish this debt.
The payment of dividends or distributions, including surplus note payments, by our life subsidiaries is subject to regulation by each subsidiary's state of domicile's insurance department. Currently, American Equity Life may pay dividends or make other distributions without the prior approval of the Iowa Insurance Commissioner, unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1) American Equity Life's net gain from operations for the preceding calendar year, or (2) 10% of American Equity Life's statutory capital and surplus at the preceding December 31. For 2011, up to $187.5 million can be distributed as dividends by American Equity Life without prior approval of the Iowa Insurance Commissioner. In addition, dividends and surplus note payments may be made only out of statutory earned surplus, and all surplus note payments are subject to prior approval by regulatory authorities in the life subsidiary's state of domicile. American Equity Life had $493.6 million of statutory earned surplus at December 31, 2010.
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. In addition, we manage the statutory capital and surplus in American Equity Life to maintain American Equity Life's current A.M. Best rating. As of December 31, 2010, we estimate American Equity Life has sufficient statutory capital and surplus, combined with capital available to the holding company, to meet this rating objective. However, this capital may not be sufficient if significant future losses are incurred or A.M. Best modifies its rating criteria and, given the current market conditions, access to additional capital could be limited.
The transfer of funds by American Equity Life is also restricted by a covenant in our revolving line of credit agreement which requires American Equity Life to maintain a minimum risk-based capital ratio of 275%. American Equity Life's risk-based capital ratio was 339% at December 31, 2010.
Statutory accounting practices prescribed or permitted for our life subsidiaries differ in many respects from those governing the preparation of financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. Information as to statutory capital and surplus and statutory net income for our life subsidiaries as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 is included in note 12 to our audited consolidated financial statements.
During the third quarter 2010, we issued $200.0 million principal amount of the 2015 notes. Concurrently with the issuance of the 2015 notes, we entered into hedge transactions (the "2015 notes hedges") with various parties whereby we have the option to receive the cash equivalent of approximately 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. In separate transactions, we also sold warrants (the "2015 warrants") to two counterparties for the purchase of up to approximately 16.0 million shares of our common stock at a price of $16.00 per share. The 2015 notes, 2015 notes hedges and 2015 warrants produced net cash proceeds of $171.9 million. We used $150.0 million of these proceeds to pay off the amount drawn on our now terminated revolving line of credit.
As discussed above, subsequent to December 31, 2010, we terminated the $150 million line of credit and entered into a $160 million revolving line of credit agreement (see note 9 to our audited consolidated financial statements). The new revolving line of credit terminates on January 28, 2014, and borrowings are available for general corporate purposes of the parent company and its subsidiaries. During 2009, we borrowed $75.0 million under our now terminated revolving line of credit and used the proceeds to make $75.0 million in capital contributions to American Equity Life.
During 2008, we purchased $78.1 million principal amount of the 2024 notes at a discount and recognized a gain of $9.7 million related to the retirement of these notes. The cash required to retire these notes totaled $61.4 million. We also repurchased 3,545,744 shares of our common stock as part of our share repurchase program during 2008. We suspended the repurchase of our common stock under this program in August 2008. The cash used to purchase our common stock during 2008 was $30.7 million. The sources of cash to fund the debt retirements and the common stock repurchases primarily came from draws on our $150 million revolving line of credit and sales of investments including sales to American Equity Life.
On August 20, 2009, we entered into distribution agreements with Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC (“FPK”) and Sandler O’Neill & Partners, L.P. ("Sandler O'Neill") to offer and sell shares of our common stock up to an aggregate offering price of $50 million. On December 3, 2009, Macquarie Capital (USA) Inc. ("Macquarie Capital") assumed all of FPK's rights and obligations under our distribution
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agreement with FPK. On August 4, 2010, we provided notice to Macquarie Capital and Sandler O'Neill that we were terminating the distribution agreements. During 2009, we sold 132,300 shares of our common stock pursuant to these distribution agreements, resulting in gross proceeds to us of $1.1 million, and we had no sales in 2010.
We have the ability to issue equity, debt or other types of securities through one or more methods of distribution under a currently effective shelf registration statement on Form S-3. The terms of any offering would be established at the time of the offering, subject to market conditions.
In the normal course of business, we enter into financing transactions, lease agreements, or other commitments. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations as of December 31, 2010.
Payments Due by Period | |||||||||||||||||||
Total | Less Than 1 year | 1–3 Years | 4–5 Years | After 5 Years | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Annuity and single premium universal life products (1) | $ | 23,918,065 | $ | 1,685,055 | $ | 5,329,045 | $ | 3,388,376 | $ | 13,515,589 | |||||||||
Notes payable, including interest payments | 446,570 | 91,486 | 26,163 | 328,921 | — | ||||||||||||||
Subordinated debentures, including interest payments (2) | 680,103 | 14,147 | 28,295 | 28,295 | 609,366 | ||||||||||||||
Operating leases | 11,942 | 1,274 | 2,285 | 2,093 | 6,290 | ||||||||||||||
Mortgage loan funding | 96,215 | 96,215 | — | — | — | ||||||||||||||
Total | $ | 25,152,895 | $ | 1,888,177 | $ | 5,385,788 | $ | 3,747,685 | $ | 14,131,245 | |||||||||
(1) | Amounts shown in this table are projected payments through the year 2030 which we are contractually obligated to pay to our annuity policyholders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency, when applicable. These assumptions are based on our historical experience. |
(2) | Amount shown is net of equity investments in the capital trusts due to the contractual right of offset upon repayment of the notes. |
Inflation
Inflation does not have a significant effect on our consolidated balance sheet. We have minimal investments in property, equipment or inventories. To the extent that interest rates may change to reflect inflation or inflation expectations, there would be an effect on our balance sheet and operations. Lower interest rates and tighter spreads experienced in recent periods have increased the value of our fixed maturity investments. It is likely that rising interest rates and wider spreads would have the opposite effect. It is not possible to calculate the effect such changes in interest rates, if any, have had on our operating results.
Critical Accounting Policies
The increasing complexity of the business environment and applicable authoritative accounting guidance require us to closely monitor our accounting policies. We have identified five critical accounting policies that are complex and require significant judgment. The following summary of our critical accounting policies is intended to enhance your ability to assess our financial condition and results of operations and the potential volatility due to changes in estimates.
Valuation of Investments
Our fixed maturity securities (bonds and redeemable preferred stocks maturing more than one year after issuance) and equity securities (common and perpetual preferred stocks) classified as available for sale are reported at fair value. Unrealized gains and losses, if any, on these securities are included directly in stockholders' equity as a component of Accumulated Other Comprehensive Loss, net of income taxes and certain adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements. Unrealized gains and losses represent the difference between the amortized cost or cost basis and the fair value of these investments. We use significant judgment within the process used to determine fair value of these investments.
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GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. We categorize our investments into three levels of fair value hierarchy based on the priority for use of inputs in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1 — Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2 — Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3 — Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
The following table presents the fair value of fixed maturity and equity securities, available for sale, by pricing source and hierarchy level as of December 31, 2010 and 2009, respectively:
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | ||||||||||||
(Dollars in thousands) | |||||||||||||||
December 31, 2010 | |||||||||||||||
Priced via third party pricing services | $ | 122,543 | $ | 13,045,622 | $ | — | $ | 13,168,165 | |||||||
Priced via independent broker quotations | — | 2,524,103 | — | 2,524,103 | |||||||||||
Priced via matrices | — | — | — | — | |||||||||||
Priced via other methods | — | 201,654 | 2,702 | 204,356 | |||||||||||
$ | 122,543 | $ | 15,771,379 | $ | 2,702 | $ | 15,896,624 | ||||||||
% of Total | 0.8 | % | 99.2 | % | 0.0 | % | 100.0 | % | |||||||
December 31, 2009 | |||||||||||||||
Priced via third party pricing services | $ | 154,035 | $ | 610,195 | $ | — | $ | 764,230 | |||||||
Priced via independent broker quotations | 2,545 | 9,945,634 | — | 9,948,179 | |||||||||||
Priced via matrices | — | 53,647 | — | 53,647 | |||||||||||
Priced via other methods | — | 13,243 | 17,918 | 31,161 | |||||||||||
$ | 156,580 | $ | 10,622,719 | $ | 17,918 | $ | 10,797,217 | ||||||||
% of Total | 1.5 | % | 98.4 | % | 0.2 | % | 100.0 | % | |||||||
Management's assessment of all available data when determining fair value of our investments is necessary to appropriately apply fair value accounting.
We utilize independent pricing services in estimating the fair values of investment securities. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
• | reported trading prices, |
• | benchmark yields |
• | broker-dealer quotes, |
• | benchmark securities, |
• | bids and offers, |
• | credit ratings, |
• | relative credit information, and |
• | other reference data. |
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary. We generally
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obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
In addition, we obtain prices from a broker for our callable United States Government sponsored agencies. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments during the years ended December 31, 2010 and 2009.
Evaluation of Other Than Temporary Impairments
The evaluation of investments for other than temporary impairments involves significant judgment and estimates by management. We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost or cost basis of each investment that has a fair value that is lower than its amortized cost or cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process in place to identify securities that could potentially have an impairment that is other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
• | the length of time and the extent to which the fair value has been less than amortized cost or cost; |
• | whether the issuer is current on all payments and all contractual payments have been made as agreed; |
• | the remaining payment terms and the financial condition and near-term prospects of the issuer; |
• | the lack of ability to refinance due to liquidity problems in the credit market; |
• | the fair value of any underlying collateral; |
• | the existence of any credit protection available; |
• | our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities; |
• | our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot recover to cost in a reasonable period of time; |
• | our intent and ability to retain equity securities for a period of time sufficient to allow for recovery; |
• | consideration of rating agency actions; and |
• | changes in estimated cash flows of residential mortgage and asset backed securities. |
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and circumstances surrounding each security. Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations.
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The remaining amount of the other than temporary impairment is recognized in other comprehensive income.
The determination of the credit loss component of a residential mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use our "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations. The default curves generally assume lower loss levels for older vintage securities versus more recent vintage securities, which reflects the decline in underwriting standards over the years.
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, large changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.
Policy Liabilities for Fixed Index Annuities
We offer a variety of fixed index annuities with crediting strategies linked to the S&P 500 Index and other equity and bond market indices. We purchase call options on the applicable indices as an investment to provide the income needed to fund the annual index credits on the index products. See Financial Condition—Derivative Instruments. Certain derivative instruments embedded in the fixed index annuity contracts are recognized in the consolidated balance sheet at their fair values and changes in fair value are recognized immediately in our consolidated statements of operations in accordance with accounting standards for derivative instruments and hedging activities.
Accounting for derivatives prescribes that the contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. Policy liabilities for fixed index annuities are equal to the sum of the "host" (or guaranteed) component and the embedded derivative component for each fixed index annuity policy. The host value is established at inception of the contract and accreted over the policy's life at a constant rate of interest. We estimate the fair value of the embedded derivative component at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values. The amounts reported in the consolidated statements of operations as "Interest sensitive and index product benefits" represent amounts credited to policy liabilities pursuant to accounting by insurance companies for certain long-duration contracts which include index credits through the most recent policy anniversary. The amounts reported in the consolidated statements of operations as "Changes in fair value of embedded derivatives" equal the change in the difference between policy benefit reserves for fixed index annuities computed under the derivative accounting standard and the long-duration contracts accounting standard at each balance sheet date.
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In general, the change in the fair value of the embedded derivatives will not correspond to the change in fair value of the purchased call options because the purchased call options are one year options while the options valued in the embedded derivatives represent the rights of the contract holder to receive index credits over the entire period the fixed index annuities are expected to be in force, which typically exceeds 10 years.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at December 31, 2010 were to increase by100 basis points, our reserves for fixed index annuities would decrease by $131.6 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $81.6 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase our reserves for fixed index annuities by $146.2 million recorded through operations as a increase in the change in fair value of embedded derivatives and increase our combined balance for deferred policy acquisition costs and deferred sales inducements by $91.7 million recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.
Deferred Policy Acquisition Costs and Deferred Sales Inducements
Costs relating to the production of new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs or deferred sales inducements. Only costs which are expected to be recovered from future policy revenues and gross profits may be deferred.
Deferred policy acquisition costs and deferred sales inducements are subject to loss recognition testing on a quarterly basis or when an event occurs that may warrant loss recognition. Deferred policy acquisition costs consist principally of commissions and certain costs of policy issuance. Deferred sales inducements consist of premium and interest bonuses credited to policyholder account balances.
For annuity products, these costs are being amortized generally in proportion to expected gross profits from interest margins and, to a lesser extent, from surrender charges. Current and future period gross profits/margins for fixed index annuities also include the impact of amounts recorded for the change in fair value of derivatives and the change in fair value of embedded derivatives. Current period amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of realized investment gains and losses) to be realized from a group of products are revised. Our estimates of future gross profits/margins are based on actuarial assumptions related to the underlying policies terms, lives of the policies, yield on investments supporting the liabilities and level of expenses necessary to maintain the polices over their entire lives. Revisions are made based on historical results and our best estimates of future experience.
The impact of unlocking during 2010 was a $0.3 million increase in the amortization of deferred sales inducements and a $1.4 million increase in amortization of deferred policy acquisition costs. The impact of unlocking during 2010 was primarily due to adjustments made to future period assumptions for interest margins, surrenders, lifetime income benefit rider utilization and reinsurance costs. The impact of unlocking during 2008 was a $1.3 million increase in the amortization of deferred sales inducements and a $14.6 million increase in amortization of deferred policy acquisition costs. The impact of unlocking during 2008 was primarily due to actual index credits to policies being lower than what was estimated due to the lack of performance of the indices upon which the index credits are based. There were no changes in our estimated future gross profits in 2009 that resulted in unlocking adjustments to the deferred policy acquisition costs and deferred sales inducements balances.
Estimated future gross profits vary based on a number of sources including investment spread margins, surrender charge income, policy persistency, policy administrative expenses and realized gains and losses on investments including credit related other than temporary impairment losses. Estimated future gross profits are most sensitive to changes in investment spread margins which are the most significant component of gross profits. If estimated gross profits for all future years on business in force at December 31, 2010 were to increase by 10%, our combined balance for deferred policy acquisition costs and deferred sales inducements at December 31, 2010 would increase by $61.4 million recorded through operations as a decrease to amortization of deferred policy acquisition costs and deferred sales inducements. Correspondingly, a 10% decrease in estimated gross profits for all future years would result in a $69.2 million decrease in the combined December 31, 2010 balances recorded through operations as an increase to amortization of deferred policy acquisition costs and deferred sales inducements.
Deferred Income Taxes
We account for income taxes using the liability method. This method provides for the tax effects of transactions reported in the consolidated financial statements for both taxes currently due and deferred. Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. A temporary difference is a transaction, or amount of a transaction, that is recognized currently for financial reporting purposes but will not be recognized for tax purposes until a future tax period, or is recognized currently for tax purposes but will not be recognized for financial reporting purposes until a future reporting period. Deferred income taxes are measured by applying enacted tax rates for the years in which the temporary differences are expected to be recovered or settled to the amount of each temporary difference.
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The realization of deferred income tax assets is primarily based upon management's estimates of future taxable income. Valuation allowances are established when management estimates, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. When making such determination, consideration is given to, among other things, the following:
• | future taxable income of the necessary character exclusive of reversing temporary differences and carryforwards; |
• | future reversals of existing taxable temporary differences; |
• | taxable income in prior carryback years; and |
• | tax planning strategies. |
Actual realization of deferred income tax assets and liabilities may materially differ from these estimates as a result of changes in tax laws as well as unanticipated future transactions impacting related income tax balances.
The realization of deferred income tax assets related to unrealized losses on our available for sale fixed maturity securities is also based upon our intent to hold these securities for a period of time sufficient to allow for a recovery in fair value and not realize the unrealized loss.
New Accounting Pronouncements
In January 2010, the FASB issued an accounting standards update that expands the disclosure requirements related to fair value measurements. A reporting entity is now required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurement categories and describe the reasons for the transfers. Additionally, a reporting entity will be required to present on a gross basis rather than as one net number information about the purchases, sales, issuances and settlements of financial instruments that are categorized as Level 3 for fair value measurements. Clarification on existing disclosure requirements is also provided in this update relating to the level of disaggregation of information as to determining appropriate classes of assets and liabilities as well as disclosure requirements regarding valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This standard was effective for us on January 1, 2010. The disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements will become effective for fiscal years beginning after December 15, 2010.
In July 2010, the FASB issued an accounting standards update that expands disclosures and provide users more transparency about allowances for credit losses and the credit quality of the financing receivables of an entity. This guidance requires additional disclosures about an entity's financing receivables, such as credit quality indicators, aging of past due financing receivables, and significant purchases and sales of financing receivables. In addition, disclosures must be disaggregated by portfolio segment or class based on how an entity develops its allowance for credit losses and how it manages its credit exposure. Most of the disclosure requirements were effective for the fourth quarter of 2010 with certain additional disclosures required for the first quarter of 2011.
In October 2010, as a result of a consensus of the FASB Emerging Issues Task Force, the FASB issued an accounting standards update that modifies the definition of the types of costs incurred that can be capitalized in the acquisition of new and renewal insurance contracts. This guidance defines the costs that qualify for deferral as incremental direct costs that result directly from and are essential to successful contract transactions and would not have been incurred by the insurance entity had the contract transactions not occurred. In addition, it lists certain costs as deferrable as those that are directly related to underwriting, policy issuance and processing, medical and inspection, and sales force contract selling as deferrable, as well as the portion of an employee's total compensation related directly to time spent performing those activities for actual acquired contracts and other costs related directly to those activities that would not have been incurred if the contract had not been acquired. This amendment to current GAAP should be applied prospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with retrospective application permitted. We are currently evaluating the impact of the guidance on our consolidated financial statements. See note 6 to our audited consolidated financial statements for the policy issue costs that could be subject to non-deferral.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We seek to invest our available funds in a manner that will maximize shareholder value and fund future obligations to policyholders and debtors, subject to appropriate risk considerations. We seek to meet this objective through investments that: (i) consist predominately 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 to encourage persistency.
We seek to maximize the total return on our available for sale investments 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. An OTTI shall be considered to have occurred when we have an intention to sell available for sale securities in an unrealized loss position. If we do not intend to sell a debt security, we consider all available evidence to make an assessment of whether it is more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. If it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, an OTTI will be considered to have occurred. We have a portfolio of held for investment securities which principally consists of long duration bonds issued by U.S. government agencies. These securities are purchased to secure long-term yields which meet our spread targets and support the underlying liabilities.
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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, the fair value of our investments, and the amount of interest we pay on our floating rate subordinated debentures. Our floating rate trust preferred securities issued by Trust III, IV, VII, VIII, IX, X, XI (beginning on December 31, 2010) and XII bear interest at the three month LIBOR plus 3.50%-4.00%. Our outstanding balance of floating rate trust preferred securities was $164.5 million at December 31, 2010, of which $40 million had been swapped to fixed rates (see note 10 to our audited consolidated financial statements). In 2009, we swapped the floating interest rate to fixed rates of $150.0 million of the borrowings outstanding on our now terminated revolving line of credit (see note 9 to our audited consolidated financial statements). These swaps remain outstanding and expire in 2011. 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). In addition, substantially all of our annuity products have surrender and withdrawal penalty provisions designed to encourage persistency and to help ensure targeted spreads are earned. 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 computer 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% (43 basis points) from levels at December 31, 2010, we estimate that the fair value of our fixed maturity securities would decrease by approximately $633.6 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 $162.4 million in the accumulated other comprehensive income and a decrease to stockholders' equity. The computer 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 an other than temporary impairment) would generally be realized only if we were required to sell such securities at losses prior to their maturity to meet our liquidity needs, which we manage using the surrender and withdrawal provisions of our annuity contracts and through other means. See Financial Condition—Liquidity for Insurance Operations for a further discussion of the liquidity risk.
At December 31, 2010, 36% of our fixed income securities have call features and 1% ($0.1 billion) were subject to call redemption. Another 21% ($3.4 billion) will become subject to call redemption through December 31, 2011. During the years ended December 31, 2010 and 2009, we received $5.2 billion and $4.2 billion, respectively, in net redemption proceeds related to the exercise of such call options. We have reinvestment risk related to these redemptions to the extent we cannot reinvest the net proceeds in assets with credit quality and yield characteristics similar to the redeemed bonds. Such reinvestment risk typically occurs in a declining rate environment. Should rates decline to levels which tighten the spread between our average portfolio yield and average cost of interest credited on our 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. At December 31, 2010, approximately 99% of our annuity liabilities are subject to annual adjustment of the applicable crediting rates at our discretion, limited by minimum guaranteed crediting rates specified in the policies.
With respect to our fixed index annuities, we purchase call options on the applicable indices to fund the annual index credits on such 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 index products. For the years ended December 31, 2010, 2009 and 2008, the annual index credits to policyholders on their anniversaries were $454.7 million, $94.6 million and $33.3 million, respectively. Proceeds received at expiration or gains recognized upon early termination of these options related to such credits were $438.4 million, $70.6 million and $26.2 million for the years ended December 31, 2010, 2009 and 2008, respectively. The difference between proceeds received at expiration or gains recognized upon early termination of these options and index credits is primarily due to credits attributable to minimum guaranteed interest self funded by us. Proceeds for 2009 and 2008 were adversely affected by $12.0 million and $2.1 million, respectively, in proceeds not received from affiliates of Lehman Brothers which declared bankruptcy in the third quarter of 2008.
Within our hedging process we purchase options out of the money to the extent of anticipated minimum guaranteed interest on index policies. 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 index business. We manage this risk through the terms of our fixed index annuities, which permit us to change caps, participation rates and asset fees, subject to contractual features. By modifying caps, participation rates or asset fees, we can limit option costs to budgeted amounts, except in cases where the contractual features would prevent further modifications. Based upon actuarial testing which we conduct as a part of the design of our index products and on an ongoing basis, we believe the risk that contractual features would prevent us from controlling option costs is not material.
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Item 8. Consolidated Financial Statements and Supplementary Data
The consolidated financial statements are included as a part of this report on Form 10-K on pages F-1 through F-47.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) | Evaluation of Disclosure Controls and Procedures. |
In accordance with the Securities Exchange Act Rules 13a-15 and 15d-15, our management, under the supervision of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures were effective as of December 31, 2010 in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports the Company files or submits under the Exchange Act.
(b) | Management's Report on Internal Control over Financial Reporting. |
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in the Exchange Act Rule 13a-15(f). The Company's internal control system is designed to provide reasonable assurance to the Company's management and the board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2010 based upon criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the assessment, management has determined that we maintained effective internal control over financial reporting as of December 31, 2010.
The Company's independent registered public accounting firm, KPMG LLP, issued an attestation report on the effectiveness of management's internal control over financial reporting. This report appears on page F-2.
(c) | Changes in Internal Control over Financial Reporting. |
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
There is no information required to be disclosed on Form 8-K for the quarter ended December 31, 2010 which has not been previously reported.
PART III
The information required by Part III is incorporated by reference from our definitive proxy statement for our annual meeting of shareholders to be held June 9, 2011 to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2010.
PART IV
Item 15. Exhibits and Financial Statement Schedules
Financial Statements and Financial Statement Schedules. See Index to Consolidated Financial Statements and Schedules on page F-1 for a list of financial statements and financial statement schedules included in this report.
All other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are omitted because they are not applicable, not required, or because the information is included elsewhere in the consolidated financial statements or notes thereto.
Exhibits. See Exhibit Index immediately preceding the Exhibits for a list of Exhibits filed with this report.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 9th day of March, 2011.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY | |||
By: | /s/ WENDY C. WAUGAMAN | ||
Wendy C. Waugaman, Chief Executive Officer and President | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, this registration statement has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature | Title (Capacity) | Date | ||
/s/ WENDY C. WAUGAMAN | Chief Executive Officer, President and Director (Principal Executive Officer) | March 9, 2011 | ||
Wendy C. Waugaman | ||||
/s/ JOHN M. MATOVINA | Vice Chairman, Chief Financial Officer, Treasurer and Director (Principal Financial Officer) | March 9, 2011 | ||
John M. Matovina | ||||
/s/ TED M. JOHNSON | Vice President—Controller (Principal Accounting Officer) | March 9, 2011 | ||
Ted M. Johnson | ||||
/s/ D.J. NOBLE | Executive Chairman and Director | March 9, 2011 | ||
D.J. Noble | ||||
/s/ JOYCE A. CHAPMAN | Director | March 9, 2011 | ||
Joyce A. Chapman | ||||
/s/ ALEXANDER M. CLARK | Director | March 9, 2011 | ||
Alexander M. Clark | ||||
/s/ JAMES M. GERLACH | Director | March 9, 2011 | ||
James M. Gerlach | ||||
/s/ ROBERT L. HILTON | Director | March 9, 2011 | ||
Robert L. Hilton | ||||
/s/ ROBERT L. HOWE | Director | March 9, 2011 | ||
Robert L. Howe | ||||
/s/ DAVID S. MULCAHY | Director | March 9, 2011 | ||
David S. Mulcahy | ||||
/s/ GERARD D. NEUGENT | Director | March 9, 2011 | ||
Gerard D. Neugent | ||||
/s/ DEBRA J. RICHARDSON | Director | March 9, 2011 | ||
Debra J. Richardson | ||||
/s/ A.J. STRICKLAND, III | Director | March 9, 2011 | ||
A.J. Strickland, III | ||||
/s/ HARLEY A. WHITFIELD | Director | March 9, 2011 | ||
Harley A. Whitfield |
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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
YEARS ENDED DECEMBER 31, 2010, 2009, AND 2008
Report of Independent Registered Public Accounting Firm | |
Consolidated Financial Statements | |
Consolidated Balance Sheets | |
Consolidated Statements of Operations | |
Consolidated Statements of Changes in Stockholders' Equity | |
Consolidated Statements of Cash Flows | |
Notes to Consolidated Financial Statements | |
Schedules | |
Schedule I—Summary of Investments—Other Than Investments in Related Parties | |
Schedule II—Condensed Financial Information of Registrant | |
Schedule III—Supplementary Insurance Information | |
Schedule IV—Reinsurance | |
Schedule V—Valuation and Qualifying Accounts |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
American Equity Investment Life Holding Company
We have audited the accompanying consolidated balance sheets of American Equity Investment Life Holding Company and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2010. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules listed in the Index on page F-1. We also have audited the Company's internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these consolidated financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2009, the Company changed its method of accounting for other-than-temporary impairments of debt securities due to the adoption of Financial Accounting Standards Board Accounting Standards Codification (ASC) 320, and the Company changed its method of accounting for convertible debt instruments due to the retrospective adoption of ASC 470.
/s/ KPMG LLP
Des Moines, Iowa
March 9, 2011
F-2
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
December 31, | |||||||
2010 | 2009 | ||||||
Assets | |||||||
Investments: | |||||||
Fixed maturity securities: | |||||||
Available for sale, at fair value (amortized cost: 2010 - $15,621,894; 2009 - $10,912,680) | $ | 15,830,663 | $ | 10,704,131 | |||
Held for investment, at amortized cost (fair value: 2010 - $781,748; 2009 - $1,601,864) | 822,200 | 1,635,083 | |||||
Equity securities, available for sale, at fair value (cost: 2010 - $61,185; 2009 - $82,930) | 65,961 | 93,086 | |||||
Mortgage loans on real estate | 2,598,641 | 2,449,778 | |||||
Derivative instruments | 479,786 | 479,272 | |||||
Other investments | 19,680 | 12,760 | |||||
Total investments | 19,816,931 | 15,374,110 | |||||
Cash and cash equivalents | 597,766 | 528,002 | |||||
Coinsurance deposits | 2,613,191 | 2,237,740 | |||||
Accrued investment income | 167,645 | 113,658 | |||||
Deferred policy acquisition costs | 1,747,760 | 1,625,785 | |||||
Deferred sales inducements | 1,227,328 | 1,011,449 | |||||
Deferred income taxes | 143,253 | 85,661 | |||||
Income taxes recoverable | 6,134 | 103,684 | |||||
Other assets | 106,755 | 231,915 | |||||
Total assets | $ | 26,426,763 | $ | 21,312,004 | |||
Liabilities and Stockholders' Equity | |||||||
Liabilities: | |||||||
Policy benefit reserves: | |||||||
Traditional life and accident and health insurance products | $ | 190,997 | $ | 140,351 | |||
Annuity products | 23,464,810 | 19,195,870 | |||||
Other policy funds and contract claims | 222,860 | 119,403 | |||||
Notes payable | 330,835 | 316,468 | |||||
Subordinated debentures | 268,435 | 268,347 | |||||
Other liabilities | 1,010,779 | 516,942 | |||||
Total liabilities | 25,488,716 | 20,557,381 | |||||
Stockholders' equity: | |||||||
Preferred stock, no par value, 2,000,000 shares authorized, 2010 and 2009 - no shares issued and outstanding | — | — | |||||
Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding: 2010 - 56,968,446 shares (excluding 5,874,392 treasury shares); 2009 - 56,203,159 shares (excluding 5,936,696 treasury shares) | 56,968 | 56,203 | |||||
Additional paid-in capital | 454,454 | 422,225 | |||||
Unallocated common stock held by ESOP; 2010 - 447,048 shares; 2009 - 527,272 shares | (4,815 | ) | (5,679 | ) | |||
Accumulated other comprehensive income (loss) | 81,820 | (30,456 | ) | ||||
Retained earnings | 349,620 | 312,330 | |||||
Total stockholders' equity | 938,047 | 754,623 | |||||
Total liabilities and stockholders' equity | $ | 26,426,763 | $ | 21,312,004 | |||
See accompanying notes to consolidated financial statements.
F-3
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Revenues: | |||||||||||
Traditional life and accident and health insurance premiums | $ | 11,982 | $ | 12,654 | $ | 12,512 | |||||
Annuity product charges | 69,075 | 63,358 | 52,671 | ||||||||
Net investment income | 1,036,106 | 932,172 | 822,077 | ||||||||
Change in fair value of derivatives | 168,862 | 216,896 | (372,009 | ) | |||||||
Net realized gains on investments, excluding other than temporary impairment ("OTTI") losses | 23,726 | 51,279 | 5,555 | ||||||||
OTTI losses on investments: | |||||||||||
Total OTTI losses | (19,544 | ) | (220,415 | ) | (192,648 | ) | |||||
Portion of OTTI losses recognized in (from) other comprehensive income | (4,323 | ) | 133,644 | — | |||||||
Net OTTI losses recognized in operations | (23,867 | ) | (86,771 | ) | (192,648 | ) | |||||
Gain (loss) on extinguishment of debt | (292 | ) | (675 | ) | 9,746 | ||||||
Total revenues | 1,285,592 | 1,188,913 | 337,904 | ||||||||
Benefits and expenses: | |||||||||||
Insurance policy benefits and change in future policy benefits | 8,251 | 8,889 | 8,972 | ||||||||
Interest sensitive and index product benefits | 733,218 | 347,883 | 205,131 | ||||||||
Amortization of deferred sales inducements | 59,873 | 39,999 | 30,705 | ||||||||
Change in fair value of embedded derivatives | 130,950 | 529,508 | (210,753 | ) | |||||||
Interest expense on notes payable | 22,125 | 14,853 | 19,773 | ||||||||
Interest expense on subordinated debentures | 14,906 | 15,819 | 19,445 | ||||||||
Interest expense on amounts due under repurchase agreements | — | 534 | 8,207 | ||||||||
Amortization of deferred policy acquisition costs | 136,388 | 88,009 | 126,738 | ||||||||
Other operating costs and expenses | 114,615 | 57,255 | 52,633 | ||||||||
Total benefits and expenses | 1,220,326 | 1,102,749 | 260,851 | ||||||||
Income before income taxes | 65,266 | 86,164 | 77,053 | ||||||||
Income tax expense | 22,333 | 17,634 | 61,106 | ||||||||
Net income | $ | 42,933 | $ | 68,530 | $ | 15,947 | |||||
Earnings per common share | $ | 0.73 | $ | 1.22 | $ | 0.30 | |||||
Earnings per common share - assuming dilution | $ | 0.68 | $ | 1.18 | $ | 0.30 | |||||
Weighted average common shares outstanding (in thousands): | |||||||||||
Earnings per common share | 58,507 | 56,138 | 53,750 | ||||||||
Earnings per common share - assuming dilution | 64,580 | 58,915 | 56,622 | ||||||||
See accompanying notes to consolidated financial statements.
F-4
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Common Stock | Additional Paid-in Capital | Unallocated Common Stock Held by ESOP | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total Stockholders' Equity | ||||||||||||||||||
Balance at December 31, 2007 | $ | 53,556 | $ | 402,879 | $ | (6,781 | ) | $ | (38,929 | ) | $ | 210,599 | $ | 621,324 | |||||||||
Other comprehensive loss: | |||||||||||||||||||||||
Net income for the year | — | — | — | — | 15,947 | 15,947 | |||||||||||||||||
Change in net unrealized investment gains/losses | — | — | — | (108,447 | ) | — | (108,447 | ) | |||||||||||||||
Other comprehensive loss | (92,500 | ) | |||||||||||||||||||||
Conversion of $250 of subordinated debentures | 31 | 182 | — | — | — | 213 | |||||||||||||||||
Acquisition of 3,737,238 shares of common stock | (3,738 | ) | (28,886 | ) | — | — | — | (32,624 | ) | ||||||||||||||
Allocation of 41,253 shares of common stock by ESOP, including excess income tax benefits | — | (68 | ) | 445 | — | — | 377 | ||||||||||||||||
Share-based compensation, including excess income tax benefits | — | 3,471 | — | — | — | 3,471 | |||||||||||||||||
Issuance of 889,728 shares of common stock under compensation plans, including excess income tax benefits | 890 | (574 | ) | — | — | — | 316 | ||||||||||||||||
Acquisition of convertible debt | — | (222 | ) | — | — | — | (222 | ) | |||||||||||||||
Dividends on common stock ($0.07 per share) | — | — | — | — | (3,511 | ) | (3,511 | ) | |||||||||||||||
Balance at December 31, 2008 | 50,739 | 376,782 | (6,336 | ) | (147,376 | ) | 223,035 | 496,844 | |||||||||||||||
Cumulative effect of noncredit OTTI, net | — | — | — | (20,094 | ) | 25,240 | 5,146 | ||||||||||||||||
Other comprehensive income: | |||||||||||||||||||||||
Net income for the year | — | — | — | — | 68,530 | 68,530 | |||||||||||||||||
Change in net unrealized investment gains/losses | — | — | — | 223,882 | — | 223,882 | |||||||||||||||||
Noncredit component of OTTI losses, available for sale securities, net | — | — | — | (86,868 | ) | — | (86,868 | ) | |||||||||||||||
Other comprehensive income | 205,544 | ||||||||||||||||||||||
Issuance of treasury stock | 5 | 50 | — | — | (18 | ) | 37 | ||||||||||||||||
Acquisition of 12,362 shares of common stock | (12 | ) | (40 | ) | — | — | — | (52 | ) | ||||||||||||||
Allocation of 61,040 shares of common stock by ESOP, including excess income tax benefits | — | (168 | ) | 657 | — | — | 489 | ||||||||||||||||
Share-based compensation, including excess income tax benefits | — | 4,261 | — | — | — | 4,261 | |||||||||||||||||
Issuance of 5,000,000 shares of common stock in exchange for notes payable | 5,000 | 26,226 | — | — | — | 31,226 | |||||||||||||||||
Issuance of convertible debt | — | 15,162 | — | — | — | 15,162 | |||||||||||||||||
Issuance of 132,300 shares of common stock | 132 | 292 | — | — | — | 424 | |||||||||||||||||
Issuance of 339,015 shares of common stock under compensation plans, including excess income tax benefits | 339 | (340 | ) | — | — | — | (1 | ) | |||||||||||||||
Dividends on common stock ($0.08 per share) | — | — | — | — | (4,457 | ) | (4,457 | ) | |||||||||||||||
Balance at December 31, 2009 | 56,203 | 422,225 | (5,679 | ) | (30,456 | ) | 312,330 | 754,623 | |||||||||||||||
F-5
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Continued)
(Dollars in thousands, except per share data)
Common Stock | Additional Paid-in Capital | Unallocated Common Stock Held by ESOP | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total Stockholders' Equity | ||||||||||||||||||
Other comprehensive income: | |||||||||||||||||||||||
Net income for the year | — | — | — | — | 42,933 | 42,933 | |||||||||||||||||
Change in net unrealized investment gains/losses | — | — | — | 111,097 | — | 111,097 | |||||||||||||||||
Noncredit component of OTTI losses, available for sale securities, net | — | — | — | 1,179 | — | 1,179 | |||||||||||||||||
Other comprehensive income | 155,209 | ||||||||||||||||||||||
Conversion of $60 of subordinated debtentures | 7 | 49 | — | — | — | 56 | |||||||||||||||||
Acquisition of 104,661 shares of common stock | (105 | ) | (1,119 | ) | — | — | — | (1,224 | ) | ||||||||||||||
Allocation of 80,224 shares of common stock by ESOP, including excess income tax benefits | — | (23 | ) | 864 | — | — | 841 | ||||||||||||||||
Share-based compensation, including excess income tax benefits | — | 12,239 | — | — | — | 12,239 | |||||||||||||||||
Issuance of 862,504 shares of common stock under compensation plans, including excess income tax benefits | 863 | 5,483 | — | — | — | 6,346 | |||||||||||||||||
Issuance of warrants | — | 15,600 | — | — | — | 15,600 | |||||||||||||||||
Dividends on common stock ($0.10 per share) | — | — | — | — | (5,643 | ) | (5,643 | ) | |||||||||||||||
Balance at December 31, 2010 | $ | 56,968 | $ | 454,454 | $ | (4,815 | ) | $ | 81,820 | $ | 349,620 | $ | 938,047 | ||||||||||
See accompanying notes to consolidated financial statements.
F-6
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Operating activities | |||||||||||
Net income | $ | 42,933 | $ | 68,530 | $ | 15,947 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Interest sensitive and index product benefits | 733,218 | 347,883 | 205,131 | ||||||||
Amortization of deferred sales inducements | 59,873 | 39,999 | 30,705 | ||||||||
Annuity product charges | (69,075 | ) | (63,358 | ) | (52,671 | ) | |||||
Change in fair value of embedded derivatives | 130,950 | 529,508 | (210,753 | ) | |||||||
Increase in traditional life and accident and health insurance reserves | 43,921 | 9,960 | 6,031 | ||||||||
Policy acquisition costs deferred | (402,607 | ) | (305,477 | ) | (266,864 | ) | |||||
Amortization of deferred policy acquisition costs | 136,388 | 88,009 | 126,738 | ||||||||
Provision for depreciation and other amortization | 11,580 | 5,904 | 6,806 | ||||||||
Amortization of discounts and premiums on investments | (240,532 | ) | (212,498 | ) | (260,412 | ) | |||||
Loss (gain) on extinguishment of debt | 292 | 675 | (9,746 | ) | |||||||
Realized losses (gains) on investments | 141 | 35,492 | 187,093 | ||||||||
Change in fair value of derivatives | (141,719 | ) | (219,154 | ) | 371,116 | ||||||
Deferred income taxes | (118,048 | ) | (56,150 | ) | 45,075 | ||||||
Share-based compensation | 11,993 | 4,630 | 3,291 | ||||||||
Change in accrued investment income | (53,987 | ) | (21,902 | ) | (14,408 | ) | |||||
Change in income taxes recoverable/payable | 97,550 | (117,817 | ) | 39,123 | |||||||
Change in other assets | (26,516 | ) | (10,877 | ) | 500 | ||||||
Change in other policy funds and contract claims | 103,457 | 8,198 | (8,981 | ) | |||||||
Change in collateral held for derivatives | 35,075 | 346,118 | — | ||||||||
Change in other liabilities | 64,776 | 40,637 | 9,761 | ||||||||
Other | 812 | (1,759 | ) | (242 | ) | ||||||
Net cash provided by operating activities | 420,475 | 516,551 | 223,240 | ||||||||
Investing activities | |||||||||||
Sales, maturities, or repayments of investments: | |||||||||||
Fixed maturity securities—available for sale | 4,568,499 | 2,975,790 | 1,486,554 | ||||||||
Fixed maturity securities—held for investment | 1,585,267 | 2,057,023 | 1,984,167 | ||||||||
Equity securities, available for sale | 46,187 | 22,727 | 13,528 | ||||||||
Mortgage loans on real estate | 145,754 | 109,969 | 126,181 | ||||||||
Derivative instruments | 492,058 | 79,341 | 30,263 | ||||||||
Short-term investments | 600,000 | — | — | ||||||||
Acquisitions of investments: | |||||||||||
Fixed maturity securities—available for sale | (8,544,788 | ) | (6,742,292 | ) | (3,632,326 | ) | |||||
Fixed maturity securities—held for investment | (745,207 | ) | — | — | |||||||
Equity securities, available for sale | (10,125 | ) | (6,674 | ) | (102,882 | ) | |||||
Mortgage loans on real estate | (317,250 | ) | (249,162 | ) | (502,111 | ) | |||||
Derivative instruments | (331,263 | ) | (257,435 | ) | (292,211 | ) | |||||
Short-term investments | (599,746 | ) | — | — | |||||||
Other investments | (456 | ) | (46 | ) | (19 | ) | |||||
Purchases of property, furniture and equipment | (5,318 | ) | (2,971 | ) | (341 | ) | |||||
Net cash used in investing activities | (3,116,388 | ) | (2,013,730 | ) | (889,197 | ) | |||||
F-7
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Financing activities | |||||||||||
Receipts credited to annuity and single premium universal life policyholder account balances | $ | 4,668,719 | $ | 3,677,558 | $ | 2,289,006 | |||||
Coinsurance deposits | (267,638 | ) | (555,500 | ) | 183,215 | ||||||
Return of annuity policyholder account balances | (1,637,062 | ) | (1,418,797 | ) | (1,346,473 | ) | |||||
Financing fees incurred and deferred | (6,800 | ) | (2,751 | ) | — | ||||||
Proceeds from notes payable | 200,000 | 127,225 | 70,000 | ||||||||
Repayments of notes payable | (156,641 | ) | (4,110 | ) | (65,479 | ) | |||||
Purchase of 2015 notes hedges | (37,000 | ) | — | — | |||||||
Decrease in amounts due under repurchase agreements | — | — | (257,225 | ) | |||||||
Acquisition of common stock | (1,224 | ) | (34 | ) | (27,065 | ) | |||||
Excess tax benefits realized from share-based compensation plans | 480 | 93 | 313 | ||||||||
Proceeds from issuance of common stock | 6,124 | 1,061 | 219 | ||||||||
Proceeds from issuance of warrants | 15,600 | — | — | ||||||||
Equity issue costs incurred | — | (1,364 | ) | — | |||||||
Change in checks in excess of cash balance | (13,238 | ) | (8,605 | ) | 18,931 | ||||||
Dividends paid | (5,643 | ) | (4,457 | ) | (3,511 | ) | |||||
Net cash provided by financing activities | 2,765,677 | 1,810,319 | 861,931 | ||||||||
Increase in cash and cash equivalents | 69,764 | 313,140 | 195,974 | ||||||||
Cash and cash equivalents at beginning of year | 528,002 | 214,862 | 18,888 | ||||||||
Cash and cash equivalents at end of year | $ | 597,766 | $ | 528,002 | $ | 214,862 | |||||
Supplemental disclosures of cash flow information | |||||||||||
Cash paid during the year for: | |||||||||||
Interest expense | $ | 25,802 | $ | 19,669 | $ | 41,636 | |||||
Income taxes | 143,748 | 191,878 | — | ||||||||
Income tax refunds received | 101,395 | — | — | ||||||||
Non-cash operating activity: | |||||||||||
Deferral of sales inducements | 370,714 | 292,791 | 193,481 | ||||||||
Non-cash investing activity: | |||||||||||
Real estate acquired in satisfaction of mortgage loans | 7,408 | 12,268 | — | ||||||||
Non-cash financing activities: | |||||||||||
Conversion of subordinated debentures | 60 | — | 213 | ||||||||
Stock acquired in satisfaction of obligations | — | — | 5,559 | ||||||||
Stock issued in retirement of debt | — | 31,250 | — | ||||||||
Retirement of debt through debt exchange | — | 63,614 | — | ||||||||
See accompanying notes to consolidated financial statements.
F-8
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Significant Accounting Policies
Nature of Operations
American Equity Investment Life Holding Company ("we", "us" or "our"), through its wholly-owned subsidiaries, American Equity Investment Life Insurance Company ("American Equity Life"), American Equity Investment Life Insurance Company of New York and Eagle Life Insurance Company ("Eagle Life"), is licensed to sell insurance products in 50 states and the District of Columbia at December 31, 2010. We operate solely in the insurance business.
We primarily market fixed index and fixed rate annuities and to a lesser extent, life insurance. In connection with our reinsured group life business, we also collect renewal premiums on certain accident and health insurance policies. Premiums and annuity deposits (net of coinsurance), which are not included as revenues in the accompanying consolidated statements of operations, collected in 2010, 2009 and 2008, by product type were as follows:
Year Ended December 31, | ||||||||||||
Product Type | 2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | ||||||||||||
Fixed Index Annuities: | ||||||||||||
Index Strategies | $ | 2,312,720 | $ | 1,252,294 | $ | 1,303,343 | ||||||
Fixed Strategy | 1,472,576 | 1,495,017 | 936,847 | |||||||||
3,785,296 | 2,747,311 | 2,240,190 | ||||||||||
Fixed Rate Annuities | 404,460 | 180,986 | 47,506 | |||||||||
Life Insurance | 11,707 | 12,355 | 12,323 | |||||||||
Accident and Health | 275 | 299 | 189 | |||||||||
$ | 4,201,738 | $ | 2,940,951 | $ | 2,300,208 | |||||||
One national marketing organization through which we market our products accounted for more than 10% of the annuity deposits and insurance premium collections during 2010, 2009 and 2008, representing 17%, 10% and 12% of the annuity deposits and insurance premiums collected, respectively.
Consolidation and Basis of Presentation
The consolidated financial statements include our accounts and our wholly-owned subsidiaries: American Equity Life, American Equity Investment Life Insurance Company of New York, Eagle Life, AERL, L.C., American Equity Capital, Inc., American Equity Investment Properties, L.C., American Equity Advisors, Inc. and American Equity Investment Service Company. All significant intercompany accounts and transactions have been eliminated.
Estimates and Assumptions
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are utilized in the calculation of deferred policy acquisition costs, deferred sales inducements, policy benefit reserves, valuation of derivatives, including embedded derivatives on index annuity reserves, contingent convertible senior notes, valuation of investments, other than temporary impairment of investments, impairments of mortgage loans and valuation allowances on deferred tax assets. A description of each critical estimate is incorporated within the discussion of the related accounting policies which follow. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized.
Investments
Fixed maturity securities (bonds and redeemable preferred stocks maturing more than one year after issuance) that may be sold prior to maturity are classified as available for sale. Available for sale securities are reported at fair value and unrealized gains and losses, if any, on these securities are included directly in a separate component of stockholders' equity, net of income taxes and certain adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements. Fair values, as reported herein, of fixed maturity and equity securities are based on quoted market prices in active markets when available, or for those fixed maturity securities not actively traded, yield data and other factors relating to instruments or securities with similar characteristics are used. See note 2 for more information on assumptions and valuation models used in the determination of fair value. Premiums and discounts are amortized/accrued using methods which result in a constant yield over the securities' expected lives. Amortization/accrual of premiums and discounts on residential mortgage backed securities incorporate prepayment assumptions to estimate the securities' expected lives. Interest income is recognized as earned.
Fixed maturity securities that we have the positive intent and ability to hold to maturity are classified as held for investment. Such securities
F-9
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
may, at times, be called prior to maturity. Held for investment securities are reported at cost adjusted for amortization of premiums and discounts. Changes in the fair value of these securities, except for declines that are other than temporary, are not reflected in our consolidated financial statements. Premiums and discounts are amortized/accrued using methods which result in a constant yield over the securities' expected lives.
Equity securities, comprised of common and perpetual preferred stocks, are classified as available for sale and are reported at fair value. Unrealized gains and losses are included directly in a separate component of stockholders' equity, net of income taxes and certain adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements. Dividends are recognized when declared.
The carrying amounts of our impaired investments in fixed maturity and equity securities are adjusted for declines in value that are other than temporary. Other than temporary impairment losses are reported as a component of revenues in the consolidated statements of operations, which presents the amount of non credit impairment losses for certain fixed maturity securities that is reported in Accumulated Other Comprehensive Income (Loss). See note 3 for further discussion of other than temporary impairment losses.
Deterioration in credit quality of the companies or assets backing our investment securities, deterioration in the condition of the financial services industry, imbalances in liquidity recurring in the marketplace or declines in real estate values may further affect the fair value of these investment securities and increase the potential that certain unrealized losses be recognized as other than temporary impairments in the future.
Mortgage loans on real estate are reported at cost, adjusted for amortization of premiums and accrual of discounts. Interest income is recorded when earned; however, interest ceases to accrue for loans on which interest is more than 60 days past due and/or when the collection of interest is not considered probable. We evaluate the mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the measurement of an estimated loss for each impaired loan identified and an analysis of the mortgage loan portfolio for the need of a general loan allowance for probable losses on all loans. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's contractual interest rate, or the fair value of the underlying collateral, less costs to sell. The amount of the general loan allowance, if any, is based upon our evaluation of the probability of collection, historical loss experience, delinquencies, credit concentrations, underwriting standards and national and local economic conditions. The carrying value of impaired loans is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments. Interest income on impaired loans is recorded on a cash basis.
Real estate owned is reported at cost less accumulated depreciation. Cost is determined at the time ownership is acquired in satisfaction of mortgage loans and is the lower of the carrying value of the mortgage loan or fair value of the real estate less its estimated cost to sell. Building and improvements are depreciated using the straight-line method over their estimated useful lives. Impairment losses on real estate owned are recognized when there are indicators of impairment present and the expected future undiscounted cash flows are not sufficient to recover the real estate's carrying value. Any impairment losses are reported as realized losses and are part of net income.
Policy loans and other investments are reported at cost.
Derivative Instruments
Our derivative instruments include interest rate swaps entered into to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures and borrowings under our line of credit, call options used to fund fixed index annuity credits and certain other derivative instruments embedded in other contracts. All of our derivative instruments are recognized in the balance sheet at fair value and changes in fair value are recognized immediately in operations. See note 5 for more information on derivative instruments.
Cash and Cash Equivalents
We consider all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Reinsurance
Coinsurance agreements are reported on a gross basis on our consolidated balance sheets as coinsurance deposits for the amounts recoverable from reinsurers and policyholder reserves. Product charges, interest sensitive and index product benefits and deferred acquisition costs are reported net of insurance ceded.
Deferred Policy Acquisition Costs and Deferred Sales Inducements
To the extent recoverable from future policy revenues and gross profits, certain costs that vary with and are directly related to the production of new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs or deferred sales inducements. Deferred policy acquisition costs and deferred sales inducements are subject to loss recognition testing on a quarterly basis or when an event occurs that may warrant loss recognition. Deferred policy acquisition costs consist primarily of commissions and certain costs of policy issuance. Deferred sales inducements consist of first-year premium and interest bonuses credited to policyholder account balances.
For annuity products, these capitalized costs are being amortized generally in proportion to expected gross profits from investment spreads, including the cost of hedging the fixed indexed annuity obligations, and, to a lesser extent, from surrender charges and mortality and expense margins. That amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins
F-10
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(including the impact of net realized gains on investments and net OTTI losses recognized in operations) to be realized from a group of products are revised. Deferred policy acquisition costs and deferred sales inducements are also adjusted for the change in amortization that would have occurred if available for sale fixed maturity securities and equity securities had been sold at their aggregate fair value at the end of the reporting period and the proceeds reinvested at current yields. The impact of this adjustment is included in accumulated other comprehensive loss within consolidated stockholders' equity, net of applicable taxes.
For traditional life and accident and health insurance, deferred policy acquisition costs are being amortized over the premium-paying period of the related policies in proportion to premium revenues recognized, principally using the same assumptions for interest, mortality and withdrawals that are used for computing liabilities for future policy benefits subject to traditional "lock-in" concepts.
Future Policy Benefit Reserves
Future policy benefit reserves for fixed index annuities with returns linked to the performance of a specified market index are equal to the sum of the fair value of the embedded derivatives and the host (or guaranteed) component of the contracts. The host value is established at inception of the contract and accreted over the policy's life at a constant rate of interest. Future policy benefit reserves for fixed index annuities earning a fixed rate of interest and other deferred annuity products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. For the years ended December 31, 2010, 2009 and 2008, interest crediting rates for these products ranged from 2.50%to 5.25%. These rates include first-year interest bonuses capitalized as deferred sales inducements.
The liability for future policy benefits for traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality, and other assumptions underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 3.0% to 5.5%. The liabilities for future policy benefits for accident and health insurance are computed using a net level premium method, including assumptions as to morbidity and other assumptions based on our experience, modified as necessary to give effect to anticipated trends and to include provisions for possible unfavorable deviations. Policy benefit claims are charged to expense in the period that the claims are incurred.
Unpaid claims include amounts for losses and related adjustment expenses and are determined using individual claim evaluations and statistical analysis. Unpaid claims represent estimates of the ultimate net costs of all losses, reported and unreported, which remain unpaid at December 31 of each year. These estimates are necessarily subject to the impact of future changes in claim severity, frequency and other factors. In spite of the variability inherent in such situations, management believes that the unpaid claim amounts are adequate. The estimates are continuously reviewed and as adjustments to these amounts become necessary, such adjustments are reflected in current operations.
Certain group policies include provisions for annual experience refunds of premiums equal to net premiums received less a 16% administrative fee and less claims incurred. Such amounts (2010—$1.1 million; 2009—$0.6 million; and 2008—$0.2 million) are reported as a reduction of traditional life and accident and health insurance premiums in the consolidated statements of operations.
Deferred Income Taxes
Deferred income tax assets or liabilities are computed based on the temporary differences between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. Deferred income tax assets are subject to ongoing evaluation of whether such assets will more likely than not be realized. The realization of deferred income tax assets primarily depends on generating future taxable income during the periods in which temporary differences become deductible. Deferred income tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. In making such a determination, all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations, is considered. The realization of deferred income tax assets related to unrealized losses on available for sale fixed maturity securities is also based upon our intent and ability to hold those securities for a period of time sufficient to allow for a recovery in fair value and not realize the unrealized loss.
Recognition of Premium Revenues and Costs
Revenues for annuity products include surrender and living income benefit rider charges assessed against policyholder account balances during the period. Interest sensitive and index product benefits related to annuity products include interest credited or index credits to policyholder account balances. In addition, the change in fair value of embedded derivatives within fixed index annuity contracts is included in benefits and expenses.
Traditional life and accident and health insurance premiums are recognized as revenues over the premium-paying period. Future policy benefits are recognized as expenses over the life of the policy by means of the provision for future policy benefits.
All insurance-related revenues, including the change in the fair value of derivatives for call options related to the business ceded under coinsurance agreements (see note 7), benefits, losses and expenses are reported net of reinsurance ceded.
Other Comprehensive Income (Loss)
Other comprehensive income (loss) includes all changes in stockholders' equity during a period except those resulting from investments by and distributions to stockholders. Other comprehensive income excludes net realized investment gains (losses) included in net income which merely
F-11
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
represent transfers from unrealized to realized gains and losses. These amounts totaled $(0.2) million, $(35.5) million and $(187.1) million in 2010, 2009 and 2008, respectively. Such amounts, which have been measured through the date of sale, are net of adjustments to deferred policy acquisition costs, deferred sales inducements and income taxes totaling $0.2 million in 2010, $(36.8) million in 2009 and $(94.6) million in 2008.
Adopted Accounting Pronouncements
In July 2010, the Financial Accounting Standards Board ("FASB") issued an accounting standards update that expands disclosures and provide users more transparency about allowances for credit losses and the credit quality of the financing receivables of an entity. This guidance requires additional disclosures about an entity's financing receivables, such as credit quality indicators, aging of past due financing receivables, and significant purchases and sales of financing receivables. In addition, disclosures must be disaggregated by portfolio segment or class based on how an entity develops its allowance for credit losses and how it manages its credit exposure. Most of the disclosure requirements are effective for the fourth quarter of 2010 with certain additional disclosures required for the first quarter of 2011. We adopted this guidance in the preparation of our December 31, 2010 financial statements; however, adoption did not have a material effect on the results of our operations or financial position. Our expanded disclosures as a result of these requirements are included in note 4—Mortgage Loans on Real Estate.
In January 2010, the FASB issued an accounting standards update that expanded the disclosure requirements related to fair value measurements. A reporting entity is now required to disclose separately the amounts of significant transfers in to and out of Level 1 and Level 2 fair value measurement categories and describe the reasons for the transfers. Clarification on existing disclosure requirements is also provided in this update relating to the level of disaggregation of information as to determining appropriate classes of assets and liabilities as well as disclosure requirements regarding valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This standard was effective for us on January 1, 2010, and has not had a material effect on our consolidated financial statements.
In August 2009, the FASB issued an accounting standards update that amended the fair value measurement of liabilities. The update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of fair value. This guidance was effective for the first reporting period beginning after issuance, which was our three months and year ending December 31, 2009, and did not have a material effect on our consolidated financial statements.
In June 2009, the FASB amended accounting standards for transfers and servicing of financial assets and extinguishment of liabilities. The new standard removed the concept of a qualifying special-purpose entity ("QSPE") from existing standards and removed the exception of QSPE's from consolidation requirements. Additionally, more stringent conditions for reporting a transfer of a portion of a financial asset as a sale were created, derecognition criteria was clarified, the initial measurement of retained interests was revised, the guaranteed mortgage securitization recharacterization provisions were removed and disclosure requirements were added. This standard was effective for us on January 1, 2010 and had no effect on our consolidated financial statements upon adoption.
In June 2009, the FASB issued an amendment to the accounting standards for consolidation of variable interest entities. The new standard replaced the quantitative-based risks and rewards calculation of existing standards for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a primarily qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity ("VIE") that most significantly impacts the entity's economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. This standard was effective for us on January 1, 2010, and had no effect on our consolidated financial statements upon adoption. Through our funds withheld coinsurance agreement with an unauthorized life reinsurer we have been named as beneficiary of the trust that holds the funds withheld. We have determined that this trust is a VIE. We also have determined that the reinsurer is the primary beneficiary of this VIE due to the fact that all earnings of the trust inure to the reinsurer, and the reinsurer directs the operations of the trust subject to an investment policy. Therefore, we have not consolidated the trust prior to or after the adoption of this amendment to the accounting standards for consolidation of VIE's.
In May 2009, the FASB issued an accounting standard that required reporting entities to recognize in their financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing those financial statements. These requirements were effective for periods ending after June 15, 2009. Accordingly, we adopted the subsequent event reporting requirements effective June 30, 2009, and it did not have a material effect on our consolidated financial statements.
In April 2009, the FASB issued further guidance on the recognition and presentation of other than temporary impairments. This guidance amended the other than temporary impairment guidance for debt securities only to make the guidance more operational and to expand the presentation and disclosure of other than temporary impairments on debt and equity securities in the financial statements. This guidance requires management to determine cash flows expected to be collected on each debt security for which an other than temporary impairment is being recognized. In accordance with this guidance, the reporting entity shall allocate its other than temporary impairments on debt securities between credit and noncredit components with the noncredit portion of the other than temporary impairments recognized as a component of other comprehensive income (loss) and the credit loss portion included in operations. Credit loss is defined as the amount that the amortized cost basis of the impaired security exceeds the present value of cash flows expected to be collected discounted at the security's yield at acquisition. This guidance also required a cumulative effect adjustment to the opening balance of retained earnings and accumulated other comprehensive
F-12
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
income (loss) in the period of adoption for other than temporary impairments on debt securities recognized in prior periods which were still held as investments at the date of adoption. This guidance was effective for interim and annual reporting periods ending after June 15, 2009; however, early application was permitted. We elected to adopt these accounting standards effective January 1, 2009. The cumulative effect adjustment as of January 1, 2009 increased retained earnings by $25.2 million and decreased accumulated other comprehensive income by $20.1 million.
In April 2009, the FASB issued additional guidance for estimating fair value of financial instruments including investment securities when the volume and level of activity for the asset or liability have significantly decreased, as well as guidance on identifying circumstances that indicate a transaction is not orderly. This guidance was effective for interim and annual reporting periods ending after June 15, 2009, and were to be applied prospectively, with early adoption permitted. We elected to adopt this guidance as of January 1, 2009, and it did not have a material effect on our consolidated financial statements.
In April 2009, the FASB issued disclosure guidance that requires disclosures about fair value of financial instruments within the scope of existing standards for interim reporting periods as well as in annual financial statements. This guidance also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim and annual basis and to highlight any changes from prior periods and was effective for financial statements issued for interim and annual periods ending after June 15, 2009. We adopted these disclosure requirements as of and for the periods ended June 30, 2009.
On January 1, 2009, we adopted FASB accounting standards that enhanced the required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how an entity uses derivative instruments and how derivative instruments and related hedged items are accounted for and affect an entity's financial position, financial performance and cash flows. The adoption of these disclosure requirements did not have a material effect on our consolidated financial position or results of operations as it impacts financial statement disclosure only.
On January 1, 2009, we adopted and applied retrospectively to all periods presented an accounting standard issued by the FASB for convertible debt instruments that may be settled in whole or in part with cash. This standard specifies that issuers of such instruments should separately account for the liability component and the equity component represented by the embedded conversion option in a manner that will reflect the issuer's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon settlement, the issuer shall allocate consideration transferred and transaction costs incurred to the retirement of the liability component and the reacquisition of the equity component.
In December 2004, we issued $260 million of contingent convertible senior notes with a fixed rate of 5.25% and a maturity date of December 6, 2024. On the date of issuance bifurcation of these notes into a debt component and an equity component is required. The difference between the fair value of the debt component at the date of issuance and the initial proceeds at the date of issuance is recorded as a component of stockholders' equity. The fair value of the notes without the embedded conversion option (liability component) at the date of issuance was $221.4 million. The fair value of the embedded conversion option (equity component) at the date of issuance was $39.1 million. The fair value of the equity component at issuance has been recorded as a debt discount to the notes, with a corresponding increase to additional paid-in capital, net of income tax. The debt discount is being amortized over the expected life of the debt.
The following summarizes the effects of the retrospective adoption of the accounting for convertible debt on the consolidated statements of operations and earnings per share:
Year Ended December 31, 2008 | |||||||||||
As Originally Reported | Adjustments | As Adjusted | |||||||||
(Dollars in thousands, except per share data) | |||||||||||
Gain (loss) on retirement of debt | $ | 13,651 | $ | (3,905 | ) | $ | 9,746 | ||||
Interest expense on notes payable | 15,425 | 4,348 | 19,773 | ||||||||
Income tax expense | 64,531 | (3,425 | ) | 61,106 | |||||||
Net income (loss) | 20,775 | (4,828 | ) | 15,947 | |||||||
Earnings per common share | $ | 0.39 | $ | (0.09 | ) | $ | 0.30 | ||||
Earnings per common share—assuming dilution | $ | 0.39 | $ | (0.09 | ) | $ | 0.30 | ||||
Effective January 1, 2008, we adopted FASB's authoritative guidance that permits entities to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be reported at fair value. There was no effect on the consolidated financial statements upon adoption as we did not elect to report any assets or liabilities at fair value that were eligible to be reported at fair value.
Effective January 1, 2008, we adopted FASB's standards for fair value measurements. This guidance defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. It also provides guidance regarding the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. For assets and liabilities that are measured at fair value on a recurring basis in periods subsequent to initial recognition, the reporting entity shall disclose information that enables financial statement users to assess the inputs used to develop those measurements. For recurring
F-13
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
fair value measurements using significant unobservable inputs, the reporting entity shall disclose the effect of the measurements on earnings for the period. This guidance is applicable whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. Adoption primarily resulted in a change prospectively beginning on January 1, 2008, in the discount rates used in the calculation of the fair values of the embedded derivative component of our policy benefit reserves for fixed index annuities from risk-free interest rates to interest rates that include nonperformance risk related to those liabilities. These standards were adopted prospectively on January 1, 2008, and the changes in the discount rates resulted in a decrease in reserves on January 1, 2008, of $150.6 million. The net income impact of this decrease in reserves net of the related adjustments in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes was $40.7 million.
In October 2008, the FASB issued accounting standards for determining the fair value of a financial asset in a market that is not active. These standards were effective upon issuance, and applied to periods for which financial statements have not been issued. The guidance clarifies various application issues with respect to the objective of a fair value measurement, distressed transactions, relevance of observable data, and the use of management's assumptions. We adopted this guidance in the preparation of our September 30, 2008 financial statements; however, adoption did not have a material effect on the results of our operations or financial position. Our expanded disclosures as a result of fair value measurements are included in note 2—Fair Values of Financial Instruments.
New Accounting Pronouncements
In January 2010, the FASB issued an accounting standards update that expands the disclosure requirements related to fair value measurements. A reporting entity is now required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurement categories and describe the reasons for the transfers. Additionally, a reporting entity will be required to present on a gross basis rather than as one net number information about the purchases, sales, issuances and settlements of financial instruments that are categorized as Level 3 for fair value measurements. Clarification on existing disclosure requirements is also provided in this update relating to the level of disaggregation of information as to determining appropriate classes of assets and liabilities as well as disclosure requirements regarding valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This standard was effective for us on January 1, 2010. The disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements will become effective for fiscal years beginning after December 15, 2010.
In July 2010, the FASB issued an accounting standards update that expands disclosures and provide users more transparency about allowances for credit losses and the credit quality of the financing receivables of an entity. This guidance requires additional disclosures about an entity's financing receivables, such as credit quality indicators, aging of past due financing receivables, and significant purchases and sales of financing receivables. In addition, disclosures must be disaggregated by portfolio segment or class based on how an entity develops its allowance for credit losses and how it manages its credit exposure. Most of the disclosure requirements were effective for the fourth quarter of 2010 and are incorporated herein with certain additional disclosures required for the first quarter of 2011.
In October 2010, as a result of a consensus of the FASB Emerging Issues Task Force, the FASB issued an accounting standards update that modifies the definition of the types of costs incurred that can be capitalized in the acquisition of new and renewal insurance contracts. This guidance defines the costs that qualify for deferral as incremental direct costs that result directly from and are essential to successful contract transactions and would not have been incurred by the insurance entity had the contract transactions not occurred. In addition, it lists certain costs as deferrable as those that are directly related to underwriting, policy issuance and processing, medical and inspection, and sales force contract selling as deferrable, as well as the portion of an employee's total compensation related directly to time spent performing those activities for actual acquired contracts and other costs related directly to those activities that would not have been incurred if the contract had not been acquired. This amendment to current GAAP should be applied prospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with retrospective application permitted. We are currently evaluating the impact of the guidance on our consolidated financial statements. See note 6 for the policy issue costs that could be subject to non-deferral.
F-14
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Fair Values of Financial Instruments
The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:
December 31, | |||||||||||||||
2010 | 2009 | ||||||||||||||
Carrying Amount | Fair Value | Carrying Amount | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
Assets | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Available for sale | $ | 15,830,663 | $ | 15,830,663 | $ | 10,704,131 | $ | 10,704,131 | |||||||
Held for investment | 822,200 | 781,748 | 1,635,083 | 1,601,864 | |||||||||||
Equity securities, available for sale | 65,961 | 65,961 | 93,086 | 93,086 | |||||||||||
Mortgage loans on real estate | 2,598,641 | 2,670,009 | 2,449,778 | 2,409,197 | |||||||||||
Derivative instruments | 479,786 | 479,786 | 479,272 | 479,272 | |||||||||||
Other investments | 19,680 | 19,680 | 12,760 | 12,760 | |||||||||||
Cash and cash equivalents | 597,766 | 597,766 | 528,002 | 528,002 | |||||||||||
Coinsurance deposits | 2,613,191 | 2,282,998 | 2,237,740 | 1,934,996 | |||||||||||
2015 notes hedges | 66,595 | 66,595 | — | — | |||||||||||
Liabilities | |||||||||||||||
Policy benefit reserves | 23,464,810 | 19,594,396 | 19,195,870 | 16,152,088 | |||||||||||
Notes payable | 330,835 | 489,097 | 316,468 | 340,673 | |||||||||||
Subordinated debentures | 268,435 | 213,369 | 268,347 | 186,215 | |||||||||||
2015 notes embedded derivatives | 66,595 | 66,595 | — | — | |||||||||||
Interest rate swaps | 1,976 | 1,976 | 1,891 | 1,891 | |||||||||||
Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.
We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1— Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2— Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3— Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security.
F-15
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Our assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2010 and 2009 are presented below based on the fair value hierarchy levels:
Total Fair Value | Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||
(Dollars in thousands) | |||||||||||
December 31, 2010 | |||||||||||
Assets | |||||||||||
Fixed maturity securities: | |||||||||||
Available for sale: | |||||||||||
United States Government full faith and credit | 4,388 | 4,388 | — | — | |||||||
United States Government sponsored agencies | 3,003,651 | — | 3,003,651 | — | |||||||
United States municipalities, states and territories | 2,367,003 | — | 2,367,003 | — | |||||||
Corporate securities | 7,577,064 | 71,230 | 7,505,834 | — | |||||||
Residential mortgage backed securities | 2,878,557 | — | 2,875,855 | 2,702 | |||||||
Equity securities, available for sale: finance, insurance and real estate | 65,961 | 46,925 | 19,036 | — | |||||||
Derivative instruments | 479,786 | — | 479,786 | — | |||||||
Cash and cash equivalents | 597,766 | 597,766 | — | — | |||||||
2015 notes hedges | 66,595 | — | 66,595 | — | |||||||
17,040,771 | 720,309 | 16,317,760 | 2,702 | ||||||||
Liabilities | |||||||||||
Interest rate swaps | 1,976 | — | 1,976 | — | |||||||
2015 notes embedded derivatives | 66,595 | — | 66,595 | — | |||||||
Fixed index annuities—embedded derivatives | 1,971,383 | — | — | 1,971,383 | |||||||
2,039,954 | — | 68,571 | 1,971,383 | ||||||||
December 31, 2009 | |||||||||||
Assets | |||||||||||
Fixed maturity securities: | |||||||||||
Available for sale: | |||||||||||
United States Government full faith and credit | 3,310 | 2,545 | 765 | — | |||||||
United States Government sponsored agencies | 3,998,537 | — | 3,998,537 | — | |||||||
United States municipalities, states and territories | 355,634 | — | 355,634 | — | |||||||
Corporate securities | 3,857,549 | 70,363 | 3,773,078 | 14,108 | |||||||
Residential mortgage backed securities | 2,489,101 | — | 2,486,290 | 2,811 | |||||||
Equity securities, available for sale: finance, insurance and real estate | 93,086 | 83,672 | 8,415 | 999 | |||||||
Derivative instruments | 479,272 | — | 479,272 | — | |||||||
Cash and cash equivalents | 528,002 | 528,002 | — | — | |||||||
11,804,491 | 684,582 | 11,101,991 | 17,918 | ||||||||
Liabilities | |||||||||||
Interest rate swaps | 1,891 | — | 1,891 | — | |||||||
Fixed index annuities—embedded derivatives | 1,375,866 | — | — | 1,375,866 | |||||||
1,377,757 | — | 1,891 | 1,375,866 | ||||||||
During the third quarter of 2010, we transferred four corporate securities with a fair value of $12.5 million from Level 2 to Level 1 as quoted prices in active markets as evidenced by actual trades of these securities occurred at the end of this period. Identical security trading had not been observable prior to this period for these four securities.
F-16
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.
Fixed maturity securities, equity securities, and short-term investments
The fair values of fixed maturity securities, equity securities, and short-term investments in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
• | reported trading prices, |
• | benchmark yields |
• | broker-dealer quotes, |
• | benchmark securities, |
• | bids and offers, |
• | credit ratings, |
• | relative credit information, and |
• | other reference data. |
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of December 31, 2010 and 2009.
The fixed income securities markets in early 2009 experienced a period of extreme volatility and limited market liquidity conditions, which affected a broad range of asset classes and sectors. In addition, there were credit downgrade events and an increased probability of default for many fixed income instruments. These volatile market conditions increased the difficulty of valuing certain instruments as trading was less frequent and/or market data was less observable. There were certain instruments that were in active markets with significant observable data that became illiquid due to financial environment or market conditions. As a result, certain valuations required greater estimation and judgment as well as valuation methods which were more complex.
Mortgage loans on real estate
The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans which are not fair value exit prices.
Derivative instruments
The fair values of derivative instruments are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.
Other investments
Other investments is comprised of policy loans, rental real estate and real estate held for sale. We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair value of our real estate owned was determined either by obtaining a third party appraisal of the property or by estimating the potential annual
F-17
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
net operating income from each commercial rental property, which we discount by a current market capitalization rate. We consider the fair value of our real estate owned to be level 3 fair value measurements due to the significant unobservable data used by third party appraisers and by us.
Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
2015 notes hedges
The fair value of these call options is determined by applying market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.
Policy benefit reserves and coinsurance deposits
The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value.
Notes payable
The fair value of the convertible senior notes is based upon quoted market prices. Fair values of other notes payable are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.
Subordinated debentures
Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.
Interest rate swaps
The fair values of our pay fixed/receive variable interest rate swaps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swaps.
2015 notes embedded derivatives
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion premium are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.
Fixed index annuities - embedded derivatives
We estimate the fair value of the embedded derivative component of our fixed index annuity policy liabilities at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the years ended December 31, 2010 and 2009:
Year Ended December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Available for sale securities | |||||||
Beginning balance | $ | 17,918 | $ | 20,082 | |||
Transfers in to or out of Level 3, net | (3,899 | ) | — | ||||
Purchases, issuances and settlements | (15,470 | ) | (224 | ) | |||
Total gains (losses) (unrealized/realized): | |||||||
Included in other comprehensive income | 6,383 | 3,784 | |||||
Net OTTI losses recognized in operations | (2,230 | ) | (5,724 | ) | |||
$ | 2,702 | $ | 17,918 | ||||
F-18
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The transfers out of Level 3 were corporate debt and equity securities in the home building sector that were issued as a result of a bankruptcy reorganization in late 2009. The operation that has resulted from this emergence from bankruptcy has become a stable business to which a third party broker has applied observable market data such as similar securities and credit spreads in determining fair value of these securities. Other-than-temporary-impairment losses of $2.2 million and $5.7 million for year ended December 31, 2010 and 2009, respectively, are included in net OTTI losses recognized in operations in the consolidated statements of operations.
Year Ended December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Fixed index annuities—embedded derivatives | |||||||
Beginning balance | $ | 1,375,866 | $ | 998,015 | |||
Reinsurance adjustment | — | (18,262 | ) | ||||
Premiums less benefits | 808,545 | 62,070 | |||||
Change in unrealized losses (gains), net | (213,028 | ) | 334,043 | ||||
$ | 1,971,383 | $ | 1,375,866 | ||||
Change in unrealized losses (gains), net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the consolidated statements of operations.
F-19
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Investments
At December 31, 2010 and 2009, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
December 31, 2010 | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Available for sale: | |||||||||||||||
United States Government full faith and credit | $ | 4,082 | $ | 324 | $ | (18 | ) | $ | 4,388 | ||||||
United States Government sponsored agencies | 2,994,174 | 11,123 | (1,646 | ) | 3,003,651 | ||||||||||
United States municipalities, states and territories | 2,397,622 | 22,765 | (53,384 | ) | 2,367,003 | ||||||||||
Corporate securities | 7,325,988 | 387,916 | (136,840 | ) | 7,577,064 | ||||||||||
Residential mortgage backed securities | 2,900,028 | 86,950 | (108,421 | ) | 2,878,557 | ||||||||||
$ | 15,621,894 | $ | 509,078 | $ | (300,309 | ) | $ | 15,830,663 | |||||||
Held for investment: | |||||||||||||||
United States Government sponsored agencies | $ | 746,414 | $ | — | $ | (15,309 | ) | $ | 731,105 | ||||||
Corporate security | 75,786 | — | (25,143 | ) | 50,643 | ||||||||||
$ | 822,200 | $ | — | $ | (40,452 | ) | $ | 781,748 | |||||||
Equity securities, available for sale: | |||||||||||||||
Finance, insurance and real estate | $ | 61,185 | $ | 6,722 | $ | (1,946 | ) | $ | 65,961 | ||||||
December 31, 2009 | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Available for sale: | |||||||||||||||
United States Government full faith and credit | $ | 3,101 | $ | 215 | $ | (6 | ) | $ | 3,310 | ||||||
United States Government sponsored agencies | 4,113,457 | 3,468 | (118,388 | ) | 3,998,537 | ||||||||||
United States municipalities, states and territories | 350,787 | 7,110 | (2,263 | ) | 355,634 | ||||||||||
Corporate securities | 3,709,446 | 233,023 | (84,920 | ) | 3,857,549 | ||||||||||
Residential mortgage backed securities | 2,735,889 | 59,584 | (306,372 | ) | 2,489,101 | ||||||||||
$ | 10,912,680 | $ | 303,400 | $ | (511,949 | ) | $ | 10,704,131 | |||||||
Held for investment: | |||||||||||||||
United States Government sponsored agencies | $ | 1,559,434 | $ | 1,647 | $ | (5,900 | ) | $ | 1,555,181 | ||||||
Corporate security | 75,649 | — | (28,966 | ) | 46,683 | ||||||||||
$ | 1,635,083 | $ | 1,647 | $ | (34,866 | ) | $ | 1,601,864 | |||||||
Equity securities, available for sale: | |||||||||||||||
Finance, insurance and real estate | $ | 82,930 | $ | 13,425 | $ | (3,269 | ) | $ | 93,086 | ||||||
During 2010 and 2009, we received $5.2 billion and $4.2 billion, respectively, in net redemption proceeds related to calls of our callable United States Government sponsored agency securities, of which $1.6 billion and $2.1 billion, respectively, were classified as held for investment. We reinvested the proceeds from these redemptions primarily in United States Government sponsored agencies, corporate securities and United States municipalities, states, and territories classified as available for sale. At December 31, 2010, 36% of our fixed income securities have call features and 1% ($0.1 billion) were subject to call redemption. Another 21% ($3.4 billion) will become subject to call redemption during 2011.
F-20
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The amortized cost and fair value of fixed maturity securities at December 31, 2010, by contractual maturity 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 residential mortgage and asset backed securities provide for periodic payments throughout their lives and are shown below as a separate line.
Available for sale | Held for investment | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
Due in one year or less | $ | 26,033 | $ | 26,284 | $ | — | $ | — | |||||||
Due after one year through five years | 401,008 | 440,698 | — | — | |||||||||||
Due after five years through ten years | 1,647,988 | 1,816,850 | — | — | |||||||||||
Due after ten years through twenty years | 2,895,065 | 2,910,182 | — | — | |||||||||||
Due after twenty years | 7,751,772 | 7,758,092 | 822,200 | 781,748 | |||||||||||
12,721,866 | 12,952,106 | 822,200 | 781,748 | ||||||||||||
Residential mortgage backed securities | 2,900,028 | 2,878,557 | — | — | |||||||||||
$ | 15,621,894 | $ | 15,830,663 | $ | 822,200 | $ | 781,748 | ||||||||
Net unrealized gains (losses) on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Net unrealized gains (losses) on available for sale fixed maturity securities and equity securities | $ | 213,545 | $ | (198,393 | ) | ||
Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements | (122,336 | ) | 116,870 | ||||
Deferred tax valuation allowance reversal | 22,534 | 22,534 | |||||
Deferred income tax benefit | (31,923 | ) | 28,533 | ||||
Net unrealized gains (losses) reported as accumulated other comprehensive income (loss) | $ | 81,820 | $ | (30,456 | ) | ||
The National Association of Insurance Commissioners ("NAIC") assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations ("NRSRO's"). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered "investment grade" while NAIC Class 3 through 6 designations are considered "non-investment grade." Based on the NAIC designations and fair values, 98% and 97% of our fixed maturity portfolio rated investment grade at December 31, 2010 and 2009, respectively.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
NAIC Designation | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(Dollars in thousands) | ||||||||||||||||
1 | $ | 12,152,552 | $ | 12,246,954 | $ | 9,495,015 | $ | 9,370,647 | ||||||||
2 | 3,892,680 | 4,012,076 | 2,571,815 | 2,555,826 | ||||||||||||
3 | 368,680 | 323,113 | 409,860 | 315,948 | ||||||||||||
4 | 19,820 | 19,178 | 24,375 | 20,799 | ||||||||||||
5 | 6,089 | 6,262 | 21,013 | 20,749 | ||||||||||||
6 | 4,273 | 4,828 | 25,685 | 22,026 | ||||||||||||
$ | 16,444,094 | $ | 16,612,411 | $ | 12,547,763 | $ | 12,305,995 | |||||||||
F-21
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 780 and 355 securities, respectively) have been in a continuous unrealized loss position, at December 31, 2010 and 2009:
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
December 31, 2010 | |||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||
Available for sale: | |||||||||||||||||||||||
United States Government full faith and credit | $ | 548 | $ | (18 | ) | $ | — | $ | — | $ | 548 | $ | (18 | ) | |||||||||
United States Government sponsored agencies | 110,101 | (1,646 | ) | — | — | 110,101 | (1,646 | ) | |||||||||||||||
United States municipalities, states and territories | 1,510,354 | (51,989 | ) | 7,525 | (1,395 | ) | 1,517,879 | (53,384 | ) | ||||||||||||||
Corporate securities: | |||||||||||||||||||||||
Finance, insurance and real estate | 626,363 | (31,352 | ) | 114,128 | (13,001 | ) | 740,491 | (44,353 | ) | ||||||||||||||
Manufacturing, construction and mining | 1,032,170 | (33,893 | ) | 34,490 | (2,333 | ) | 1,066,660 | (36,226 | ) | ||||||||||||||
Utilities and related sectors | 933,727 | (34,657 | ) | 14,157 | (4,552 | ) | 947,884 | (39,209 | ) | ||||||||||||||
Wholesale/retail trade | 153,699 | (4,947 | ) | 9,175 | (1,304 | ) | 162,874 | (6,251 | ) | ||||||||||||||
Services, media and other | 195,516 | (10,801 | ) | — | — | 195,516 | (10,801 | ) | |||||||||||||||
Residential mortgage backed securities | 396,083 | (14,100 | ) | 966,332 | (94,321 | ) | 1,362,415 | (108,421 | ) | ||||||||||||||
$ | 4,958,561 | $ | (183,403 | ) | $ | 1,145,807 | $ | (116,906 | ) | $ | 6,104,368 | $ | (300,309 | ) | |||||||||
Held for investment: | |||||||||||||||||||||||
United States Government sponsored agencies | $ | 731,105 | $ | (15,309 | ) | $ | — | $ | — | $ | 731,105 | $ | (15,309 | ) | |||||||||
Corporate security: | |||||||||||||||||||||||
Finance, insurance and real estate | — | — | 50,643 | (25,143 | ) | 50,643 | (25,143 | ) | |||||||||||||||
$ | 731,105 | $ | (15,309 | ) | $ | 50,643 | $ | (25,143 | ) | $ | 781,748 | $ | (40,452 | ) | |||||||||
Equity securities, available for sale: | |||||||||||||||||||||||
Finance, insurance and real estate | $ | 14,583 | $ | (1,199 | ) | $ | 16,253 | $ | (747 | ) | $ | 30,836 | $ | (1,946 | ) | ||||||||
December 31, 2009 | |||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||
Available for sale: | |||||||||||||||||||||||
United States Government full faith and credit | $ | 332 | $ | (6 | ) | $ | — | $ | — | $ | 332 | $ | (6 | ) | |||||||||
United States Government sponsored agencies | 2,908,205 | (118,388 | ) | — | — | 2,908,205 | (118,388 | ) | |||||||||||||||
United States municipalities, states and territories | 111,969 | (2,263 | ) | — | — | 111,969 | (2,263 | ) | |||||||||||||||
Corporate securities: | |||||||||||||||||||||||
Finance, insurance and real estate | 154,093 | (10,560 | ) | 239,211 | (39,995 | ) | 393,304 | (50,555 | ) | ||||||||||||||
Manufacturing, construction and mining | 93,922 | (2,032 | ) | 74,258 | (8,430 | ) | 168,180 | (10,462 | ) | ||||||||||||||
Utilities and related sectors | 149,515 | (5,046 | ) | 63,933 | (8,110 | ) | 213,448 | (13,156 | ) | ||||||||||||||
Wholesale/retail trade | 35,629 | (623 | ) | 39,547 | (4,800 | ) | 75,176 | (5,423 | ) | ||||||||||||||
Services, media and other | 46,625 | (512 | ) | 61,359 | (4,812 | ) | 107,984 | (5,324 | ) | ||||||||||||||
Residential mortgage backed securities | 226,567 | (22,781 | ) | 1,186,542 | (283,591 | ) | 1,413,109 | (306,372 | ) | ||||||||||||||
$ | 3,726,857 | $ | (162,211 | ) | $ | 1,664,850 | $ | (349,738 | ) | $ | 5,391,707 | $ | (511,949 | ) | |||||||||
Held for investment: | |||||||||||||||||||||||
United States Government sponsored agencies | $ | 359,100 | $ | (5,900 | ) | $ | — | $ | — | $ | 359,100 | $ | (5,900 | ) | |||||||||
Corporate security: | |||||||||||||||||||||||
Finance, insurance and real estate | — | — | 46,683 | (28,966 | ) | 46,683 | (28,966 | ) | |||||||||||||||
$ | 359,100 | $ | (5,900 | ) | $ | 46,683 | $ | (28,966 | ) | $ | 405,783 | $ | (34,866 | ) | |||||||||
Equity securities, available for sale: | |||||||||||||||||||||||
Finance, insurance and real estate | $ | 9,802 | $ | (147 | ) | $ | 28,877 | $ | (3,122 | ) | $ | 38,679 | $ | (3,269 | ) | ||||||||
F-22
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following is a description of the factors causing the unrealized losses by investment category as of December 31, 2010:
United States municipalities, states and territories: These securities are relatively long in duration, making the value of such securities sensitive to changes in market interest rates. These securities carry yields less than those available at December 31, 2010 as the result of rising interest rates in 2010.
Corporate securities: The unrealized losses in these securities are due partially to the continuation of wider than historic credit spreads in certain sectors of the corporate bond market. While credit spreads have stabilized, several sectors remain at spreads wider than levels prior to the 2008 financial crisis, such as financial and select economic sensitive issuers. As the result of wider spreads, these issues carry yields less than those available in the market as of December 31, 2010.
Residential mortgage backed securities: At December 31, 2010, we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $478.0 million and a fair value of $441.1 million. Despite recent improvements in the capital markets, the fair values of RMBS continue at prices below amortized cost. RMBS prices will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Equity securities: The unrealized loss on equity securities, which are primarily investment grade perpetual preferred stocks with exposure to REITS, investment banks and finance companies, are due to the ongoing concerns relating to capital, asset quality and earnings stability due to the financial crisis. All of the equity securities in an unrealized loss position for 12 months or more are investment grade perpetual preferred stocks that are absent credit deterioration. A continued difficult housing market has raised concerns in regard to earnings and dividend stability in many companies which directly affect the values of these securities.
Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these securities before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until a recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis based upon consideration of all the evidence available to us, including the magnitude of an unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security. For equity securities we measure other than temporary impairment charges based upon the difference between the book value of a security and its fair value.
Approximately 85% and 81% of the unrealized losses on fixed maturity securities shown in the above table for December 31, 2010 and 2009, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains/losses on investments for the years ended December 31, 2010, 2009 and 2008 are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Fixed maturity securities held for investment carried at amortized cost | $ | (7,233 | ) | $ | (17,184 | ) | $ | (126,883 | ) | ||
Investments carried at fair value: | |||||||||||
Fixed maturity securities, available for sale | $ | 417,318 | $ | 321,691 | $ | (418,744 | ) | ||||
Equity securities, available for sale | (5,380 | ) | 35,761 | (7,862 | ) | ||||||
411,938 | 357,452 | (426,606 | ) | ||||||||
Adjustment for effect on other balance sheet accounts: | |||||||||||
Deferred policy acquisition costs and deferred sales inducements | (239,206 | ) | (212,243 | ) | 259,765 | ||||||
Change in deferred tax valuation allowance | — | 22,534 | — | ||||||||
Deferred income tax asset | (60,456 | ) | (50,823 | ) | 58,394 | ||||||
(299,662 | ) | (240,532 | ) | 318,159 | |||||||
Decrease (increase) in net unrealized losses on investments carried at fair value | $ | 112,276 | $ | 116,920 | $ | (108,447 | ) | ||||
F-23
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Components of net investment income are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Fixed maturity securities | $ | 870,945 | $ | 780,729 | $ | 674,674 | |||||
Equity securities | 5,299 | 7,930 | 11,512 | ||||||||
Mortgage loans on real estate | 159,193 | 147,657 | 137,588 | ||||||||
Cash and cash equivalents | 621 | 736 | 1,192 | ||||||||
Other | 6,585 | 1,692 | 418 | ||||||||
1,042,643 | 938,744 | 825,384 | |||||||||
Less investment expenses | (6,537 | ) | (6,572 | ) | (3,307 | ) | |||||
Net investment income | $ | 1,036,106 | $ | 932,172 | $ | 822,077 | |||||
Proceeds from sales of available for sale fixed maturity securities for the years ended December 31, 2010, 2009 and 2008 were $340.6 million, $659.1 million and $580.9 million, respectively. Scheduled principal repayments, calls and tenders for available for sale fixed maturity securities for the years ended December 31, 2010, 2009 and 2008 were $4.1 billion, $2.5 billion and $905.7 million, respectively. Calls of held for investment fixed maturity securities for the years ended December 31, 2010, 2009 and 2008 were $1.6 billion, $2.1 billion and $2.0 billion, respectively.
Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains on investments, excluding other than temporary impairment losses for the years ended December 31, 2010, 2009 and 2008 are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Available for sale fixed maturity securities: | |||||||||||
Gross realized gains | $ | 27,755 | $ | 54,401 | $ | 5,852 | |||||
Gross realized losses | (2,575 | ) | (2,162 | ) | (589 | ) | |||||
25,180 | 52,239 | 5,263 | |||||||||
Equity securities: | |||||||||||
Gross realized gains | 14,384 | 5,620 | 292 | ||||||||
Gross realized losses | (71 | ) | (96 | ) | — | ||||||
14,313 | 5,524 | 292 | |||||||||
Other investments: | |||||||||||
Impairment losses | (542 | ) | — | — | |||||||
Mortgage loans on real estate: | |||||||||||
Impairment losses | (15,225 | ) | (6,484 | ) | — | ||||||
$ | 23,726 | $ | 51,279 | $ | 5,555 | ||||||
We had investments in fixed maturity, available for sale securities with carrying values totaling $2.1 million and $1.6 million as of December 31, 2010 and 2009, that had not produced income for the preceding 12 months. Reductions in interest income associated with nonperforming investments in fixed maturity securities totaled $0.4 and $1.1 million in 2010 and 2009, respectively.
We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost or cost basis of each investment that has a fair value that is lower than its amortized cost or cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
F-24
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We have a policy and process in place to identify securities that could potentially have an impairment that is other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
• | the length of time and the extent to which the fair value has been less than amortized cost or cost; |
• | whether the issuer is current on all payments and all contractual payments have been made as agreed; |
• | the remaining payment terms and the financial condition and near-term prospects of the issuer; |
• | the lack of ability to refinance due to liquidity problems in the credit market; |
• | the fair value of any underlying collateral; |
• | the existence of any credit protection available; |
• | our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities; |
• | our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot recover to cost in a reasonable period of time; |
• | our intent and ability to retain equity securities for a period of time sufficient to allow for recovery; |
• | consideration of rating agency actions; and |
• | changes in estimated cash flows of residential mortgage and asset backed securities. |
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and circumstances surrounding each security. Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We calculate the present value of the cash flows expected to be collected discounted at each security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income.
The determination of the credit loss component of a residential mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations. The default curves generally assume lower loss levels for older vintage securities versus more recent vintage securities, which reflects the decline in underwriting standards over the years.
F-25
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments we have recognized on residential mortgage backed securities at December 31, 2010 and 2009, which are all senior level tranches within the structure of the securities:
Discount Rate | Default Rate | Loss Severity | ||||||||||||||||||
Sector | Vintage | Min | Max | Min | Max | Min | Max | |||||||||||||
Year ended December 31, 2010 | ||||||||||||||||||||
Prime | 2005 | 7.5 | % | 7.5 | % | 11 | % | 11 | % | 45 | % | 45 | % | |||||||
2006 | 6.5 | % | 7.6 | % | 7 | % | 11 | % | 45 | % | 60 | % | ||||||||
2007 | 5.8 | % | 6.7 | % | 11 | % | 28 | % | 40 | % | 60 | % | ||||||||
2008 | 6.6 | % | 6.6 | % | 5 | % | 5 | % | 50 | % | 50 | % | ||||||||
Alt-A | 2005 | 6.0 | % | 7.4 | % | 12 | % | 27 | % | 45 | % | 50 | % | |||||||
2006 | 6.5 | % | 7.3 | % | 30 | % | 36 | % | 50 | % | 60 | % | ||||||||
2007 | 6.5 | % | 7.0 | % | 35 | % | 51 | % | 50 | % | 60 | % | ||||||||
Year ended December 31, 2009 | ||||||||||||||||||||
Prime | 2005 | 7.7 | % | 7.7 | % | 7 | % | 7 | % | 50 | % | 50 | % | |||||||
2006 | 6.5 | % | 9.2 | % | 7 | % | 14 | % | 35 | % | 55 | % | ||||||||
2007 | 5.8 | % | 7.9 | % | 8 | % | 31 | % | 35 | % | 50 | % | ||||||||
Alt-A | 2004 | 5.8 | % | 5.8 | % | 11 | % | 11 | % | 40 | % | 40 | % | |||||||
2005 | 5.6 | % | 8.7 | % | 10 | % | 25 | % | 10 | % | 55 | % | ||||||||
2006 | 6.0 | % | 7.3 | % | 16 | % | 31 | % | 40 | % | 60 | % | ||||||||
2007 | 6.2 | % | 7.5 | % | 15 | % | 52 | % | 45 | % | 70 | % | ||||||||
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.
F-26
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes other than temporary impairments by asset type:
General Description | Number of Securities | Other Than Temporary Impairments | Portion Recognized In Comprehensive Income | Net Impairment Losses Recognized in Operations | |||||||||||
(Dollars in thousands) | |||||||||||||||
Year ended December 31, 2010 | |||||||||||||||
Corporate bonds: | |||||||||||||||
Finance | 1 | $ | (822 | ) | $ | — | $ | (822 | ) | ||||||
Retail | 1 | (1,576 | ) | — | (1,576 | ) | |||||||||
Residential mortgage backed securities | 30 | (17,146 | ) | (4,323 | ) | (21,469 | ) | ||||||||
32 | $ | (19,544 | ) | $ | (4,323 | ) | $ | (23,867 | ) | ||||||
Year ended December 31, 2009 | |||||||||||||||
United States Government full faith and credit | 1 | $ | (245 | ) | $ | — | $ | (245 | ) | ||||||
Corporate bonds: | |||||||||||||||
Finance | 3 | (8,388 | ) | (1,521 | ) | (9,909 | ) | ||||||||
Insurance | 2 | (766 | ) | (421 | ) | (1,187 | ) | ||||||||
Home building | 3 | (5,242 | ) | (814 | ) | (6,056 | ) | ||||||||
Residential mortgage backed securities | 54 | (184,590 | ) | 136,400 | (48,190 | ) | |||||||||
Common & preferred stocks: | |||||||||||||||
Finance | 7 | (18,292 | ) | — | (18,292 | ) | |||||||||
Insurance | 2 | (1,492 | ) | — | (1,492 | ) | |||||||||
Real estate | 2 | (1,400 | ) | — | (1,400 | ) | |||||||||
74 | $ | (220,415 | ) | $ | 133,644 | $ | (86,771 | ) | |||||||
Year ended December 31, 2008 | |||||||||||||||
Corporate bonds: | |||||||||||||||
Finance | 3 | $ | (13,462 | ) | |||||||||||
Insurance | 2 | (10,662 | ) | ||||||||||||
Home building | 3 | (7,009 | ) | ||||||||||||
Media | 1 | (5,325 | ) | ||||||||||||
Residential mortgage backed securities | 15 | (76,171 | ) | ||||||||||||
Common & preferred stocks: | |||||||||||||||
Finance | 9 | (49,763 | ) | ||||||||||||
Insurance | 3 | (7,093 | ) | ||||||||||||
Real estate | 14 | (23,163 | ) | ||||||||||||
50 | $ | (192,648 | ) | ||||||||||||
F-27
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The cumulative portion of other than temporary impairments determined to be credit losses which have been recognized in operations for debt securities are summarized as follows:
Year Ended December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Cumulative credit loss at beginning of period | $ | (82,930 | ) | $ | (34,229 | ) | |
Credit losses on securities not previously impaired | (4,553 | ) | (27,655 | ) | |||
Additional credit losses on securities previously impaired | (19,314 | ) | (37,932 | ) | |||
Accumulated losses on securities that were disposed of during the period | 9,904 | 16,886 | |||||
$ | (96,893 | ) | $ | (82,930 | ) | ||
The following table summarizes the cumulative noncredit portion of OTTI and the change in fair value since recognition of OTTI, both of which were recognized in other comprehensive income, by major type of security for securities that are part of our investment portfolio at December 31, 2010 and 2009:
Amortized Cost | OTTI Recognized in Other Comprehensive Income | Change in Fair Value Since OTTI was Recognized | Fair Value | ||||||||||||
(Dollars in thousands) | |||||||||||||||
December 31, 2010 | |||||||||||||||
Corporate fixed maturity securities | $ | 5,055 | $ | (2,151 | ) | $ | 5,437 | $ | 8,341 | ||||||
Residential backed securities | 904,704 | (200,921 | ) | 124,240 | 828,023 | ||||||||||
Equity securities: | |||||||||||||||
Finance, insurance and real estate | 14,771 | — | 5,783 | 20,554 | |||||||||||
$ | 924,530 | $ | (203,072 | ) | $ | 135,460 | $ | 856,918 | |||||||
December 31, 2009 | |||||||||||||||
Corporate fixed maturity securities | $ | 25,603 | $ | (9,488 | ) | $ | 7,763 | $ | 23,878 | ||||||
Residential backed securities | 809,632 | (205,245 | ) | 11,809 | 616,196 | ||||||||||
Equity securities: | |||||||||||||||
Finance, insurance and real estate | 34,645 | — | 13,045 | 47,690 | |||||||||||
$ | 869,880 | $ | (214,733 | ) | $ | 32,617 | $ | 687,764 | |||||||
At December 31, 2010 and 2009, fixed maturity securities and short-term investments with an amortized cost of $20.5 billion and $16.0 billion, respectively, were on deposit with state agencies to meet regulatory requirements. There are no restrictions on these assets.
At December 31, 2009, the following investment in any person or its affiliates (other than bonds issued by agencies of the United States Government) exceeded 10% of stockholders' equity:
Issuer | Fair Value | Amortized Cost | ||||
(Dollars in thousands) | ||||||
December 31, 2009: | ||||||
FBL Capital Trust I | 46,683 | 75,649 | ||||
F-28
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. Mortgage Loans on Real Estate
Our mortgage loan portfolio totaled $2.6 billion and $2.5 billion at December 31, 2010 and 2009, respectively, with commitments outstanding of $96.2 million at December 31, 2010. The portfolio consists of commercial 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 reduce the risk of default. The mortgage loan portfolio is summarized by geographic region and property type as follows:
December 31, | |||||||||||||
2010 | 2009 | ||||||||||||
Carrying Amount | Percent | Carrying Amount | Percent | ||||||||||
(Dollars in thousands) | |||||||||||||
Geographic distribution | |||||||||||||
East | $ | 618,250 | 23.6 | % | $ | 560,256 | 22.8 | % | |||||
Middle Atlantic | 172,443 | 6.6 | % | 168,246 | 6.9 | % | |||||||
Mountain | 402,965 | 15.4 | % | 388,940 | 15.9 | % | |||||||
New England | 42,695 | 1.6 | % | 44,541 | 1.8 | % | |||||||
Pacific | 247,254 | 9.5 | % | 216,382 | 8.8 | % | |||||||
South Atlantic | 496,606 | 19.0 | % | 464,077 | 18.9 | % | |||||||
West North Central | 419,002 | 16.0 | % | 410,883 | 16.7 | % | |||||||
West South Central | 215,650 | 8.3 | % | 201,719 | 8.2 | % | |||||||
$ | 2,614,865 | 100.0 | % | $ | 2,455,044 | 100.0 | % | ||||||
Loan loss allowance | (16,224 | ) | (5,266 | ) | |||||||||
2,598,641 | 2,449,778 | ||||||||||||
Property type distribution | |||||||||||||
Office | $ | 683,404 | 26.1 | % | $ | 664,701 | 27.1 | % | |||||
Medical Office | 166,930 | 6.4 | % | 145,390 | 5.9 | % | |||||||
Retail | 589,369 | 22.5 | % | 564,023 | 23.0 | % | |||||||
Industrial/Warehouse | 666,908 | 25.5 | % | 610,279 | 24.9 | % | |||||||
Hotel | 151,516 | 5.8 | % | 155,594 | 6.3 | % | |||||||
Apartment | 131,682 | 5.1 | % | 122,854 | 5.0 | % | |||||||
Mixed use/other | 225,056 | 8.6 | % | 192,203 | 7.8 | % | |||||||
$ | 2,614,865 | 100.0 | % | $ | 2,455,044 | 100.0 | % | ||||||
Loan loss allowance | (16,224 | ) | (5,266 | ) | |||||||||
2,598,641 | 2,449,778 | ||||||||||||
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the measurement of an estimated loss for each individual loan identified. A mortgage loan is impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. In addition, we analyze the mortgage loan portfolio for the need of a general loan allowance for probable losses on all other loans. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell. The amount of the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience, delinquencies, credit concentrations, underwriting standards and national and local economic conditions. Based upon this process and analysis, we established a general loan loss allowance of $3.0 million during the year ended December 31, 2010. No general loan loss allowance was necessary at December 31, 2009.
Our specific allowance for credit losses on mortgage loans totaled $13.2 million and $5.3 million at December 31, 2010 and 2009, respectively, on mortgage loans with total outstanding balances of $31.0 million and $20.2 million as of December 31, 2010 and 2009, respectively. During 2010 and 2009, five and four mortgage loans, respectively, were satisfied by taking ownership of the real estate serving as collateral on each loan. These loans had an aggregate principal amount outstanding of $11.7 million and $12.6 million, for which specific loan loss allowances totaling $4.3 million and $1.2 million were established and recognized in 2010 and 2009, respectively. Additional impairment of $0.6 million was recognized on two properties after ownership of the real estate was taken in 2010 as the fair value of each property was revalued by a third party appraiser and the fair value less the estimated costs to sell was lower due to new facts discovered after ownership was obtained.
F-29
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Mortgage loans summarized in the following table represent all loans that we are either not currently collecting or those we feel it is probable we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the borrower to alleviate short-term cash flow issues and loans delinquent for more than 60 days at the reporting date).
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Impaired mortgage loans with allowances | $ | 31,027 | $ | 15,869 | |||
Impaired mortgage loans with no allowance for losses | 81,994 | 70,214 | |||||
Allowance for probable loan losses | (13,224 | ) | (5,266 | ) | |||
Net carrying value of impaired mortgage loans | $ | 99,797 | $ | 80,817 | |||
Our financing receivables currently consist of one portfolio segment which is our commercial mortgage loan portfolio. These are mortgage loans with collateral consisting of commercial real estate and borrowers consisting mostly of limited liability partnerships or limited liability corporations with some personal guarantors. We added mortgage loans on commercial real estate to our investment mix in 2001. Credit loss experience in our mortgage loan portfolio has been limited to the most recent fiscal years. In 2009, we experienced our first credit loss from our mortgage loan portfolio.
Since 2008, we have consistently had a population of mortgage loans that we have been carrying with workout terms (e.g. short-term interest only periods, short-term suspended payments, etc.) and a population of mortgage loans that have been in a delinquent status (i.e. more than 60 days past due). It is from this population that we have been recognizing some impairment loss due to nonpayment and eventual satisfaction of the loan by taking ownership of the collateral real estate, which in most cases the fair value of the collateral less estimated costs to sell such collateral has been less than the outstanding principal amount of the mortgage loan.
Beginning in 2010, we have calculated a general loan loss allowance on the cumulative outstanding principal on loans making up the group of loans currently in workout terms and loans currently more than 60 days past due. We apply a factor to the total outstanding principal of these loans that is calculated as the average specific impairment loss for the most recent 4 quarters divided by the sum of the average of the total outstanding principal of delinquent loans for the previous 4 quarters and the average of the total outstanding principal of loans in workout for the previous 4 quarters.
The following table presents a rollforward of our valuation allowance for Commercial Mortgage Loans for the year ended December 31, 2010, ending balances of the allowance by basis of impairment and the totals of the loans that were evaluated for impairment at December 31, 2010 (dollars in thousands):
Year Ended December 31, 2010 | |||
Allowance for Credit Losses: | |||
Beginning allowance balance | $ | (5,266 | ) |
Charge-offs | 4,267 | ||
Recoveries | — | ||
Provision for credit losses | (15,225 | ) | |
Ending allowance balance | $ | (16,224 | ) |
December 31, 2010 | |||
Ending allowance balance by type of impairment | |||
Individually evaluated for impairment | $ | (13,224 | ) |
Collectively evaluated for impairment | (3,000 | ) | |
Ending allowance balance | $ | (16,224 | ) |
Financing Receivables: | |||
Individually evaluated for impairment | 31,027 | ||
Collectively evaluated for impairment | 81,994 | ||
The amount of charge-offs include the amount of allowance that has been established for loans that we were in the process of satisfying the outstanding principal of certain loans by taking ownership of the collateral. When the property is taken it is recorded at its fair value and the mortgage loan is recorded as fully paid, with any allowance for credit loss that has been established charged off. There could be other situations that develop where we have established a larger specific loan loss allowance than is needed based on increases in the fair value of collateral
F-30
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
supporting collateral dependent loans, or improvements in the financial position of a borrower so that a loan would become reliant on cash flows from debt service instead of dependent upon sale of the collateral. Charge-offs of the allowance would be recognized in those situations as well.
All of our commercial mortgage loans depend on the cash flow of each borrower to be at a sufficient level to service the principal and interest payments as they come due. In general, cash inflows of the borrowers are generated by collecting monthly rent from tenants occupying space within the borrowers' facilities. Our borrowers face collateral risks such as tenants going out of business, tenants struggling to make rent payments as they become due, and tenants canceling leases and moving to other locations. We have a number of loans where the real estate is occupied by a single tenant. The current depressed and somewhat inactive commercial real estate market has resulted in some of our borrowers experiencing both a reduction in cash flow on their mortgage property as well as a reduction in the fair value of the real estate collateral. If these borrowers are unable to replace lost rent revenue and increases in the fair value of their property do not materialize we could potentially incur more losses than what we have allowed for in our specific and general loan loss allowances.
We analyze credit risk of our mortgage loans by analyzing all available evidence on loans that are delinquent and loans that are in a workout period.
December 31, 2010 | |||
(Dollars in thousands) | |||
Credit Exposure--By Payment Activity | |||
Performing | $ | 2,501,843 | |
In workout | 68,477 | ||
Delinquent | 20,482 | ||
Collateral dependent | 24,063 | ||
$ | 2,614,865 | ||
Mortgage loans are considered delinquent when they become 60 days past due. When loans become 90 days past due, become collateral dependent or enter a period with no debt service payments required we place them on non-accrual status and discontinue recognizing interest income. If payments are received on a delinquent loan, interest income is recognized to the extent it would have been recognized if normal principal and interest would have been received timely. If the payments are received to bring a delinquent loan back to current we will resume accruing interest income on that loan. Outstanding principal of loans in a non-accrual status at December 31, 2010 totals $41.0 million.
Aging of financing receivables as of December 31, 2010:
30 - 59 Days | 60 - 89 Days | 90 Days and Over | Total Past Due | Current | Collateral Dependent Receivables | Total Financing Receivables | |||||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||||||
Commercial mortgage loans | $ | 3,002 | $ | 9,169 | $ | 11,313 | $ | 23,484 | $ | 2,567,318 | $ | 24,063 | $ | 2,614,865 | |||||||||||||
Financing receivables summarized in the following table represent all loans that we are either not currently collecting or those we feel it is probable we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the borrower to alleviate short-term cash flow issues and loans delinquent for more than 60 days at the reporting date).
Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Mortgage loans with an allowance | $ | 17,803 | $ | 31,027 | $ | (13,224 | ) | $ | 24,062 | $ | 656 | ||||||||
Mortgage loans with no related allowance | 81,994 | 81,994 | — | 82,535 | 4,921 | ||||||||||||||
$ | 99,797 | $ | 113,021 | $ | (13,224 | ) | $ | 106,597 | $ | 5,577 | |||||||||
We have not experienced any troubled debt restructures in our commercial mortgage loan portfolio.
F-31
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. 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. The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts, presented in the consolidated balance sheets are as follows:
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Assets | |||||||
Derivative instruments | |||||||
Call options | $ | 479,786 | $ | 479,272 | |||
Other Assets | |||||||
2015 notes hedges | 66,595 | — | |||||
$ | 546,381 | $ | 479,272 | ||||
Liabilities | |||||||
Policy benefit reserves—annuity products | |||||||
Fixed index annuities—embedded derivatives | $ | 1,971,383 | $ | 1,375,866 | |||
Other liabilities | |||||||
2015 notes embedded conversion derivative | 66,595 | — | |||||
Interest rate swaps | 1,976 | 1,891 | |||||
$ | 2,039,954 | $ | 1,377,757 | ||||
The change in fair value of derivatives included in the consolidated statements of operations are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Change in fair value of derivatives: | |||||||||||
Call options | $ | 141,803 | $ | 219,275 | $ | (370,814 | ) | ||||
2015 notes hedges (see note 9) | 29,595 | — | — | ||||||||
Interest rate swaps | (2,536 | ) | (2,379 | ) | (1,195 | ) | |||||
$ | 168,862 | $ | 216,896 | $ | (372,009 | ) | |||||
Change in fair value of embedded derivatives: | |||||||||||
2015 notes embedded derivatives (see note 9) | $ | 29,595 | $ | — | $ | — | |||||
Fixed index annuities—embedded derivatives | 101,355 | 529,508 | (210,753 | ) | |||||||
$ | 130,950 | $ | 529,508 | $ | (210,753 | ) | |||||
We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps, participation rates, or asset fees, we can generally manage option costs except in cases where the contractual features would prevent further modifications.
Our strategy attempts to mitigate any potential risk of loss under these agreements through a regular monitoring process which evaluates the program's effectiveness. We do not purchase call options that would require payment or collateral to another institution and our call options do not contain counterparty credit-risk-related contingent features. We are exposed to risk of loss in the event of nonperformance by the counterparties and, accordingly, we purchase our option contracts from multiple counterparties and evaluate the creditworthiness of all counterparties prior to purchase of the contracts. All of these options have been purchased from nationally recognized financial institutions with a Standard and Poor's
F-32
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
credit rating of A- or higher at the time of purchase and the maximum credit exposure to any single counterparty is subject to concentration limits. We also have credit support agreements that allow us to request the counterparty to provide collateral to us when the fair value of our exposure to the counterparty exceeds specified amounts.
The notional amount and fair value of our call options by counterparty and each counterparty's current credit rating are as follows:
December 31, | ||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||
Counterparty | Credit Rating (S&P) | Credit Rating (Moody's) | Notional Amount | Fair Value | Notional Amount | Fair Value | ||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Bank of America | A+ | Aa3 | $ | 588,650 | $ | 25,704 | $ | 796 | $ | — | ||||||||||
BNP Paribas | AA | Aa2 | 786,561 | 34,772 | 1,647,627 | 101,888 | ||||||||||||||
Lehman | NR | NR | — | — | 1,437 | — | ||||||||||||||
Bank of New York | AA- | Aa2 | 18,082 | 111 | 112,193 | 6,153 | ||||||||||||||
Credit Suisse | A+ | Aa1 | 2,462,920 | 95,910 | 2,711,027 | 163,321 | ||||||||||||||
Barclays | AA- | Aa3 | 1,728,218 | 72,751 | 258,853 | 10,082 | ||||||||||||||
SunTrust | BBB+ | A3 | 50,540 | 3,164 | 427,572 | 27,735 | ||||||||||||||
Wells Fargo (Wachovia) | NR | Aa2 | 1,745,775 | 76,250 | 1,189,234 | 70,746 | ||||||||||||||
J.P. Morgan | AA- | Aa1 | 2,858,902 | 133,368 | 1,648,394 | 99,347 | ||||||||||||||
UBS | A+ | Aa3 | 921,596 | 37,756 | — | — | ||||||||||||||
$ | 11,161,244 | $ | 479,786 | $ | 7,997,133 | $ | 479,272 | |||||||||||||
As of December 31, 2010 and 2009, we held $381.2 million and $346.1 million, respectively, of cash and cash equivalents received from counterparties for derivative collateral, which is included in other liabilities on our consolidated balance sheets. This derivative collateral limits the maximum amount of economic loss due to credit risk that we would incur if parties to the call options failed completely to perform according to the terms of the contracts to $108.1 million and $149.6 million at December 31, 2010 and 2009, respectively.
We had unsecured counterparty exposure in connection with options purchased from affiliates of Lehman Brothers ("Lehman") which declared bankruptcy during the third quarter of 2008. All options purchased from affiliates of Lehman had expired as of June 30, 2010. The amount of option proceeds due on expired options purchased from affiliates of Lehman that we did not receive payment on was $12.0 million and $2.1 million for the years ended December 31, 2009 and 2008, respectively. No amount has been recognized for any recovery of these amounts that may result from our claim in Lehman's bankruptcy proceedings.
We entered into interest rate swaps to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures and our revolving line of credit. See notes 9 and 10 for more information on our revolving line of credit and subordinated debentures. The terms of the interest rate swaps provide that we pay a fixed rate of interest and receive a floating rate of interest. The interest rate swaps are not effective hedges under accounting guidance for derivative instruments and hedging activities. Therefore, we record the interest rate swaps at fair value with the changes in fair value and any net cash payments received or paid included in the change in fair value of derivatives in our consolidated statements of operations.
Details regarding the interest rate swaps are as follows:
December 31, | ||||||||||||||||||
Notional Amount | Receive Rate | Pay Rate | 2010 | 2009 | ||||||||||||||
Maturity Date | Counterparty | Fair Value | Fair Value | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||
September 15, 2010 | 20,000 | *LIBOR(a) | 5.19 | % | Bank of America | — | (142 | ) | ||||||||||
April 7, 2011 | 20,000 | *LIBOR(a) | 5.23 | % | Bank of America | (99 | ) | (290 | ) | |||||||||
October 15, 2011 | 15,000 | **LIBOR | 1.54 | % | SunTrust | (193 | ) | (144 | ) | |||||||||
October 31, 2011 | 30,000 | **LIBOR | 1.51 | % | SunTrust | (374 | ) | (241 | ) | |||||||||
October 31, 2011 | 30,000 | **LIBOR | 1.61 | % | SunTrust | (405 | ) | (301 | ) | |||||||||
October 31, 2011 | 75,000 | **LIBOR | 1.77 | % | SunTrust | (905 | ) | (773 | ) | |||||||||
$ | (1,976 | ) | $ | (1,891 | ) | |||||||||||||
*—three month London Interbank Offered Rate
**—one month London Interbank Offered Rate
(a)—subject to a floor of 4.25%
F-33
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Deferred Policy Acquisition Costs and Deferred Sales Inducements
Policy acquisition costs deferred and amortized are as follows:
December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Balance at beginning of year | $ | 1,625,785 | $ | 1,579,871 | $ | 1,272,108 | |||||
Cumulative effect of noncredit OTTI | — | (29,853 | ) | — | |||||||
Costs deferred during the year: | |||||||||||
Commissions | 390,631 | 297,733 | 256,862 | ||||||||
Policy issue costs | 11,976 | 8,130 | 10,002 | ||||||||
Amortized to expense during the year | (136,388 | ) | (88,009 | ) | (126,738 | ) | |||||
Effect of net unrealized gains/losses | (144,244 | ) | (142,087 | ) | 167,637 | ||||||
Balance at end of year | $ | 1,747,760 | $ | 1,625,785 | $ | 1,579,871 | |||||
Sales inducements deferred and amortized are as follows:
December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Balance at beginning of year | $ | 1,011,449 | $ | 843,377 | $ | 588,473 | |||||
Cumulative effect of noncredit OTTI | — | (14,940 | ) | — | |||||||
Costs deferred during the year | 370,714 | 293,167 | 193,482 | ||||||||
Amortized to expense during the year | (59,873 | ) | (39,999 | ) | (30,705 | ) | |||||
Effect of net unrealized gains/losses | (94,962 | ) | (70,156 | ) | 92,127 | ||||||
Balance at end of year | $ | 1,227,328 | $ | 1,011,449 | $ | 843,377 | |||||
The unlocking adjustments in 2010 and 2008 were increases of $1.4 and $14.6 million in amortization of deferred policy acquisition costs and increases of $0.3 and $1.3 million in amortization for deferred sales inducements, respectively. There was no unlocking adjustment necessary in 2009.
7. Reinsurance and Policy Provisions
Coinsurance
We have entered into two coinsurance agreements with EquiTrust Life Insurance Company ("EquiTrust"), covering 70% of certain of our index and fixed rate annuities issued from August 1, 2001 through December 31, 2001, 40% of those contracts issued during 2002 and 2003 and 20% of those contracts issued from January 1, 2004 to July 31, 2004, when the agreement was suspended by mutual consent of the parties. As a result of the suspension, new business is no longer ceded to EquiTrust. The business reinsured under these agreements is not eligible for recapture before the expiration of 10 years.
Coinsurance deposits (aggregate policy benefit reserves transferred to EquiTrust under these agreements) were $1.3 billion and $1.4 billion at December 31, 2010 and 2009, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to EquiTrust should EquiTrust fail to meet the obligations it has coinsured. None of the coinsurance deposits with EquiTrust are deemed by management to be uncollectible. The balance due under these agreements to EquiTrust was $24.3 million and $30.8 million at December 31, 2010 and 2009, respectively, and represents the fair value of call options held by us to fund index credits related to the ceded business net of cash due to or from EquiTrust related to monthly settlements of policy activity.
Effective July 1, 2009, we entered into two funds withheld coinsurance agreements with Athene Life Re Ltd. ("Athene"), an unauthorized life reinsurer domiciled in Bermuda. One agreement cedes 20% of certain of our fixed index annuities issued from January 1, 2009 through March 31, 2010. The business reinsured under this agreement is not eligible for recapture until the end of the month following seven years after the date of issuance of the policy. The other agreement cedes 80% of our multi-year rate guaranteed annuities issued on or after July 1, 2009. The business reinsured under this agreement may not be recaptured. Coinsurance deposits (aggregate policy benefit reserves transferred to Athene under these agreements) were $1.3 billion and $834.2 million at December 31, 2010 and 2009, respectively. We remain liable to policyholders with respect to the policy liabilities ceded to Athene should Athene fail to meet the obligations it has coinsured. The annuity deposits that have been ceded to Athene are being held in a trust on a funds withheld basis. American Equity Life is named as the sole beneficiary of the trust. The funds withheld are required to remain at a value that is sufficient to support the current balance of policy benefit liabilities of the ceded business on a statutory basis. If the value of the funds withheld account would ever reach a point where it is less than the amount of the ceded policy benefit liabilities on a statutory basis, Athene is required to either establish a letter of credit or deposit securities in a trust for the amount
F-34
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of any shortfall. At December 31, 2010, Athene has adequate capital reserves and a significant capital commitment from its equity investor. None of the coinsurance deposits with Athene are deemed by management to be uncollectible. The balance due under these agreements to Athene was $19.0 million and $16.9 million at December 31, 2010 and 2009, respectively, and represents the fair value of call options held by us to fund index credits related to the ceded business net of cash due to or from Athene related to monthly settlements of policy activity.
Amounts ceded to EquiTrust and Athene under these agreements are as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Consolidated Statements of Operations | |||||||||||
Annuity product charges | $ | 6,937 | $ | 7,196 | $ | 8,540 | |||||
Change in fair value of derivatives | 19,408 | 22,878 | (37,436 | ) | |||||||
$ | 26,345 | $ | 30,074 | $ | (28,896 | ) | |||||
Interest sensitive and index product benefits | $ | 96,872 | $ | 45,734 | $ | 33,208 | |||||
Change in fair value of embedded derivatives | 3,373 | 46,284 | (10,626 | ) | |||||||
Other operating costs and expenses | 8,948 | 9,764 | 1,669 | ||||||||
$ | 109,193 | $ | 101,782 | $ | 24,251 | ||||||
Consolidated Statements of Cash Flows | |||||||||||
Annuity deposits | $ | (478,962 | ) | $ | (749,260 | ) | $ | (1,310 | ) | ||
Cash payments to policyholders | 211,324 | 193,760 | 184,525 | ||||||||
$ | (267,638 | ) | $ | (555,500 | ) | $ | 183,215 | ||||
Financing Arrangements
We have entered into two reinsurance transactions with Hannover Life Reassurance Company of America ("Hannover"), which are treated as reinsurance under statutory accounting practices and as financing arrangements under GAAP. The statutory surplus benefits under these agreements are eliminated under GAAP and the associated charges are recorded as risk charges and are included in other operating costs and expenses in the consolidated statements of operations. The transactions became effective October 1, 2005 (the "2005 Hannover Transaction") and December 31, 2008 (the "2008 Hannover Transaction").
The 2008 Hannover Transaction is a coinsurance and yearly renewable term reinsurance agreement for statutory purposes and provided $29.5 million in net pretax statutory surplus benefit in 2008. Pursuant to the terms of this agreement, pretax statutory surplus was reduced by $6.7 million in 2010 and is expected to be reduced as follows: 2011—$6.7 million; 2012—$6.8 million; 2013—$6.9 million. These amounts include risk charges equal to 5.0% of the pretax statutory surplus benefit as of the end of each calendar quarter. During 2008 we recaptured business previously ceded to Hannover under another coinsurance and yearly renewable term reinsurance agreement which was similar to the 2008 Hannover Transaction. Risk charges attributable to these two agreements were $1.1 million, $1.3 million and $0.6 million during 2010, 2009 and 2008, respectively.
The 2005 Hannover Transaction is a yearly renewable term reinsurance agreement for statutory purposes covering 47% of waived surrender charges related to penalty free withdrawals and deaths on certain business. The agreement was amended in 2010 and 2009 to include policy forms that were not in existence at the time this agreement became effective. We may recapture the risks reinsured under this agreement as of the end of any quarter beginning October 1, 2008. The 2009 amendment includes a provision that makes it punitive for us not to recapture the business ceded prior to January 1, 2013. The reserve credit recorded on a statutory basis by American Equity Life was $135.2 million and $106.8 million at December 31, 2010 and 2009, respectively. We pay quarterly reinsurance premiums under this agreement with an experience refund calculated on a quarterly basis resulting in a risk charge equal to approximately 5.8% of the weighted average statutory reserve credit. Risk charges attributable to the 2005 Hannover Transaction were $6.9 million, $5.1 million and $3.8 million during 2010, 2009 and 2008, respectively.
Indemnity Reinsurance
In the normal course of business, we seek to limit our exposure to loss on any single insured and to recover a portion of benefits paid under our annuity, life and accident and health insurance products by ceding reinsurance to other insurance enterprises or reinsurers. Reinsurance contracts do not relieve us of our obligations to its policyholders. To the extent that reinsuring companies are later unable to meet obligations under reinsurance agreements, our life insurance subsidiaries would be liable for these obligations, and payment of these obligations could result in losses to us. To limit the possibility of such losses, we evaluate the financial condition of our reinsurers, and monitor concentrations of credit risk. No allowance for uncollectible amounts has been established against our asset for amounts receivable from other insurance companies since none of the receivables are deemed by management to be uncollectible.
F-35
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Reinsurance coverages for life insurance vary according to the age and risk classification of the insured. Reinsurance related to life and accident and health insurance that was ceded by us primarily to two reinsurers was immaterial.
During 2007, we entered into reinsurance agreements with Ace Tempest Life Reinsurance Ltd and Hannover to cede 50% to each of the risk associated with our living income benefit rider on certain fixed index annuities issued in 2007. The amounts ceded under these agreements were immaterial as of and for the years ended December 31, 2010, 2009 and 2008.
8. Income Taxes
We file consolidated federal income tax returns that include all of our wholly-owned subsidiaries except Eagle Life which must file a separate federal income tax return for 2009–2013 under applicable federal income tax guidelines. Our income tax expense as presented in the consolidated financial statements is summarized as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Consolidated statements of operations: | |||||||||||
Current income taxes | $ | 140,381 | $ | 73,784 | $ | 16,031 | |||||
Deferred income taxes (benefits) | (118,048 | ) | (56,150 | ) | 45,075 | ||||||
Total income tax expense included in consolidated statements of operations | 22,333 | 17,634 | 61,106 | ||||||||
Stockholders' equity: | |||||||||||
Expense (benefit) relating to: | |||||||||||
Cumulative effect of noncredit OTTI | — | 2,462 | — | ||||||||
Change in net unrealized investment losses | 60,456 | 39,680 | (58,394 | ) | |||||||
Share-based compensation | (480 | ) | 277 | (313 | ) | ||||||
Issuance of convertible debt | — | 10,756 | — | ||||||||
Total income tax expense included in consolidated financial statements | $ | 82,309 | $ | 70,809 | $ | 2,399 | |||||
Income tax expense (benefit) in the consolidated statements of operations differed from the amount computed at the applicable statutory federal income tax rate of 35% as follows:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands) | |||||||||||
Income before income taxes | $ | 65,266 | $ | 86,164 | $ | 77,053 | |||||
Income tax expense on income before income taxes | $ | 22,843 | $ | 30,157 | $ | 26,969 | |||||
Tax effect of: | |||||||||||
State income taxes | (859 | ) | (438 | ) | (449 | ) | |||||
Deferred tax asset valuation allowance | — | (11,949 | ) | 34,483 | |||||||
Other | 349 | (136 | ) | 103 | |||||||
Income tax expense | $ | 22,333 | $ | 17,634 | $ | 61,106 | |||||
Effective tax rate | 34.2 | % | 20.5 | % | 79.3 | % | |||||
F-36
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Deferred income tax assets or liabilities are established for temporary differences between the financial reporting amounts and tax bases of assets and liabilities that will result in deductible or taxable amounts, respectively, in future years. The tax effects of temporary differences that give rise to the deferred tax assets and liabilities at December 31, 2010 and 2009, are as follows:
December 31, | |||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Deferred income tax assets: | |||||||
Policy benefit reserves | $ | 1,265,860 | $ | 999,544 | |||
Net unrealized losses on available for sale fixed maturity and equity securities | — | 28,533 | |||||
Other than temporary impairments | 12,920 | 24,883 | |||||
Amounts due reinsurer | 5,045 | 11,567 | |||||
Other policyholder funds | 5,448 | 2,510 | |||||
Litigation settlement accrual | 16,800 | — | |||||
Deferred compensation | 14,453 | 11,786 | |||||
Net operating loss carryforwards | 10,144 | 4,912 | |||||
Other | 8,518 | 8,896 | |||||
Gross deferred tax assets | 1,339,188 | 1,092,631 | |||||
Deferred income tax liabilities: | |||||||
Deferred policy acquisition costs and deferred sales inducements | (1,043,016 | ) | (845,411 | ) | |||
Net unrealized gains on available for sale fixed maturity and equity securities | (31,923 | ) | — | ||||
Convertible senior notes | (17,567 | ) | (18,363 | ) | |||
Derivative instruments | (89,898 | ) | (137,516 | ) | |||
Investment income items | (8,902 | ) | (2,314 | ) | |||
Other | (4,629 | ) | (3,366 | ) | |||
Gross deferred tax liabilities | (1,195,935 | ) | (1,006,970 | ) | |||
Net deferred income tax asset | $ | 143,253 | $ | 85,661 | |||
The total deferred income tax asset includes other than temporary impairments on investments. The other than temporary impairments will not be available for utilization for tax purposes until the securities are either sold at a loss or deemed completely worthless. The other than temporary impairments totaled $36.9 million and $70.8 million as of December 31, 2010 and 2009, respectively. In 2008, we recorded a valuation allowance of $34.5 million on the deferred income tax assets related to capital loss carryforwards and other than temporary impairments on investment securities, as utilization of the income tax benefits from a portion of these items was not more likely than not due to the fact that we had insufficient future taxable income from capital gain sources. The valuation allowance was eliminated in 2009 due to taxable income from capital gain sources and an increase in anticipated future taxable income from capital gain sources. The 2009 taxable income from capital gain sources resulted from the recognition of net realized gains on sales of available for sale fixed maturity and equity securities that were sold as part of a tax planning strategy to generate taxable capital gains to offset the recognition of capital losses for income tax purposes and resulted in $11.9 million recognized as a component of 2009 income tax expense. The remaining $22.5 million of the valuation allowance was reversed through an adjustment to retained earnings. The increase in anticipated future taxable income from capital gain sources resulted from an increase in unrealized gains on securities in our available for sale investment portfolio which may be sold as part of a tax planning strategy to generate capital gains to offset capital losses.
Included in the deferred income taxes is the expected income tax benefit attributable to unrealized losses on available for sale fixed maturity securities. There is no valuation allowance provided for the deferred tax asset attributable to unrealized losses on available for sale fixed maturity securities. Management expects that the passage of time will result in the reversal of these unrealized losses due to the fair value increasing as these securities near maturity. Management has the intent and ability to hold these securities to maturity because we generate adequate cash flow from new business to fund all foreseeable cash flow needs and do not believe it would ever be necessary to liquidate these securities at a loss to meet cash flow needs. For deferred income taxes related to unrealized losses on equity securities, we had sufficient future taxable income from capital gain sources to support the realizability of the deferred tax asset.
Realization of our deferred income tax assets is more likely than not based on expectations as to our future taxable income and considering all other available evidence, both positive and negative. Therefore, no valuation allowance against deferred income tax assets has been established as of December 31, 2010 and 2009.
There were no material income tax contingencies requiring recognition in our consolidated financial statements as of December 31, 2010. We are no longer subject to income tax examinations by tax authorities for years prior to 2007.
At December 31, 2010, we had non-life net operating loss carryforwards for federal income tax purposes totaling $22.0 million which expire beginning in 2018 through 2030.
F-37
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Notes Payable and Amounts Due Under Repurchase Agreements
In September 2010, we issued $200.0 million principal amount of 3.5% Convertible Senior Notes Due 2015 (the "2015 notes"). The 2015 notes have a stated interest rate of 3.5%, mature on September 15, 2015, and are intended to be settled in cash; however, in certain limited circumstances we have the discretion to settle in shares of our common stock or a combination of cash and shares of our common stock. Contractual interest payable on the 2015 notes began accruing in September 2010 and is payable semi-annually in arrears each March 15th and September 15th. The initial purchaser's transaction fees and expenses totaling $6.8 million were capitalized as deferred financing costs and will be amortized over the term of the 2015 notes using the effective interest method.
Upon occurrence of any of the conditions described below, holders may convert their 2015 notes at the applicable conversion rate at any time prior to June 15, 2015. On or after June 15, 2015 through the maturity date of September 15, 2015, holders may convert each of their 2015 notes at the applicable conversion rate regardless of the following conditions:
• | during the 5 business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; |
• | during any calendar quarter commencing after December 31, 2010, the Notes may be converted if the last reported price of the common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day. The “last reported sale price” means the closing sale price per share (or if no closing sale price is reported, the average of the bid and ask prices or, if more than one in either case, the average of the average bid and the average ask prices) on that date as reported in composite transactions for the New York Stock Exchange; or |
• | upon the occurrence of specified corporate transactions. |
The initial conversion rate for the 2015 notes is 80 shares of our common stock per $1,000 principal amount of 2015 notes, equivalent to a conversion price of approximately $12.50 per share of our common stock, with the amount due on conversion. Upon conversion, a holder will receive the sum of the daily settlement amounts, calculated on a proportionate basis for each day, during a specified observation period following the conversion date.
If a fundamental change, as defined in the indenture, occurs prior to maturity and our stock price is at least $10.00 per share at that time, the conversion rate will increase by an additional amount of up to 20 shares of our common stock per $1,000 principal amount of 2015 notes, which amount would be paid to each holder that elects to convert its 2015 notes at that time.
The conversion option of the 2015 notes (the "2015 notes embedded conversion derivative") is an embedded derivative that requires bifurcation from the 2015 notes and is accounted for as a derivative liability, which is included in Other liabilities in our Consolidated Balance Sheets. The fair value of the 2015 notes embedded conversion derivative at the time of issuance of the 2015 notes was $37.0 million, and was recorded as the original debt discount for purposes of accounting for the debt component of the 2015 notes. This discount will be recognized as interest expense using the effective interest method over the term of the 2015 notes. The estimated fair value of the 2015 notes embedded conversion derivative was $66.6 million as of December 31, 2010.
Concurrently with the issuance of the 2015 notes, we entered into hedge transactions (the "2015 notes hedges") with various parties whereby we have the option to receive the cash equivalent of the conversion spread on approximately 16.0 million shares of our common stock based upon a strike price of $12.50 per share, subject to certain conversion rate adjustments in the 2015 notes. These options expire on September 15, 2015 and must be settled in cash. The aggregate cost of the 2015 notes hedges was $37.0 million. The 2015 notes hedges are accounted for as derivative assets, and are included in Other assets in our Consolidated Balance Sheets. The estimated fair value of the 2015 notes hedges was $66.6 million as of December 31, 2010.
The 2015 notes embedded conversion derivative and the 2015 notes hedges are adjusted to fair value each reporting period and unrealized gains and losses are reflected in our Consolidated Statements of Operations.
In separate transactions, we also sold warrants (the "2015 warrants") to two counterparties for the purchase of up to approximately 16.0 million shares of our common stock at a price of $16.00 per share. The warrants expire on various dates from December 2015 through March 2016 and are intended to be settled in net shares. The total number of shares of common stock deliverable under the 2015 warrants is, however, currently limited to 11.6 million shares. We received $15.6 million in cash proceeds from the sale of the 2015 warrants, which has been recorded as an increase in additional paid-in capital. Changes in the fair value of these warrants will not be recognized in our Consolidated Financial Statements as long as the instruments remain classified as equity. The warrants are included in diluted earnings per share to the extent the impact is dilutive.
In December 2004, we issued $260.0 million of convertible senior notes due December 15, 2024 (the "2024 notes"), of which $22.9 million was assigned to the equity component (net of income tax of $16.1 million). In December 2009, we issued $115.8 million of contingent convertible senior notes due December 15, 2029 (the "2029 notes"), of which $15.6 million was assigned to the equity component (net of income tax of $11.0 million). $52.2 million of the December 2029 notes were issued for cash, and $63.6 million were issued in exchange of $63.6 million of the 2024 notes.
F-38
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The 2024 notes and 2029 notes bear interest at a fixed rate of 5.25% per annum. Interest is payable semi-annually in arrears on June 6 and December 6 of each year. In addition to regular interest on the notes, beginning with the six-month interest period ending June 6, 2012 for the December 2024 notes and June 6, 2015 for the 2029 notes, we will also pay contingent interest under certain conditions at a rate of 0.5% per annum based on the average trading price of the notes during a specified period.
The 2024 and 2029 notes are convertible at the holders' option prior to the maturity date into cash and shares of our common stock under the following conditions:
• | during any fiscal quarter, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the fiscal quarter preceding the quarter in which the conversion occurs is more than 120% of the conversion price of the notes in effect on that 30th trading day; |
• | we have called the notes for redemption and the redemption has not yet occurred; or |
• | upon the occurrence of specified corporate transactions. |
Holders may convert any outstanding notes into cash and shares of our common stock at a conversion price per share of $14.03 for the 2024 notes and $9.69 for the 2029 notes. This represents a conversion rate of approximately 71.3 shares and 103.2 shares of common stock per $1,000 in principal amount of notes (the "conversion rate") for the 2024 notes and the 2029 notes, respectively. Subject to certain exceptions described in the indentures covering these notes, at the time the notes are tendered for conversion, the value (the "conversion value") of the cash and shares of our common stock, if any, to be received by a holder converting $1,000 principal amount of the notes will be determined by multiplying the conversion rate by the "ten day average closing stock price", which equals the average of the closing per share prices of our common stock on the New York Stock Exchange on the ten consecutive trading days beginning on the second trading day following the day the notes are submitted for conversion. We will deliver the conversion value to holders as follows: (1) an amount in cash (the "principal return") equal to the lesser of (a) the aggregate conversion value of the notes to be converted and (b) the aggregate principal amount of the notes to be converted, and (2) if the aggregate conversion value of the notes to be converted is greater than the principal return, an amount in shares (the "net shares") equal to such aggregate conversion value less the principal return (the "net share amount") and (3) an amount in cash in lieu of fractional shares of common stock. The number of net shares to be paid will be determined by dividing the net share amount by the ten day average closing stock price.
We may redeem some or all of the 2024 notes and the 2029 notes at any time on or after December 15, 2011 and December 15, 2014, respectively. In addition, the holders may require us to repurchase all or a portion of their 2024 notes on December 15, 2011, 2014 and 2019 or their 2029 notes on December 15, 2014, 2019 and 2024 and upon a change in control, as defined in the indenture governing the notes, holders may require us to repurchase all or a portion of their notes for a period of time after the change in control. The redemption price or repurchase price shall be payable in cash and equal to 100% of the principal amount of the notes plus accrued and unpaid interest (contingent interest and liquidated damages, if any) up to but not including the date of redemption or repurchase.
Our convertible notes are senior unsecured obligations and rank equally in right of payment with all existing and future senior indebtedness and senior to any existing and future subordinated indebtedness. Our convertible notes effectively rank junior in right of payment to any existing and future secured indebtedness to the extent of the value of the assets securing such secured indebtedness. Our convertible notes are structurally subordinated to all liabilities of our subsidiaries.
We are required to include the dilutive effect of the 2024 and 2029 notes in our diluted earnings per share calculation. Because these notes include a mandatory cash settlement feature for the principal amount, incremental dilutive shares will only exist when the fair value of our common stock at the end of the reporting period exceeds the conversion price per share of $14.03 for the 2024 notes and $9.69 for the 2029 notes. At December 31, 2010, the conversion premium of the 2029 notes was dilutive and the effect has been included in diluted earnings per share for the year ended December 31, 2010. The 2015 notes and the 2015 notes hedges are excluded from the dilutive effect in our diluted earnings per share calculation as they are currently to be settled only in cash. The 2015 warrants could have a dilutive effect on our earnings per share to the extent that the price of our common stock exceeds the strike price of the 2015 warrants.
We purchased $78.1 million principal amount of the 2024 notes, carrying $7.4 million of unamortized debt discounts and debt issue costs, in 2008 for $61.4 million in cash, of which $0.4 million was assigned to the reacquisition of the equity component which resulted in gains totaling $9.7 million. In 2009, we exchanged five million shares of our common stock for $37.2 million principal amount of the 2024 notes which resulted in a gain on exchange of debt of $3.1 million. The fair value of our common stock issued was $31.2 million and the 2024 notes extinguished in the common stock for debt exchange carried unamortized debt discount and debt issue costs totaling $2.9 million. The $63.6 million principal amount of the 2024 notes extinguished in the debt for debt exchange in 2009 carried unamortized debt discount and debt issue costs totaling $3.8 million. In 2010, we extinguished $6.7 million principal amount of the outstanding 2024 notes for $6.6 million in cash. The extinguished notes carried unamortized debt issue costs and unamortized debt discounts totaling $0.3 million. No value was assigned to reacquire of the equity component of the debt. A $0.3 million loss on extinguishment of debt was recorded for the amount that the cash payment exceeded the carrying of value the notes extinguished.
F-39
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The liability and equity components of the 2024 notes and 2029 notes are accounted for separately in the consolidated balance sheets. The liability component of the 2015 notes and the liability and equity components of the 2024 notes and 2029 notes are as follows:
December 31, 2010 | December 31, 2009 | |||||||||||||||||||
September 2015 Notes | December 2029 Notes | December 2024 Notes | December 2029 Notes | December 2024 Notes | ||||||||||||||||
(Dollars in thousands) | (Dollars in thousands) | |||||||||||||||||||
Notes payable: | ||||||||||||||||||||
Principal amount of liability component | $ | 200,000 | $ | 115,839 | $ | 74,494 | $ | 115,839 | $ | 81,152 | ||||||||||
Unamortized discount | (35,335 | ) | (22,306 | ) | (1,857 | ) | (26,542 | ) | (3,982 | ) | ||||||||||
Net carrying amount of liability component | $ | 164,665 | $ | 93,533 | $ | 72,637 | $ | 89,297 | $ | 77,170 | ||||||||||
Additional paid-in capital: | ||||||||||||||||||||
Carrying amount of equity component | $ | 15,586 | $ | 22,637 | $ | 15,586 | $ | 22,637 | ||||||||||||
Amount by which the if-converted value exceeds principal | $ | 800 | $ | 34,191 | $ | — | $ | — | $ | — | ||||||||||
The discount is being amortized over the expected life of the notes, which is December 15, 2011 for the 2024 notes, December 15, 2014 for the 2029 notes and September 15, 2015 for the 2015 notes. The expected life of the notes are based on the dates at which we may redeem the notes or the holders may require us to repurchase the notes. The effective interest rates are 8.9%, 8.5% and 11.9% on the 2015 notes, 2024 notes and 2029 notes, respectively. The interest cost recognized in operations for the convertible senior notes, inclusive of the coupon and amortization of the discount and debt issue costs was $20.9 million, $12.8 million, and $15.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.
During 2006, we entered into a $150 million revolving line of credit agreement with eight banks. The revolving period of the facility is five years. The applicable interest rate is floating at LIBOR plus 0.80% or the greater of prime rate or federal funds rate plus 0.50%, as elected by us. In September 2010, we used $150 million of the 2015 notes proceeds to pay off the revolving line of credit. No amount was outstanding at December 31, 2010. The amount outstanding under the revolving line of credit was $150.0 million at December 31, 2009. Under this agreement, we are required to maintain a minimum risk-based capital ratio at American Equity Life, a maximum ratio of debt to total capital, minimum consolidated net worth and a minimum cash coverage ratio. We are in compliance with all debt covenants at December 31, 2010.
Subsequent to December 31, 2010, we terminated the $150 million revolving line of credit agreement and entered into a $160 million revolving line of credit agreement with seven banks. The revolving period of the $160 million facility will be three years. The interest rate will be floating at a rate based on our election that will be equal to the applicable base rate (highest of the rate of interest publicly announced by JPMorgan Chase Bank as its prime rate in effect at its principal office in New York City, the federal funds effective rate from time to time plus 0.50% and the adjusted LIBOR for a one month interest period on such day plus 1.00%) plus the applicable margin or the adjusted LIBOR plus the applicable margin. The applicable margin and commitment fee rate are based on our credit rating and can change throughout the period of the credit facility. Based on our current credit rating the applicable margin is 2.00% and the commitment fee is 0.50% on the unused portion of credit available. Under this agreement, we are required to maintain a minimum risk-based capital ratio at American Equity Life, a maximum ratio of debt to total capital, a minimum cash coverage ratio, and a minimum level of statutory surplus at American Equity Life.
As part of our investment strategy, we enter into securities repurchase agreements (short-term collateralized borrowings). We had no borrowings under repurchase agreements during 2010. The maximum amount borrowed during 2009 and 2008 was $440.0 million and $641.1 million, respectively. When we do borrow cash on these repurchase agreements, we pledge collateral in the form of debt securities with fair values approximately equal to the amount due and we use the cash to purchase debt securities ahead of the time we collect the cash from selling annuity policies to avoid a lag between the investment of funds and the obligation to credit interest to policyholders. We earn investment income on the securities purchased with these borrowings at a rate in excess of the cost of these borrowings. Such borrowings averaged $150.7 million and $359.9 million for the years ended December 31, 2009 and 2008, respectively. The weighted average interest rate on amounts due under repurchase agreements was 0.35% and 2.28% for the years ended December 31, 2009 and 2008, respectively.
10. Subordinated Debentures
Our wholly-owned subsidiary trusts (which are not consolidated) have issued fixed rate and floating rate trust preferred securities and have used the proceeds from these offerings to purchase subordinated debentures from us. We also issued subordinated debentures to the trusts in exchange for all of the common securities of each trust. The sole assets of the trusts are the subordinated debentures and any interest accrued thereon. The interest payment dates on the subordinated debentures correspond to the distribution dates on the trust preferred securities issued by the trusts. The trust preferred securities mature simultaneously with the subordinated debentures. Our obligations under the subordinated debentures and related agreements provide a full and unconditional guarantee of payments due under the trust preferred securities.
F-40
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Following is a summary of subordinated debt obligations to the trusts at December 31, 2010 and 2009:
December 31, | |||||||||||
2010 | 2009 | Interest Rate | Due Date | ||||||||
(Dollars in thousands) | |||||||||||
American Equity Capital Trust I | $ | 22,893 | $ | 22,953 | 8% | September 30, 2029 | |||||
American Equity Capital Trust II | 75,932 | 75,784 | 5% | June 1, 2047 | |||||||
American Equity Capital Trust III | 27,840 | 27,840 | *LIBOR + 3.90% | April 29, 2034 | |||||||
American Equity Capital Trust IV | 12,372 | 12,372 | *LIBOR + 4.00% | January 8, 2034 | |||||||
American Equity Capital Trust VII | 10,830 | 10,830 | *LIBOR + 3.75% | December 14, 2034 | |||||||
American Equity Capital Trust VIII | 20,620 | 20,620 | *LIBOR + 3.75% | December 15, 2034 | |||||||
American Equity Capital Trust IX | 15,470 | 15,470 | *LIBOR + 3.65% | June 15, 2035 | |||||||
American Equity Capital Trust X | 20,620 | 20,620 | *LIBOR + 3.65% | September 15, 2035 | |||||||
American Equity Capital Trust XI | 20,620 | 20,620 | *LIBOR + 3.65% | December 15, 2035 | |||||||
American Equity Capital Trust XII | 41,238 | 41,238 | *LIBOR + 3.50% | April 7, 2036 | |||||||
$ | 268,435 | $ | 268,347 | ||||||||
*—three month London Interbank Offered Rate
The interest rate for Trust XI was fixed at 8.595% for 5 years until December 15, 2010 and is now floating based upon the three month London Interbank Offered Rate ("LIBOR") plus 3.65%. See note 5 for discussion on interest rate swaps used to manage the interest rate risk on our subordinated debentures.
American Equity Capital Trust I issued 865,671 shares of 8% trust preferred securities, of which 2,000 shares are held by one of our subsidiaries. During 2010 and 2008, 2,010 and 8,333 shares of these trust preferred securities converted into 7,444 and 30,862 shares of our common stock, respectively. There were no conversions during 2009. The remaining 736,328 shares of these trust preferred securities not held by a subsidiary are convertible into 2,727,084 shares of our common stock.
The principal amount of the subordinated debentures issued by us to American Equity Capital Trust II ("Trust II") is $100.0 million. These debentures were assigned a fair value of $74.7 million at the date of issue (based upon an effective yield-to-maturity of 6.8%). The difference between the fair value at the date of issue and the principal amount is being accreted over the life of the debentures. The trust preferred securities issued by Trust II were issued to Iowa Farm Bureau Federation, which owns more than 50% of the voting capital stock of FBL Financial Group, Inc. ("FBL"), parent company of EquiTrust. The consideration received by Trust II in connection with the issuance of its trust preferred securities consisted of fixed income securities of equal value which were issued by FBL.
11. Retirement and Share-based Compensation Plans
We have adopted a contributory defined contribution plan which is qualified under Section 401(k) of the Internal Revenue Code. The plan covers substantially all of our full-time employees subject to minimum eligibility requirements. Employees can contribute a percentage of their annual salary (up to a maximum contribution of $16,500 in 2010 and 2009 and $15,500 in 2008) to the plan. We contribute an additional amount, subject to limitations, based on the voluntary contribution of the employee. Further, the plan provides for additional employer contributions based on the discretion of the Board of Directors. Plan contributions charged to expense was $0.3 million for the year ended December 31, 2010 and $0.2 million for each of the years ended December 31, 2009 and 2008.
During 2010, we established the American Equity Investment Life Holding Company Short-Term Performance Incentive Plan. Under this plan, certain members of our senior management may receive incentive awards comprised of a cash component and a restricted stock component. Shares of restricted stock received will be granted pursuant to the 2009 Employee Incentive Plan and will vest on the date three years following the date the Committee approves the payment of the incentive award provided that the participant remains employed by us. Shares vest immediately for participants 65 years of age with 10 years of service with us. Compensation expense under this plan is recognized upon approval of the incentive award by the compensation committee.
We have deferred compensation arrangements with certain officers, directors, and consultants, whereby these individuals agreed to take our common stock at a future date in lieu of cash payments at the time of service. The common stock is to be issued in conjunction with a "trigger event", as that term is defined in the individual agreements. At December 31, 2010 and 2009, these individuals have earned, and we have reserved for future issuance, 479,972 and 434,029 shares of common stock, respectively, pursuant to these arrangements. We have incurred share-based compensation expense of $0.4 million for the year ended December 31, 2010, $0.1 million for the year ended December 31, 2009 and $0.2 million for the year ended December 31, 2008 under these arrangements.
We have deferred compensation agreements with certain officers whereby these individuals may defer certain bonus compensation which is deposited into the American Equity Officer Rabbi Trust (Officer Rabbi Trust). The amounts deferred are invested in assets at the direction of the employee. The assets of the Officer Rabbi Trust are included in our assets and a corresponding deferred compensation liability is recorded.
F-41
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The deferred compensation liability is recorded at the fair market value of the assets in the Officer Rabbi Trust with the change in fair value included as a component of compensation expense. The deferred compensation liability related to these agreements was $2.3 million, $1.4 million and $1.3 million at December 31, 2010, 2009 and 2008, respectively. During 2010, 2009 and 2008, the Officer Rabbi Trust purchased 104,661 shares of our common stock at a cost of $1.2 million, 8,100 shares of our common stock at a cost of $0.03 million and 28,333 shares of our common stock at a cost of $0.3 million, respectively. The Officer Rabbi Trust held 173,261 shares, 68,600 shares and 65,351 shares of our common stock at December 31, 2010, 2009 and 2008, respectively, which are treated as treasury shares.
During 1997, we established the American Equity Investment NMO Deferred Compensation Plan ("NMO Deferred Compensation Plan") whereby agents can earn common stock in addition to their normal commissions. The NMO Deferred Compensation Plan was effective until December 31, 2006 at which time it was suspended. Awards were calculated using formulas determined annually by our Board of Directors and are generally based upon new annuity deposits. These shares will be distributed at the end of the vesting and deferral period of 9 years. We recognize commission expense and an increase to additional paid-in capital as share-based compensation when the awards vest. For the years ended December 31, 2010, 2009 and 2008, agents vested in 1,052 shares, 53,208 shares and 164,777 shares of common stock, respectively, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $0.01 million, $0.4 million and $1.2 million, respectively, under these plans. At December 31, 2010 and 2009, the total number of undistributed vested shares under the NMO Deferred Compensation Plan was 2,580,612 and 2,746,525, respectively. These shares are included in the computation of earnings per share and earnings per share—assuming dilution. There were no unvested shares that potentially may be vested in by agents in the future under the NMO Deferred Compensation Plan as of December 31, 2010.
We have a Rabbi Trust, the NMO Deferred Compensation Trust (the "NMO Trust") which has purchased shares of our common stock to fund the amount of vested shares under the NMO Deferred Compensation Plan. The common stock held in the NMO Trust is treated as treasury stock. The NMO Trust purchased 4,262 shares and 163,161 shares of our common stock during 2009 and 2008 at a cost of $0.01 million and $1.6 million, respectively. The NMO Trust did not purchase any shares during 2010. The NMO Trust distributed 166,965 and 334,515 shares during 2010 and 2009, respectively. The number of shares held by the NMO Trust at December 31, 2010 and 2009 was 1,855,835 and 2,022,800, respectively.
Our 1996 Stock Option Plan, 2000 Employee Stock Option Plan and 2000 Directors Stock Option Plan authorized grants of options to officers, directors and employees for an aggregate of up to 3,225,000 shares of our common stock. All options granted under these plans have 10 year terms and a six month vesting period after which they become fully exercisable immediately. At December 31, 2010, we had no shares of common stock available for future grant under these plans. In 2009, we adopted the 2009 Employee Incentive Plan which authorizes the grant of options, stock appreciation rights, restricted stock awards and restricted stock units convertible into or based upon our common stock up to 2,500,000 shares. All options granted under this plan have 10 year terms and a 3 year vesting period after which they become fully exercisable immediately. At December 31, 2010, we had 1,818,500 shares of common stock available for future grant under the 2009 Employee Incentive Plan.
The fair value for each stock option granted to officers, directors and employees during the years ended December 31, 2010, 2009 and 2008 was estimated at the date of grant using a Black-Scholes option valuation model with the following assumptions:
Year Ended December 31, | ||||||||
2010 | 2009 | 2008 | ||||||
Directors and Retirement Eligible Employees | Non-Retirement Eligible Employees | |||||||
Average risk-free interest rate | 2.17% | 2.99% | 3.45% | 3.90 | % | |||
Dividend yield | 0.8% | 0.8% | 1.2% | 0.6 | % | |||
Average expected life | 5 years | 8 years | 8 years | 8 years | ||||
Volatility | 75.7% | 75.7% | 67.0% | 26.0 | % | |||
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. We use the historical realized volatility of our stock for the expected volatility assumption within the valuation model. For options granted since 2007, the weighted average expected term for the majority of our options were calculated using average historical behavior.
During 2007, we established the Independent Insurance Agent Stock Option Plan. During 2010, we established the 2010 Independent Insurance Agent Stock Option plan. Under these plans, agents of American Equity Life may receive grants of options to acquire shares of our common stock based upon their individual sales. The plan authorizes grants of options to agents for an aggregate of up to 5,000,000 shares of our common stock. We recognize commission expense and an increase to additional paid-in capital as share-based compensation equal to the fair value of the options as they are earned. The fair value of the options are estimated using a Black-Scholes option valuation model until the grant date, at which time the options are included as permanent equity. The assumptions used for estimating the fair value of the options for 2010 were an average risk fee rate of 1.44%, dividend yield of 0.78%, average expected life of 3 3/4 years and volatility of 68.04%. The assumptions used for estimating the fair value of the options for 2009 were an average risk fee rate of 2.22%, dividend yield of 1.05%, average expected life of 3 3/4 years and volatility of 59.8%. The assumptions used for estimating the fair value of the options for 2008 were an average risk fee rate of 1.46%, dividend yield of 1%, average expected life of 3 3/4 years and volatility of 46.6%. American Equity Life's agents earned 670,850 options
F-42
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
during 2008, which were granted in January 2009, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $1.6 million in 2008. American Equity Life's agents earned 1,052,000 options during 2009, which were granted in January 2010, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $3.4 million in 2009. American Equity Life's agents earned 1,361,900 options during 2010, which were granted in January 2011, and we recorded commission expense (capitalized as deferred policy acquisition costs) of $8.2 million in 2010. All options granted have 7 year terms and a six month vesting period after which they become exercisable immediately.
Changes in the number of stock options outstanding during the years ended December 31, 2010, 2009 and 2008 are as follows:
Number of Shares | Weighted-Average Exercise Price per Share | Total Exercise Price | ||||||||
(Dollars in thousands, except per share data) | ||||||||||
Outstanding at January 1, 2008 | 1,451,017 | $ | 9.62 | $ | 13,962 | |||||
Granted | 986,550 | 9.11 | 8,990 | |||||||
Canceled | (17,650 | ) | 10.54 | (186 | ) | |||||
Exercised | (35,529 | ) | 6.18 | (220 | ) | |||||
Outstanding at December 31, 2008 | 2,384,388 | 9.46 | 22,546 | |||||||
Granted | 1,009,250 | 6.86 | 6,926 | |||||||
Canceled | (251,449 | ) | 7.37 | (1,852 | ) | |||||
Exercised | — | — | — | |||||||
Outstanding at December 31, 2009 | 3,142,189 | 8.79 | 27,620 | |||||||
Granted | 1,794,200 | 8.76 | 15,726 | |||||||
Canceled | (120,000 | ) | 8.80 | (1,037 | ) | |||||
Exercised | (695,539 | ) | 8.64 | (6,122 | ) | |||||
Outstanding at December 31, 2010 | 4,120,850 | 8.78 | $ | 36,187 | ||||||
The following table summarizes information about stock options outstanding at December 31, 2010:
Stock Options Outstanding | Stock Options Vested | |||||||||||||||||||
Range of Exercise Prices | Number of Awards | Remaining Life (yrs) | Weighted-Average Exercise Price Per Share | Number of Awards | Remaining Life (yrs) | Weighted-Average Exercise Price Per Share | ||||||||||||||
$5.07 - $5.07 | 12,500 | 5.44 | $ | 5.07 | — | — | $ | — | ||||||||||||
$5.85 - $9.16 | 2,422,850 | 5.48 | 7.72 | 2,077,850 | 5.02 | 7.87 | ||||||||||||||
$9.49 - $11.46 | 1,662,500 | 6.35 | 10.30 | 499,000 | 3.53 | 10.76 | ||||||||||||||
$11.88 - $14.34 | 23,000 | 5.39 | 12.54 | 23,000 | 5.39 | 12.54 | ||||||||||||||
$5.07 - $14.34 | 4,120,850 | 5.83 | 8.78 | 2,599,850 | 4.74 | 8.47 | ||||||||||||||
The aggregate intrinsic value for stock options outstanding and vested awards was $15.5 million and $6.5 million, respectively, at December 31, 2010. For the years ended December 31, 2010 and 2008, the total intrinsic value of options exercised by officers, directors and employees was $0.6 million and $0.1 million, respectively. There were no option exercises during the year ended December 31, 2009. Intrinsic value for stock options is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock as of the reporting date. Cash received from stock options exercised for the years ended December 31, 2010 and 2008 was $6.1 million and $0.2 million, respectively. The tax benefit realized for the tax deduction from the exercise of stock options by officers, directors, employees and agents for the years ended December 31, 2010 and 2008 was $0.3 million and $0.1 million, respectively.
We established the American Equity Investment Employee Stock Ownership Plan ("ESOP") effective July 1, 2007. The principal purpose of the ESOP is to provide each eligible employee with an equity interest in us. Employees become eligible once they have completed a minimum of six months of service. Employees become 100% vested after two years of service. Our contribution to the ESOP is determined by the Board of Directors.
In August 2007, we issued a loan to the ESOP in the amount of $7.0 million to purchase 650,000 shares of our common stock from David J. Noble, our Executive Chairman. The loan is to be repaid over a period of 20 years with annual interest payments due on December 31 of each year. Principal payments in the amount of $1.8 million are due on December 31, 2012, 2017, and 2022 with the final principal payment due on August 31, 2027. The loan is eliminated in the consolidated financial statements. The shares purchased by the ESOP were pledged as collateral for this debt and are reported as unallocated common stock held by the ESOP, a contra-equity account in stockholders' equity. When shares are committed for release, the shares become outstanding for earnings per share computations. For each plan year in which a payment or prepayment of principal or interest is made, we will release from the pledge the number of shares determined under the principal and interest method.
F-43
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dividends on allocated ESOP shares are recorded as a reduction in retained earnings and are credited to employee accounts. Dividends on unallocated shares held by the ESOP will be used to repay indebtedness. As of December 31, 2010, 2009 and 2008, there were 50,479 shares, 35,993 shares and 22,179 shares committed for release and compensation expense of $0.8 million, $0.4 million and $0.3 million was recognized in 2010, 2009 and 2008, respectively. The fair value of 447,048 unreleased shares, 527,272 unreleased shares and 588,312 shares was $5.6 million,$3.9 million and $4.1 million at December 31, 2010, 2009 and 2008, respectively.
12. Life Insurance Subsidiaries
Prior approval of regulatory authorities is required for the payment of dividends to us by our life insurance subsidiaries which exceed an annual limitation. During 2011, American Equity Life can pay dividends to us of $187.5 million, without prior approval from regulatory authorities.
Statutory accounting practices prescribed or permitted by regulatory authorities for our life insurance subsidiaries differ from GAAP. Combined net income (loss) for our life insurance subsidiaries as determined in accordance with statutory accounting practices was $172.9 million (unaudited), $116.9 million and $(7.1) million in 2010, 2009 and 2008, respectively, and total statutory capital and surplus of our life insurance subsidiaries was $1,400.7 million and $1,193.1 million at December 31, 2010 and 2009, respectively. Calculations using the NAIC formula at December 31, 2010, indicated that American Equity Life's ratio of total adjusted capital to the highest level of required capital at which regulatory action might be initiated was 339%.
13. Commitments and Contingencies
We lease our home office space and certain equipment under various operating leases. Rent expense for the years ended December 31, 2010, 2009 and 2008 totaled $1.9 million, $1.7 million and $1.4 million, respectively. At December 31, 2010, the aggregate future minimum lease payments are $11.9 million. The following represents payments due by period for operating lease obligations as of December 31, 2010 (dollars in thousands):
Year Ending December 31: | |||
2011 | $ | 1,274 | |
2012 | 1,210 | ||
2013 | 1,075 | ||
2014 | 1,053 | ||
2015 | 1,040 | ||
2016 and thereafter | 6,290 | ||
Assessments are, from time to time, levied on us by life and health guaranty associations in most states in which we are licensed to cover losses to policyholders of insolvent or rehabilitated companies. The liability established by us for future assessments related to the insolvency of London Pacific Life and Annuity Company and Lincoln Memorial Life Insurance Company was $0.6 million as of December 31, 2010 and 2009. We believe the liability for guaranty fund assessments is sufficient to provide for future assessments based upon known insolvencies.
We are occasionally involved in litigation, both as a defendant and as a plaintiff. In addition, state regulatory bodies, such as state insurance departments, the SEC, FINRA, the Department of Labor, and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, the Employee Retirement Income Security Act of 1974, as amended, and laws governing the activities of broker-dealers.
In recent years, companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims. We are currently a defendant in two lawsuits, one class action and one purported class action, involving allegations of improper sales practices and similar claims as described below. In February 2011, we entered into a settlement with the plaintiffs in the class action lawsuit, which is subject to final court approval and is more fully described below. The pending purported class action lawsuit referred to below is in the pre-litigation and discovery stages and we do not have sufficient information to make an assessment of the plaintiffs' claims for liability or damages. The plaintiffs are seeking undefined amounts of damages or other relief, including punitive damages, which are difficult to quantify and cannot be estimated based on the information currently available. While we are uncertain as to the ultimate outcome of the pending purported class action lawsuit, there can be no assurance that such litigation, or any other pending or future litigation, will not have a material adverse effect on our business, financial condition, or results of operations.
We are a defendant in two cases, including (i) Stephens v. American Equity Investment Life Insurance Company, et. al., in the San Luis Obispo Superior Court, San Francisco, California (complaint filed November 29, 2004) (the "SLO Case") and (ii) McCormack, et al. v. American Equity Investment Life Insurance Company, et al., in the United States District Court for the Central District of California, Western Division and Anagnostis v. American Equity, et al., coordinated in the Central District, entitled, In Re: American Equity Annuity Practices and Sales Litigation, in the United States District Court for the Central District of California, Western Division (complaint filed September 7, 2005) (the "Los Angeles Case").
The plaintiffs in the SLO Case represent a class of individuals who are California residents age 65 and older and who either purchased their annuity from us through a co-defendant marketing organization or who purchased one of a defined set of particular annuities issued by us. The
F-44
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
named plaintiffs in this case are: Chalys M. Stephens and John P. Stephens. Following a mediation conducted on January 21, 2011, we reached a settlement in principal with the plaintiffs. Preliminary approval of the settlement was issued by the court on March 1, 2011, and although we anticipate final court approval of the settlement, there can be no assurance of such final approval. The settlement, if final court approval is received, will provide a total settlement benefit of $36 million to past and present policyholders who are members of the class and, if awarded by the court, will provide for attorneys' fees payable to the plaintiff's counsel up to $11 million, litigation expenses in an amount up to $950,000, and incentives of $25,000 payable to each of the two class representatives. These amounts have been recorded as an other liability in the consolidated balance sheet at December 31, 2010. The net charge to operations of the settlement (after related reductions in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes) was $27.3 million and is included in our consolidated statement of operations for the year ended December 31, 2010.
The Los Angeles Case is a consolidated action involving several lawsuits filed by individuals, and the individuals are seeking class action status for a national class of purchasers of annuities issued by us. The named plaintiffs in this consolidated case are Bernard McCormack, Gust Anagnostis by and through Gary S. Anagnostis and Robert C. Anagnostis, Regina Bush by and through Sharon Schipiour, Lenice Mathews by and through Mary Ann Maclean and George Miller. The allegations generally attack the suitability of sales of deferred annuity products to persons over the age of 65. The plaintiffs seek recessionary and injunctive relief including restitution and disgorgement of profits on behalf of all class members under California Business & Professions Code section 17200 et seq. and Racketeer Influenced and Corrupt Organizations Act; compensatory damages for breach of fiduciary duty and aiding and abetting of breach of fiduciary duty; unjust enrichment and constructive trust; and other pecuniary damages under California Civil Code section 1750 and California Welfare & Institutions Codes section 15600 et seq. We are vigorously defending against both class action status as well as the underlying claims.
14. Sale of Our Common Stock
On August 20, 2009, we entered into distribution agreements with Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC (“FPK”) and Sandler O’Neill & Partners, L.P. ("Sandler O'Neill") to offer and sell shares of our common stock up to an aggregate offering price of $50 million. On December 3, 2009, Macquarie Capital (USA) Inc. ("Macquarie Capital") assumed all of FPK's rights and obligations under our distribution agreement with FPK. On August 4, 2010, we provided notice to Macquarie Capital and Sandler O'Neill that we were terminating the distribution agreements. During 2009, we sold 132,300 shares of our common stock pursuant to these distribution agreements, resulting in gross proceeds to us of $1.1 million, and we had no sales in 2010.
15. Earnings Per Share
The following table sets forth the computation of earnings per common share and earnings per common share—assuming dilution:
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
(Dollars in thousands, except per share data) | |||||||||||
Numerator: | |||||||||||
Net income—numerator for earnings per common share | $ | 42,933 | $ | 68,530 | $ | 15,947 | |||||
Interest on convertible subordinated debentures (net of income tax benefit) | 1,035 | 1,037 | 1,042 | ||||||||
Numerator for earnings per common share—assuming dilution | $ | 43,968 | $ | 69,567 | $ | 16,989 | |||||
Denominator: | |||||||||||
Weighted average common shares outstanding(1) | 58,506,804 | 56,137,776 | 53,749,491 | ||||||||
Effect of dilutive securities: | |||||||||||
Convertible subordinated debentures | 2,729,514 | 2,734,528 | 2,753,498 | ||||||||
Convertible senior notes | 2,904,571 | — | — | ||||||||
Stock options and deferred compensation agreements | 438,834 | 43,033 | 119,219 | ||||||||
Denominator for earnings per common share—assuming dilution | 64,579,723 | 58,915,337 | 56,622,208 | ||||||||
Earnings per common share | $ | 0.73 | $ | 1.22 | $ | 0.30 | |||||
Earnings per common share—assuming dilution | $ | 0.68 | $ | 1.18 | $ | 0.30 | |||||
(1) | Weighted average common shares outstanding include shares vested under the NMO Deferred Compensation Plan and exclude unallocated shares held by the ESOP. |
F-45
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Options to purchase shares of our common stock that were outstanding during the respective periods indicated but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares are as follows:
Period | Number of Shares | Range of Exercise Prices | |||
Year ended December 31, 2010 | 4,120,850 | $8.75 - $14.34 | |||
Year ended December 31, 2009 | 2,383,789 | $6.96 - $14.34 | |||
Year ended December 31, 2008 | 1,964,388 | $7.33 - $14.34 | |||
In November 2007, our board of directors approved a share repurchase program authorizing us to repurchase up to 10,000,000 shares of our common stock. Prior to the suspension, we had repurchased 3,845,296 shares of our common stock at a cost of $33.3 million. We suspended the repurchase of our common stock under this program during August of 2008.
F-46
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. Quarterly Financial Information (Unaudited)
Unaudited quarterly results of operations are summarized below.
Quarter ended | ||||||||||||||||
March 31, | June 30, | September 30, | December 31, | |||||||||||||
(Dollars in thousands, except per share data) | ||||||||||||||||
2010 | ||||||||||||||||
Premiums and product charges | $ | 18,805 | $ | 21,260 | $ | 21,719 | $ | 19,273 | ||||||||
Net investment income | 242,910 | 254,845 | 260,475 | 277,876 | ||||||||||||
Change in fair value of derivatives | 82,015 | (208,737 | ) | 93,980 | 201,604 | |||||||||||
Net realized gains on investments, excluding OTTI losses | 9,903 | 1,063 | 11,298 | 1,462 | ||||||||||||
Net OTTI losses recognized in operations | (3,223 | ) | (818 | ) | (3,990 | ) | (15,836 | ) | ||||||||
Gain (loss) on retirement of debt | — | (292 | ) | — | — | |||||||||||
Total revenues | 350,410 | 67,321 | 383,482 | 484,379 | ||||||||||||
Net income (loss) | 14,885 | (1,504 | ) | 20,514 | 9,038 | |||||||||||
Earnings (loss) per common share | 0.26 | (0.03 | ) | 0.35 | 0.15 | |||||||||||
Earnings (loss) per common share—assuming dilution | 0.25 | (0.03 | ) | 0.33 | 0.14 | |||||||||||
2009 | ||||||||||||||||
Premiums and product charges | $ | 18,537 | $ | 19,482 | $ | 19,001 | $ | 18,992 | ||||||||
Net investment income | 220,654 | 226,803 | 241,471 | 243,244 | ||||||||||||
Change in fair value of derivatives | (43,823 | ) | 30,494 | 121,507 | 108,718 | |||||||||||
Net realized gains on investments, excluding OTTI losses | 760 | 4,317 | 5,510 | 40,692 | ||||||||||||
Net OTTI losses recognized in operations | (13,438 | ) | (5,643 | ) | (44,575 | ) | (23,115 | ) | ||||||||
Gain (loss) on retirement of debt | — | 3,098 | — | (3,773 | ) | |||||||||||
Total revenues | 182,690 | 278,551 | 342,914 | 384,758 | ||||||||||||
Net income (loss) | 26,475 | 9,012 | (2,978 | ) | 36,021 | |||||||||||
Earnings (loss) per common share | 0.50 | 0.16 | (0.05 | ) | 0.62 | |||||||||||
Earnings (loss) per common share—assuming dilution | 0.48 | 0.16 | (0.05 | ) | 0.60 | |||||||||||
Earnings per common share for each quarter is computed independently of earnings per common share for the year. As a result, the sum of the quarterly earnings per common share amounts may not equal the earnings per common share for the year.
In the quarter ended December 31, 2010, we adjusted for an overstatement of our single premium immediate annuity reserves that resulted in a cumulative overstatement of net income for the first three quarters of 2010 of $1.2 million.
The differences between the change in fair value of derivatives for each quarter primarily correspond to the performance of the indices upon which our call options are based. The comparability of net income (loss) is impacted by the application of fair value accounting to our fixed index annuity business as follows:
Quarter ended | |||||||||||||||
March 31, | June 30, | September 30, | December 31, | ||||||||||||
(Dollars in thousands) | |||||||||||||||
2010 | $ | (12,883 | ) | $ | (30,536 | ) | $ | (8,996 | ) | $ | (14,301 | ) | |||
2009 | 3,696 | (12,541 | ) | (18,162 | ) | (2,938 | ) | ||||||||
F-47
Schedule I—Summary of Investments—Other
Than Investments in Related Parties
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
December 31, 2010
Column A | Column B | Column C | Column D | |||||||||
Type of Investment | Amortized Cost(1) | Fair Value | Amount at which shown in the balance sheet | |||||||||
(Dollars in thousands) | ||||||||||||
Fixed maturity securities: | ||||||||||||
Available for sale | ||||||||||||
United States Government full faith and credit | $ | 4,082 | $ | 4,388 | $ | 4,388 | ||||||
United States Government sponsored agencies | 2,994,174 | 3,003,651 | 3,003,651 | |||||||||
United States municipalities, states and territories | 2,397,622 | 2,367,003 | 2,367,003 | |||||||||
Corporate securities | 7,325,988 | 7,577,064 | 7,577,064 | |||||||||
Residential mortgage backed securities | 2,900,028 | 2,878,557 | 2,878,557 | |||||||||
15,621,894 | 15,830,663 | 15,830,663 | ||||||||||
Held for investment | ||||||||||||
United States Government sponsored agencies | 746,414 | 731,105 | 746,414 | |||||||||
Redeemable preferred stock | 75,786 | 50,643 | 75,786 | |||||||||
822,200 | 781,748 | 822,200 | ||||||||||
Total fixed maturity securities | 16,444,094 | $ | 16,612,411 | 16,652,863 | ||||||||
Equity securities, available for sale: | ||||||||||||
Non-redeemable preferred stocks | 41,947 | $ | 42,081 | 42,081 | ||||||||
Common stocks | 19,238 | 23,880 | 23,880 | |||||||||
Total equity securities | 61,185 | $ | 65,961 | 65,961 | ||||||||
Mortgage loans on real estate | 2,598,641 | 2,598,641 | ||||||||||
Derivative instruments | 332,216 | 479,786 | ||||||||||
Other investments | 19,680 | 19,680 | ||||||||||
Total investments | $ | 19,455,816 | $ | 19,816,931 | ||||||||
(1) | On the basis of cost adjusted for repayments and amortization of premiums and accrual of discounts for fixed maturity securities and short-term investments, original cost for derivative instruments and unpaid principal balance less allowance for credit losses for mortgage loans. |
See accompanying Report of Independent Registered Public Accounting Firm.
F-48
Schedule II—Condensed Financial Information of Registrant
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Balance Sheets
(Dollars in thousands)
December 31, | |||||||
2010 | 2009 | ||||||
Assets | |||||||
Cash and cash equivalents | $ | 62,324 | $ | 54,212 | |||
Equity securities of subsidiary trusts | 8,191 | 8,187 | |||||
Receivable from subsidiaries | 1,192 | 401 | |||||
Federal income tax recoverable (from subsidiaries) | 9,010 | 6,714 | |||||
Other assets | 86,738 | 12,620 | |||||
167,455 | 82,134 | ||||||
Investment in and advances to subsidiaries | 1,449,375 | 1,271,383 | |||||
Total assets | $ | 1,616,830 | $ | 1,353,517 | |||
Liabilities and Stockholders' Equity | |||||||
Liabilities: | |||||||
Notes payable | $ | 330,835 | $ | 316,468 | |||
Subordinated debentures payable to subsidiary trusts | 268,495 | 268,407 | |||||
Deferred income tax liability | 4,815 | 9,968 | |||||
Other liabilities | 74,638 | 4,051 | |||||
Total liabilities | 678,783 | 598,894 | |||||
Stockholders' equity: | |||||||
Common stock | 56,968 | 56,203 | |||||
Additional paid-in capital | 454,454 | 422,225 | |||||
Unallocated common stock held by ESOP | (4,815 | ) | (5,679 | ) | |||
Accumulated other comprehensive income (loss) | 81,820 | (30,456 | ) | ||||
Retained earnings | 349,620 | 312,330 | |||||
Total stockholders' equity | 938,047 | 754,623 | |||||
Total liabilities and stockholders' equity | $ | 1,616,830 | $ | 1,353,517 | |||
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-49
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Operations
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Revenues: | |||||||||||
Net investment income | $ | 295 | $ | 31 | $ | 852 | |||||
Dividends from subsidiary trusts | 455 | 482 | 592 | ||||||||
Dividends from subsidiary | — | 10,000 | — | ||||||||
Investment advisory fees | 23,713 | 21,339 | 19,299 | ||||||||
Surplus note interest from subsidiary | 4,080 | 4,080 | 4,080 | ||||||||
Realized gain (loss) on investments | 13 | — | (10 | ) | |||||||
Change in fair value of derivatives | 27,059 | (2,379 | ) | (1,195 | ) | ||||||
Gain (loss) on extinguishment of debt | (292 | ) | (675 | ) | 9,746 | ||||||
Total revenues | 55,323 | 32,878 | 33,364 | ||||||||
Expenses: | |||||||||||
Change in fair value of embedded derivatives | 29,595 | — | — | ||||||||
Interest expense on notes payable | 22,125 | 14,561 | 19,013 | ||||||||
Interest expense on subordinated debentures issued to subsidiary trusts | 14,906 | 15,819 | 19,445 | ||||||||
Other operating costs and expenses | 6,013 | 8,870 | 8,519 | ||||||||
Total expenses | 72,639 | 39,250 | 46,977 | ||||||||
Loss before income taxes and equity in undistributed income of subsidiaries | (17,316 | ) | (6,372 | ) | (13,613 | ) | |||||
Income tax benefit | (7,417 | ) | (6,596 | ) | (5,594 | ) | |||||
Loss before equity in undistributed income of subsidiaries | (9,899 | ) | 224 | (8,019 | ) | ||||||
Equity in undistributed income of subsidiaries | 52,832 | 68,306 | 23,966 | ||||||||
Net income | $ | 42,933 | $ | 68,530 | $ | 15,947 | |||||
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-50
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Operating activities | |||||||||||
Net income | $ | 42,933 | $ | 68,530 | $ | 15,947 | |||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||||||
Change in fair value of 2015 notes embedded conversion derivative | 29,595 | — | — | ||||||||
Provision for depreciation and amortization | 1,270 | 838 | 4,673 | ||||||||
Accrual of discount on equity security | (4 | ) | (4 | ) | (4 | ) | |||||
Equity in undistributed income of subsidiaries | (52,832 | ) | (78,306 | ) | (23,966 | ) | |||||
Equity distributions received from subsidiaries | — | 10,000 | — | ||||||||
Amortization of premium on fixed maturity security | 185 | — | — | ||||||||
Accrual of discount on contingent convertible notes | 7,761 | 3,791 | 979 | ||||||||
Change in fair value of 2015 notes hedges | (29,595 | ) | — | — | |||||||
Realized (gain) loss on investments | (13 | ) | — | 10 | |||||||
Loss (gain) on extinguishment of debt | 292 | 675 | (9,746 | ) | |||||||
Accrual of discount on debenture issued to subsidiary trust | 148 | 138 | 129 | ||||||||
Share-based compensation | 1,087 | 320 | 277 | ||||||||
ESOP compensation | 82 | 37 | 27 | ||||||||
Deferred income tax expense (benefit) | (5,153 | ) | (3,181 | ) | (605 | ) | |||||
Changes in operating assets and liabilities: | |||||||||||
Receivable from subsidiaries | (10 | ) | 515 | 532 | |||||||
Federal income tax recoverable | (2,296 | ) | 4,575 | 3,371 | |||||||
Other assets | (1,925 | ) | (1,308 | ) | 884 | ||||||
Other liabilities | 3,708 | (1,292 | ) | 196 | |||||||
Net cash provided by (used in) operating activities | (4,767 | ) | 5,328 | (7,296 | ) | ||||||
Investing activities | |||||||||||
Capital contributions to subsidiaries | (2,400 | ) | (75,500 | ) | (110 | ) | |||||
Purchase of fixed maturity security | (50,260 | ) | — | — | |||||||
Sales, maturities or repayments of fixed maturity securities—available for sale | 50,088 | — | 34,990 | ||||||||
Purchases of property, plant and equipment | (33 | ) | — | — | |||||||
Net cash provided by (used in) investing activities | (2,605 | ) | (75,500 | ) | 34,880 | ||||||
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-51
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Condensed Statements of Cash Flows (Continued)
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2010 | 2009 | 2008 | |||||||||
Financing activities | |||||||||||
Financing fees incurred and deferred | $ | (6,800 | ) | $ | (2,751 | ) | $ | — | |||
Proceeds from notes payable | 200,000 | 127,225 | 70,000 | ||||||||
Repayments of notes payable | (156,641 | ) | — | (61,377 | ) | ||||||
Purchase of 2015 notes hedge | (37,000 | ) | — | — | |||||||
Acquisition of common stock | — | — | (30,803 | ) | |||||||
Excess tax benefits realized from share-based compensation plans | 31 | — | 53 | ||||||||
Equity issue costs incurred | — | (1,364 | ) | — | |||||||
Proceeds from issuance of common stock | 6,123 | 1,061 | 219 | ||||||||
Proceeds from issuance of warrants | 15,600 | — | — | ||||||||
Other | — | (24 | ) | — | |||||||
Dividends paid | (5,829 | ) | (4,618 | ) | (3,675 | ) | |||||
Net cash provided by (used in) financing activities | 15,484 | 119,529 | (25,583 | ) | |||||||
Increase (decrease) in cash and cash equivalents | 8,112 | 49,357 | 2,001 | ||||||||
Cash and cash equivalents at beginning of year | 54,212 | 4,855 | 2,854 | ||||||||
Cash and cash equivalents at end of year | $ | 62,324 | $ | 54,212 | $ | 4,855 | |||||
Supplemental disclosures of cash flow information | |||||||||||
Cash paid during the year for interest: | |||||||||||
Notes payable | $ | 10,918 | $ | 6,474 | $ | 13,182 | |||||
Subordinated debentures | 14,717 | 12,588 | 19,487 | ||||||||
Non-cash financing activity: | |||||||||||
Conversion of subordinated debentures | 60 | — | 213 | ||||||||
Stock issued in retirement of debt | — | 31,250 | — | ||||||||
Retirement of debt through debt exchange | — | 63,614 | — | ||||||||
See accompanying note to condensed financial statements.
See accompanying Report of Independent Registered Public Accounting Firm.
F-52
Schedule II—Condensed Financial Information of Registrant (Continued)
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY (PARENT COMPANY)
Note to Condensed Financial Statements
December 31, 2010
1. Basis of Presentation
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of American Equity Investment Life Holding Company (Parent Company).
In the Parent Company financial statements, its investment in and advances to subsidiaries are stated at cost plus equity in undistributed income (losses) of subsidiaries since the date of acquisition and net unrealized gains/losses on the subsidiaries' fixed maturity securities classified as "available for sale" and equity securities.
See notes 9 and 10 to the consolidated financial statements for a description of the Parent Company's notes payable and subordinated debentures payable to subsidiary trusts.
F-53
Schedule III—Supplementary Insurance Information
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Column A | Column B | Column C | Column D | Column E | ||||||||||||
Deferred policy acquisition costs | Future policy benefits, losses, claims and loss expenses | Unearned premiums | Other policy claims and benefits payable | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
As of December 31, 2010: Life insurance | $ | 1,747,760 | $ | 23,655,807 | $ | — | $ | 222,860 | ||||||||
As of December 31, 2009: Life insurance | $ | 1,625,785 | $ | 19,336,221 | $ | — | $ | 119,403 | ||||||||
As of December 31, 2008: Life insurance | $ | 1,579,871 | $ | 15,809,539 | $ | — | $ | 111,205 | ||||||||
Column A | Column F | Column G | Column H | Column I | Column J | |||||||||||||||
Premium revenue | Net investment income | Benefits, claims, losses and settlement expenses | Amortization of deferred policy acquisition costs | Other operating expenses | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
As of December 31, 2010: Life insurance | $ | 81,057 | $ | 1,036,106 | $ | 932,292 | $ | 136,388 | $ | 151,646 | ||||||||||
As of December 31, 2009: Life insurance | $ | 76,012 | $ | 932,172 | $ | 926,279 | $ | 88,009 | $ | 88,461 | ||||||||||
As of December 31, 2008: Life insurance | $ | 65,183 | $ | 822,077 | $ | 34,055 | $ | 126,738 | $ | 95,710 | ||||||||||
See accompanying Report of Independent Registered Public Accounting Firm.
F-54
Schedule IV—Reinsurance
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Column A | Column B | Column C | Column D | Column E | Column F | ||||||||||||||
Gross amount | Ceded to other companies | Assumed from other companies | Net amount | Percent of amount assumed to net | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Year ended December 31, 2010: | |||||||||||||||||||
Life insurance in force, at end of year | $ | 2,505,280 | $ | 3,147 | $ | 69,734 | $ | 2,571,867 | 2.71 | % | |||||||||
Insurance premiums and other considerations: | |||||||||||||||||||
Annuity product charges | $ | 76,012 | $ | 6,937 | $ | — | $ | 69,075 | — | ||||||||||
Traditional life and accident and health insurance premiums | 11,811 | 711 | 882 | 11,982 | 7.36 | % | |||||||||||||
$ | 87,823 | $ | 7,648 | $ | 882 | $ | 81,057 | 1.09 | % | ||||||||||
Year ended December 31, 2009: | |||||||||||||||||||
Life insurance in force, at end of year | $ | 2,508,623 | $ | 2,945 | $ | 72,874 | $ | 2,578,552 | 2.83 | % | |||||||||
Insurance premiums and other considerations: | |||||||||||||||||||
Annuity product charges | $ | 70,554 | $ | 7,196 | $ | — | $ | 63,358 | — | ||||||||||
Traditional life and accident and health insurance premiums | 12,014 | 243 | 883 | 12,654 | 6.98 | % | |||||||||||||
$ | 82,568 | $ | 7,439 | $ | 883 | $ | 76,012 | 1.16 | % | ||||||||||
Year ended December 31, 2008: | |||||||||||||||||||
Life insurance in force, at end of year | $ | 2,518,884 | $ | 2,275 | $ | 80,371 | $ | 2,596,980 | 3.09 | % | |||||||||
Insurance premiums and other considerations: | |||||||||||||||||||
Annuity product charges | $ | 61,211 | $ | 8,540 | $ | — | $ | 52,671 | — | ||||||||||
Traditional life and accident and health insurance premiums | 11,800 | 158 | 870 | 12,512 | 6.95 | % | |||||||||||||
$ | 73,011 | $ | 8,698 | $ | 870 | $ | 65,183 | 1.32 | % | ||||||||||
See accompanying Report of Independent Registered Public Accounting Firm.
F-55
Schedule V—Valuation and Qualifying Accounts
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Balance January 1, | Charged to Costs and Expenses | Translation Adjustment | Write-offs/Payments/Other | Balance December 31, | |||||||||||||||
(Dollars in thousands | |||||||||||||||||||
Year Ended December 31, 2010 | |||||||||||||||||||
Valuation allowance on mortgage loans | $ | (5,266 | ) | $ | (15,225 | ) | $ | — | $ | 4,267 | $ | (16,224 | ) | ||||||
Year Ended December 31, 2009 | |||||||||||||||||||
Valuation allowance on mortgage loans | $ | — | $ | (6,484 | ) | $ | — | $ | 1,218 | $ | (5,266 | ) | |||||||
Year Ended December 31, 2008 | |||||||||||||||||||
Valuation allowance on mortgage loans | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||
See accompanying Report of Independent Registered Public Accounting Firm.
Item 15. Exhibits and Financial Statement Schedules.
(a) Exhibits:
F-56
Exhibit No. | Description | |
3.1 | Articles of Incorporation, including Articles of Amendment**++ | |
3.2 | Articles of Amendment to Articles of Incorporation# | |
3.3 | Articles of Amendment to Articles of Incorporation### | |
3.4 | Third Amended and Restated Bylaws#### | |
4.4 | Amended and Restated Declaration of Trust of American Equity Capital Trust I dated September 7, 1999+ | |
4.5 | Indenture dated September 7, 1999 between American Equity Investment Life Holding Company and Wilmington Trust Company (as successor in interest to West Des Moines State Bank), as trustee# | |
4.6 | Trust Preferred Securities Guarantee Agreement dated September 7, 1999 between American Equity Investment Life Holding Company and Wilmington Trust Company (as successor in interest to West Des Moines State Bank), as trustee# | |
4.7 | Trust Common Securities Guarantee Agreement dated September 7, 1999 between American Equity Investment Life Holding Company and West Des Moines State Bank, as trustee# | |
4.7-A | Instruments of Resignation, Appointment and Acceptance, effective September 12, 2006, among American Equity Investment Life Holding Company, Wilmington Trust Company, West Des Moines State Bank and Delaware Trust Company, National Association (formerly known as First Union Trust Company, National Association)######### | |
4.8 | Indenture dated October 29, 1999 between American Equity Investment Life Holding Company and Wilmington Trust Company (as successor in interest to West Des Moines State Bank), as trustee# | |
4.9 | Trust Preferred Securities Guarantee Agreement dated October 29, 1999 between American Equity Investment Life Holding Company and Wilmington Trust Company (as successor in interest to West Des Moines State Bank), as trustee# | |
4.10 | Trust Common Securities Guarantee Agreement dated October 29, 1999 between American Equity Investment Life Holding Company and West Des Moines State Bank, as trustee# | |
4.10-A | Instruments of Resignation, Appointment and Acceptance, effective September 12, 2006, among American Equity Investment Life Holding Company, Wilmington Trust Company, West Des Moines State Bank and Delaware Trust Company, National Association (formerly known as First Union Trust Company, National Association)######### | |
4.11 | Indenture dated December 16, 2003, between American Equity Investment Life Holding Company and Wilmington Trust Company, as trustee++++++++ | |
4.12 | Guarantee Agreement dated December 16, 2003, between American Equity Investment Life Holding Company and Wilmington Trust Company, as trustee++++++++ | |
4.13 | Indenture dated April 29, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++ | |
4.14 | Guarantee Agreement dated April 29, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++ | |
4.15 | Indenture dated September 14, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++ | |
4.16 | Guarantee Agreement dated September 14, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++ | |
4.17 | Indenture dated December 22, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee## | |
4.18 | Guarantee Agreement dated December 22, 2004, between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee## | |
4.19 | Indenture dated December 6, 2004 between American Equity Investment Life Holding Company and US Bank National Association, as trustee## | |
4.20 | Registration Rights Agreement dated December 6, 2004 by and among American Equity Investment Life Holding Company, Deutsche Bank Securities Inc., Raymond James & Associates, Inc., and Advest, Inc.## | |
4.21 | First Supplemental Indenture dated December 30, 2004 between American Equity Investment Life Holding Company and US Bank National Association, as trustee## | |
4.22 | Registration Rights Agreement dated December 30, 2004 between American Equity Investment Life Holding Company and Deutsche Bank Securities Inc.## | |
4.23 | Indenture dated June 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee+++++++++++ | |
4.24 | Guarantee Agreement dated June 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee+++++++++++ | |
4.25 | Indenture dated August 4, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++++ | |
4.26 | Guarantee Agreement dated August 4, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee++++++++++++ | |
4.27 | Indenture dated December 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee*** | |
4.28 | Guarantee Agreement dated December 15, 2005 between American Equity Investment Life Holding Company and JP Morgan Chase Bank, National Association, as trustee*** |
Exhibit No. | Description | |
4.29 | Amended and Restated Indenture dated July 7, 2006 between American Equity Investment Life Holding Company and Wells Fargo Bank, National Association, as trustee***** |
F-57
4.30 | Amended and Restated Guarantee Agreement dated July 7, 2006 between American Equity Investment Life Holding Company and Wells Fargo Delaware Trust Company, as trustee***** | |
4.31 | Indenture dated December 22, 2009 between American Equity Investment Life Holding Company and U.S. Bank National Association, as trustee####### | |
4.32 | Indenture dated September 22, 2010 between American Equity Investment Life Holding Company and U.S. Bank National Association, as trustee########## | |
10.1-B | Second Restated and Amended General Agency Commission and Servicing Agreement dated October 1, 2002 between American Equity Investment Life Insurance Company and American Equity Investment Service Company++++++ | |
10.1-D | First Amendment to Second Restated and Amended General Agency Commission and Servicing Agreement effective December 29, 2004 between American Equity Investment Life Insurance Company and American Equity Investment Service Company## | |
10.2 | 1996 Stock Option Plan, as amended##### | |
10.3 | Deferred Compensation Agreements between American Equity Investment Life Holding Company and | |
(a) James M. Gerlach dated June 6, 1996* | ||
(b) Terry A. Reimer dated November 11, 1996* | ||
(c) David S. Mulcahy dated December 31, 1997* | ||
10.4 | 2000 Employee Stock Option Plan++ | |
10.5 | 2000 Director Stock Option Plan++ | |
10.6 | Retirement Benefit Agreement, dated as of June 4, 2009, between American Equity Investment Life Holding Company and David J. Noble###### | |
10.7 | American Equity Investment Life Holding Company 2009 Employee Incentive Plan###### | |
10.8 | Coinsurance Agreement dated December 19, 2001, including First Amendment dated February 26, 2002 between American Equity Investment Life Insurance Company and EquiTrust Life Insurance Company+++++ | |
10.9 | Coinsurance Agreement dated December 29, 2003 between American Equity Investment Life Insurance Company and EquiTrust Life Insurance Company++++++++ | |
10.10 | First Amendment to Coinsurance Agreement dated July 30, 2004 between American Equity Investment Life Insurance Company and EquiTrust Life Insurance Company+++++++++ | |
10.11 | Form of Change in Control Agreement between American Equity Investment Life Holding Company and each of John M. Matovina, Debra J. Richardson and Wendy L. Carlson# | |
10.12 | Form of Change in Control Agreement between American Equity Investment Life Holding Company and each James M. Gerlach and Terry A. Reimer# | |
10.13 | Stock Sale/Purchase Agreement dated September 2, 2005 between American Equity Investment Life Holding Company and D.J. Noble++++++++++++ | |
10.14 | 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America**** | |
10.15 | Amendment I, effective January 1, 2006, to 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America**** | |
10.16 | Amendment II, effective January 1, 2006, to 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America**** | |
10.17 | Credit Agreement dated November 20, 2006 among American Equity Investment Life Holding Company, KeyBank National Association and LaSalle Bank National Association****** | |
10.18 | American Equity Investment Life Holding Company Independent Insurance Agent Stock Option Plan******* | |
10.19 | Coinsurance and Yearly Renewable Term Reinsurance Agreement dated December 31, 2008 between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America######### | |
10.20 | Amendment III, effective April 1, 2009, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America******** | |
10.21 | Coinsurance Agreement effective July 1, 2009, between American Equity Investment Life Insurance Company and Athene Life Re Ltd (Treaty #070109)********* | |
10.22 | Coinsurance Agreement effective July 1, 2009, between American Equity Investment Life Insurance Company and Athene Life Re Ltd (Treaty #08042009)********* | |
10.23 | Separation and Release Agreement between Kevin R. Wingert and American Equity Investment Life Insurance Company, dated December 29, 2008##### | |
10.24 | Distribution Agreement, dated August 20, 200, between American Equity Investment Life Holding Company and Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC######## | |
10.25 | Distribution Agreement, dated August 20, 2009, between American Equity Investment Life Holding Company and Sandler O'Neill & Partners, L.P.######## | |
10.26 | Purchase Agreement, dated December 17, 2009, between American Equity Investment Life Holding Company and FBR Capital Markets & Co.####### | |
10.27 | Amendment IV, effective October 1, 2009, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America | |
10.28 | Amended Retirement Benefit Agreement, dated as of March 29, 2010, between American Equity Investment Life Holding Company and David J. Noble########### |
F-58
Exhibit No. | Description | |
10.29 | First Amendment to Credit Agreement dated September 15, 2010 among American Equity Investment Life Holding Company, KeyBank National Association and LaSalle Bank National Association############ | |
10.30 | American Equity Investment Life Holding Company Short-Term Performance Incentive Plan********** | |
10.33 | 2010 Independent Insurance Agent Stock Option Plan*********** | |
10.34 | Credit Agreement dated January 28, 2011 among American Equity Investment Life Holding Company, JPMorgan Chase Bank, National Association, Suntrust Bank and Deutsche Bank Securities, Inc. | |
10.35 | Amendment V, effective November 18, 2010, to the 2005 Coinsurance and Yearly Renewable Term Reinsurance Agreement effective October 1, 2005, between American Equity Investment Life Insurance Company and Hannover Life Reassurance Company of America | |
12.1 | Ratio of Earnings to Fixed Charges | |
21.2 | Subsidiaries of American Equity Investment Life Holding Company | |
23.1 | Consent of Independent Registered Public Accounting Firm | |
31.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | Incorporated by reference to the Registration Statement on Form 10 filed May 6, 1999, File No. 000-25985 | |
** | Incorporated by reference to the Registration Statement on Form 10 and Post-Effective Amendment No. 1 to the Registration Statement on Form 10 filed July 22, 1999, File No. 000-25985 | |
+ | Incorporated by reference to Form 10-K for the period ended December 31, 1999, File No. 000-25985 | |
++ | Incorporated by reference to Form 10-Q for the period ended June 30, 2000, File No. 000-25985 | |
+++++ | Incorporated by reference to Form 10-K for the period ended December 31, 2001, File No. 000-25985 | |
++++++ | Incorporated by reference to Form 10-K for the period ended December 31, 2002, File No. 000-25985 | |
++++++++ | Incorporated by reference to Form 10-K for the period ended December 31, 2003, File No. 001-31911 | |
+++++++++ | Incorporated by reference to Form 10-Q for the period ended June 30, 2004, File No. 001-31911 | |
++++++++++ | Incorporated by reference to Form 10-Q for the period ended September 30, 2004, File No. 001-31911 | |
+++++++++++ | Incorporated by reference to Form 10-Q for the period ended June 30, 2005, File No. 001-31911 | |
++++++++++++ | Incorporated by reference to Form 10-Q for the period ended September 30, 2005, File No. 001-31911 | |
*** | Incorporated by reference to Form 10-K for the period ended December 31, 2005, File No. 001-31911 | |
**** | Incorporated by reference to Form 10-Q for the period ended March 31, 2006, File No. 001-31911 | |
***** | Incorporated by reference to Form 10-Q for the period ended September 30, 2006, File No. 001-31911 | |
****** | Incorporated by reference to Form 10-K for the period ended December 31, 2006, File No. 001-31911 | |
******* | Incorporated by reference to Form 10-Q for the period ended September 30, 2007, File No. 001-31911 | |
******** | Incorporated by reference to Form 10-Q for the period ended June 30, 2009, File No. 001-31911 | |
********* | Incorporated by reference to Form 10-Q for the period ended September 30, 2009, File No. 001-31911 | |
********** | Incorporated by reference to Form 10-Q for the period ended September 30, 2010, File No. 001-31911 | |
*********** | Incorporated by reference to the Registration Statement on Form S-3, File No. 333-171161 | |
# | Incorporated by reference to the Registration Statement on Form S-1, File No. 333-108794, including all pre-effective amendments thereto | |
## | Incorporated by reference to Form 10-K for the period ended December 31, 2004, File No. 001-31911 | |
### | Incorporated by reference to the Registration Statement on Form S-3 filed January 15, 2008, File No. 333-148681 | |
#### | Incorporated by reference to Form 8-K filed September 2, 2008, File No. 001-31911 | |
##### | Incorporated by reference to Form 8-K/A filed January 2, 2009, File No. 001-31911 | |
###### | Incorporated by reference to Form 8-K filed June 9, 2009, File No. 001-31911 | |
####### | Incorporated by reference to Form 8-K filed December 23, 2009, File No. 001-31911 | |
######## | Incorporated by reference to Form 8-K filed August 26, 2009, File No. 001-31911 | |
######### | Incorporated by reference to Form 10-K for the period ended December 31, 2008, File No. 001-31911 | |
########## | Incorporated by reference to Form 8-K filed September 28, 2010, File No. 001-31911 | |
########### | Incorporated by reference to Form 8-K filed April 2, 2010, File No. 001-31911 | |
############ | Incorporated by reference to Form 8-K filed September 20, 2010, File No. 001-31911 |
F-59
Exhibit 10.34
Execution Copy
CREDIT AGREEMENT
dated as of
January 28, 2011
among
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY,
The Lenders Party Hereto,
JPMORGAN CHASE BANK, NATIONAL ASSOCIATION,
as Administrative Agent,
SUNTRUST BANK,
as Syndication Agent,
and
DEUTSCHE BANK SECURITIES INC.,
as Documentation Agent
J.P. MORGAN SECURITIES LLC,
as Joint Bookrunner and Joint Lead Arranger
SUNTRUST ROBINSON HUMPHREY, INC.,
as Joint Bookrunner and Joint Lead Arranger
CHI:2457818.12
TABLE OF CONTENTS
Page
ARTICLE I Definitions 1
SECTION 1.01. Defined Terms 1
SECTION 1.02. Classification of Loans and Borrowings 23
SECTION 1.03. Terms Generally 23
SECTION 1.04. Accounting Terms. 24
ARTICLE II The Credits 25
SECTION 2.01. Commitments 25
SECTION 2.02. Loans and Borrowings 25
SECTION 2.03. Requests for Revolving Borrowings 25
SECTION 2.04. Funding of Borrowings 26
SECTION 2.05. Interest Elections 27
SECTION 2.06. Termination and Reduction of Commitments 28
SECTION 2.07. Repayment of Loans; Evidence of Debt 29
SECTION 2.08. Prepayment of Loans 30
SECTION 2.09. Fees 30
SECTION 2.10. Interest 31
SECTION 2.11. Alternate Rate of Interest 32
SECTION 2.12. Increased Costs 32
SECTION 2.13. Break Funding Payments 33
SECTION 2.14. Taxes 34
SECTION 2.15. Payments Generally; Pro Rata Treatment; Sharing of Set-offs 37
SECTION 2.16. Mitigation Obligations; Replacement of Lenders 38
SECTION 2.17. Defaulting Lenders. 39
ARTICLE III Representations and Warranties 40
SECTION 3.01. Organization; Powers 40
SECTION 3.02. Authorization; Enforceability 40
SECTION 3.03. Governmental Approvals; No Conflicts 40
SECTION 3.04. Financial Statements; No Material Adverse Change 40
SECTION 3.05. Insurance Licenses 41
SECTION 3.06. Properties 41
SECTION 3.07. Borrower's Subsidiaries; Investments. 41
SECTION 3.08. Litigation 42
SECTION 3.09. Compliance with Laws and Agreements; Foreign Asset Control Regulations. 42
SECTION 3.10. Investment Company Status 42
SECTION 3.11. Taxes 43
SECTION 3.12. Material Agreements and Liens. 43
SECTION 3.13. Environmental Matters 43
SECTION 3.14. Capitalization 43
SECTION 3.15. No Reliance 44
SECTION 3.16. ERISA 44
i
SECTION 3.17. Regulation U 44
SECTION 3.18. Disclosure 44
SECTION 3.19. Solvency 44
SECTION 3.20. Anti-Terrorism Requirements. 45
ARTICLE IV Conditions 46
SECTION 4.01. Effective Date 46
SECTION 4.02. Each Credit Event 47
ARTICLE V Affirmative Covenants 47
SECTION 5.01. Financial Statements; and Other Information 47
SECTION 5.02. Notices of Material Events 49
SECTION 5.03. Insurance Subsidiary Reporting 50
SECTION 5.04. Existence; Conduct of Business 51
SECTION 5.05. Payment of Obligations 51
SECTION 5.06. Maintenance of Properties 51
SECTION 5.07. Insurance 51
SECTION 5.08. Proper Records; Rights to Inspect and Appraise 52
SECTION 5.09. Compliance with Laws. 52
SECTION 5.10. Use of Proceeds 52
SECTION 5.11. Licenses 52
ARTICLE VI Negative Covenants 53
SECTION 6.01. Debt; Certain Equity Securities. 53
SECTION 6.02. Liens 54
SECTION 6.03. Fundamental Changes 55
SECTION 6.04. Investments 56
SECTION 6.05. Asset Sales 56
SECTION 6.06. Ceded Reinsurance 57
SECTION 6.07. Sale-Leaseback Transactions 58
SECTION 6.08. Restricted Payments 58
SECTION 6.09. Transactions with Affiliates 58
SECTION 6.10. Restrictive Agreements 59
SECTION 6.11. Maximum Ratio of Debt to Capital 59
SECTION 6.12. Minimum Risk-Based Capital Ratio 59
SECTION 6.13. Minimum Coverage Ratio 59
SECTION 6.14. Minimum Statutory Surplus 59
SECTION 6.15. Amendment of Material Documents; Prepayments. 59
SECTION 6.16. Lines of Business 61
SECTION 6.17. Fiscal Year 61
ARTICLE VII Events of Default 61
ARTICLE VIII The Administrative Agent 64
ARTICLE IX Miscellaneous 66
SECTION 9.01. Notices 66
ii
SECTION 9.02. Waivers; Amendments 67
SECTION 9.03. Expenses; Indemnity; Damage Waiver 68
SECTION 9.04. Successors and Assigns 69
SECTION 9.05. Survival 72
SECTION 9.06. Counterparts; Integration; Effectiveness 72
SECTION 9.07. Severability 73
SECTION 9.08. Right of Setoff 73
SECTION 9.09. Governing Law; Jurisdiction; Consent to Service of Process 73
SECTION 9.10. WAIVER OF JURY TRIAL 74
SECTION 9.11. Headings 74
SECTION 9.12. Confidentiality 74
SECTION 9.13. Interest Rate Limitation 75
SECTION 9.14. USA PATRIOT Act 76
SCHEDULES:
Schedule 2.01 -- Commitments
Schedule 3.07 -- Borrower's Subsidiaries; Investments
Schedule 3.12 -- Material Agreements and Liens
Schedule 3.14 -- Capitalization
Schedule 6.01 -- Existing Debt
Schedule 6.02 -- Existing Liens
Schedule 6.06 - Ceded Reinsurance
Schedule 6.10 -- Restrictive Agreements
EXHIBITS:
Exhibit A -- Form of Assignment and Assumption
Exhibit B -- Form of Borrowing Notice
Exhibit C -- Form of Promissory Note
Exhibit D -- Form of U.S. Tax Certificate
Exhibit E -- Form of Compliance Certificate
iii
CREDIT AGREEMENT dated as of January 28, 2011, among AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY, the LENDERS party hereto, JPMORGAN CHASE BANK, NATIONAL ASSOCIATION, as Administrative Agent, SUNTRUST BANK, as Syndication Agent, and DEUTSCHE BANK SECURITIES INC., as Documentation Agent.
The parties hereto agree as follows:
ARTICLE I
Definitions
SECTION 1.01. Defined Terms. As used in this Agreement, the following terms have the meanings specified below:
“2010 Warrants” means each of the warrant transaction confirmation letter agreements dated September 16, 2010 between the Borrower and one or more financial institutions, and any additional warrant transaction confirmation letter agreements entered into by the Borrower in connection with the Convertible 2010 Debt.
“ABR”, when used in reference to any Loan or Borrowing, refers to whether such Loan, or the Loans comprising such Borrowing, are bearing interest at a rate determined by reference to the Alternate Base Rate.
“Adjusted Consolidated Debt” means, as of any date, Consolidated Debt (of the type described in any or all of clauses (a), (b), (c), (d), (e), (h) and (i) of the definition of “Debt”, but, as to clause (i), only to the extent that it is an unpaid obligation in respect of a letter of credit or letter of guaranty that is then due and payable and not contingent) of the Borrower and its Subsidiaries, other than (i) Debt evidenced by Trust Preferred Securities Notes, but only to the extent that the aggregate unpaid principal balance of such Trust Preferred Securities Notes on such date does not exceed an amount equal to fifteen percent (15%) of Total Capitalization on such date (for the sake of clarity, with any portion of Debt evidenced by Trust Preferred Securities Notes that exceeds an amount equal to fifteen percent (15%) of Total Capitalization on such date being included in Debt for the purposes of this definition) and (ii) Subordinated Debt other than any Debt evidenced by Trust Preferred Securities Notes.
“Adjusted LIBO Rate” means, with respect to any Eurodollar Borrowing for any Interest Period, an interest rate per annum (rounded upwards, if necessary, to the next 1/16 of 1%) equal to (a) the LIBO Rate for such Interest Period multiplied by (b) the Statutory Reserve Rate.
“Adjusted Total Capitalization” means, as of any date, an amount equal to Total Capitalization, plus Accumulated Other Comprehensive Loss, or minus Accumulated Other Comprehensive Income (as those terms are used under GAAP), as applicable, to the extent, if any, reflected as a component of Consolidated Net Worth as of such date.
“Administrative Agent” means JPMorgan Chase Bank, National Association, in its capacity as administrative agent for the Lenders hereunder.
1
“Administrative Questionnaire” means an Administrative Questionnaire in a form supplied by the Administrative Agent.
“Affiliate” means, with respect to a specified Person, another Person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by or is under common Control with the Person specified.
“Agreement” means this Credit Agreement, as amended, restated, modified or supplemented from time to time.
“Alternate Base Rate” means, for any day, a rate per annum equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Effective Rate in effect on such day plus ½ of 1% and (c) the Adjusted LIBO Rate for deposits in Dollars for a one month Interest Period on such day (or if such day is not a Business Day, the immediately preceding Business Day) plus 1%, provided that, for the avoidance of doubt, the Adjusted LIBO Rate for any Business Day shall be based on the rate appearing on the Reuters Screen LIBOR01 Page 1 (or on any successor or substitute page of such page) at approximately 11:00 a.m. London time on such day. Any change in the Alternate Base Rate due to a change in the Prime Rate, the Federal Funds Effective Rate or the Adjusted LIBO Rate shall be effective from and including the effective date of such change in the Prime Rate, the Federal Funds Effective Rate or the Adjusted LIBO Rate, respectively.
“American Equity Life” means American Equity Investment Life Insurance Company, an Iowa insurance company.
“Amounts Available for Dividends” means, (a) as of the end of the first, second and third Fiscal Quarters of any Fiscal Year, the maximum aggregate amount of dividends that are permitted to be paid as of the date of determination by (i) American Equity Life, (ii) each other Insurance Subsidiary owned directly by the Borrower and (iii) each other Insurance Subsidiary owned directly by a Wholly-Owned Subsidiary of the Borrower which is not either (A) an Insurance Subsidiary or (B) a Subsidiary of an Insurance Subsidiary, and (b) as of the end of the last Fiscal Quarter of any Fiscal Year, the maximum aggregate amount of dividends that are permitted to be paid as of the first day of the immediately succeeding Fiscal Year by (i) American Equity Life, (ii) each other Insurance Subsidiary owned directly by the Borrower and (iii) each other Insurance Subsidiary owned directly by a Wholly-Owned Subsidiary of the Borrower which is not either (A) an Insurance Subsidiary or (B) a Subsidiary of an Insurance Subsidiary, in each case under clauses (a) and (b), under the Applicable Insurance Code of its state of domicile and without necessitating approval of the Applicable Insurance Regulatory Authority.
“Anti-Terrorism Laws” means any laws relating to terrorism or money laundering, including Executive Order No. 13224, the USA Patriot Act, the laws comprising or implementing the Bank Secrecy Act, and the laws administered by the United States Treasury Department's Office of Foreign Asset Control (as any of the foregoing laws may from time to time be amended, renewed, extended, or replaced).
2
“Applicable Insurance Code” means, as to any Insurance Subsidiary, the insurance code or other statute of any state where such Insurance Subsidiary is domiciled or doing insurance business and any successor statute of similar import, together with the regulations thereunder, as amended or otherwise modified and in effect from time to time. References to sections of the Applicable Insurance Code shall be construed to also refer to successor sections.
“Applicable Insurance Regulatory Authority” means, when used with respect to any Insurance Subsidiary, the insurance department or similar administrative authority or agency located in the state in which such Insurance Subsidiary is domiciled.
“Applicable Percentage” means, with respect to any Lender, the percentage of the total Commitments represented by such Lender's Commitment; provided that in the case of Section 2.17 when a Defaulting Lender shall exist, “Applicable Percentage” shall mean the percentage of the total Commitments (disregarding any Defaulting Lender's Commitment) represented by such Lender's Commitment. If the Commitments have terminated or expired, the Applicable Percentages shall be determined based upon the Commitments most recently in effect, giving effect to any assignments and to any Lender's status as a Defaulting Lender at the time of determination.
“Applicable Rate” means, for any day, with respect to any ABR Loan or Eurodollar Loan, or with respect to the commitment fees payable hereunder, as the case may be, the applicable rate per annum set forth below under the caption “ABR Spread”, “Eurodollar Spread” or “Commitment Fee Rate”, as the case may be, based upon the S&P Rating applicable on such date to the Index Debt:
Index Debt Ratings: | ABR Spread | Eurodollar Spread | Commitment Fee Rate |
Level I Status | 1.50% | 2.50% | 0.30% |
Level II Status | 1.75% | 2.75% | 0.375% |
Level III Status | 2.00% | 3.00% | 0.50% |
Level IV Status | 2.25% | 3.25% | 0.625% |
For the purposes of this definition:
"Level I Status" exists at any date if, on such date, the Borrower's S&P Rating is BBB or better.
"Level II Status" exists at any date if, on such date, (i) the Borrower has not qualified for Level I Status and (ii) the Borrower's S&P Rating is BBB- or better.
3
"Level III Status" exists at any date if, on such date, (i) the Borrower has not qualified for Level I Status or Level II Status and (ii) the Borrower's S&P Rating is BB+ or better.
"Level IV Status" exists at any date if, on such date, the Borrower has not qualified for Level I Status, Level II Status, or Level III Status.
"S&P Rating" means, at any time, the rating issued by S&P and then in effect with respect to the Index Debt.
"Status" means Level I Status, Level II Status, Level III Status, or Level IV Status.
For purposes of the foregoing, (i) if S&P shall not have in effect a rating for the Index Debt (other than by reason of the circumstances referred to in the last sentence of this definition), then S&P shall be deemed to have established a rating in Level IV, and (ii) if the ratings established or deemed to have been established by S&P for the Index Debt shall be changed (other than as a result of a change in the rating system of S&P), such change shall be effective as of the date on which it is first announced by S&P, irrespective of when notice of such change shall have been furnished by the Borrower to the Administrative Agent and the Lenders pursuant to Section 5.02 or otherwise. Each change in the Applicable Rate shall apply during the period commencing on the effective date of such change and ending on the date immediately preceding the effective date of the next such change. If the rating system of S&P shall change, or if S&P shall cease to be in the business of rating corporate debt obligations, the Borrower and the Lenders shall negotiate in good faith to amend this definition to reflect such changed rating system or the unavailability of ratings from S&P and, pending the effectiveness of any such amendment, the Applicable Rate shall be determined by reference to the rating most recently in effect prior to such change or cessation. Notwithstanding the foregoing, until adjusted effective as of June 30, 2011, Level III Status shall be deemed to exist.
“Approved Fund” has the meaning assigned to such term in Section 9.04.
“Assignment and Assumption” means an assignment and assumption entered into by a Lender and an assignee (with the consent of any party whose consent is required by Section 9.04), and accepted by the Administrative Agent, in the form of Exhibit A or any other form approved by the Administrative Agent.
“Assumed Reinsurance” means reinsurance assumed by any Insurance Subsidiary from another Person (other than from another Insurance Subsidiary or Affiliate of the Borrower).
“Authorized Control Level Risk-Based Capital”, as of any date, has the meaning set forth on page 22, line 31, column 1 of the annual Statutory Statement most recently filed by American Equity Life and each other Insurance Subsidiary (or equivalent page, line, column or statement, to the extent that any thereof is modified or replaced).
“Availability Period” means the period from and including the Effective Date to but excluding the earlier of the Maturity Date and the date of termination of the Commitments.
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“Best” means A.M. Best & Co. and its successors and assigns or, if it shall be dissolved or shall no longer assign ratings to insurance companies, then any other nationally recognized insurance statistical rating agency designated by the Administrative Agent.
“Blocked Person” has the meaning specified in Section 3.20.
“Board” means the Board of Governors of the Federal Reserve System of the United States of America.
“Borrower” means American Equity Investment Life Holding Company, an Iowa corporation.
“Borrower-Only Cash” means, as of the end of any Fiscal Quarter, the sum of (a) Amounts Available for Dividends as of such Fiscal Quarter-end, (b) Trailing Borrower-Only EBITDA as of such Fiscal Quarter-end and (c) cash and Cash Equivalents (with the value thereof determined on a mark-to-market basis) of the Borrower as of such Fiscal Quarter-end.
“Borrowing” means Revolving Loans of the same Type, made, converted or continued on the same date and, in the case of Eurodollar Loans, as to which a single Interest Period is in effect.
“Borrowing Request” means a request by the Borrower for a Revolving Borrowing in accordance with Section 2.03.
“Business Day” means any day that is not a Saturday, Sunday or other day on which commercial banks in New York City are authorized or required by law to remain closed; provided that, when used in connection with a Eurodollar Loan, the term “Business Day” shall also exclude any day on which banks are not open for dealings in dollar deposits in the London interbank market.
“Capital Lease Obligations” of any Person means obligations of such Person to pay rent or other amounts under any lease of (or other arrangement conveying the right to use) real or personal property, or a combination thereof, which obligations are required under GAAP to be classified and accounted for as capital leases on a balance sheet of such Person. The amount of such obligations will be the capitalized amount thereof determined in accordance with GAAP.
“Cash Equivalents” means any of the following: (a) any investment in direct obligations of the United States of America or any agency thereof; (b) investments in time deposit accounts, certificates of deposit and money market deposits maturing within 90 days of the date of acquisition thereof issued by any Lender or a bank or trust company which is organized under the laws of the United States of America, any State thereof or any foreign country recognized by the United States of America, and which bank or trust company has capital, surplus and undivided profits aggregating in excess of $100,000,000 (or the foreign currency equivalent thereof) and whose long-term debt is rated “A” (or such similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Exchange Act) or any money market fund sponsored by a registered broker dealer or mutual fund distributor; (c) repurchase
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obligations with a term of not more than 30 days for underlying securities of the types described in clause (a) above entered into with a Lender or a bank meeting the qualifications described in clause (b) above; (d) investments in commercial paper, maturing not more than 90 days after the date of acquisition, issued by a corporation (other than an Affiliate of the Borrower) organized and in existence under the laws of the United States of America or any foreign country recognized by the United States of America with a rating at the times as of which any investment therein is made of “P-l” (or higher) by Moody's or “A-1” (or higher) by S&P; and (e) investments in securities with maturities of six months or less from the date of acquisition issued or fully guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least “A” by S&P or “A” by Moody's.
“Ceded Reinsurance” means risk that is ceded (whether by co-insurance, reinsurance or equivalent relationship otherwise named) by any Insurance Subsidiary to any other Person (other than to another Insurance Subsidiary or Affiliate of the Borrower), other than Surplus Relief Reinsurance.
“Change in Control” means the occurrence of any of the following:
(a) at any time that any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except that for the purposes of this clause (a) such person shall be deemed to have “beneficial ownership” of all shares that any such person has the right to acquire, whether such right is exercisable immediately or only after the passage of time), directly or indirectly, of more than any one or more of the following: (i) 10% of the aggregate ordinary voting power represented by the issued and outstanding Equity Interests in the Borrower and (ii) 10% of the aggregate equity value represented by the issued and outstanding Equity Interests in the Borrower;
(b) during any period of eighteen (18) consecutive calendar months, individuals who at the beginning of such period constituted the Board of Directors (together with any new directors (i) whose election by the Board of Directors was, or (ii) whose nomination for election by the Borrower's shareholders was, prior to the date of the proxy or consent solicitation relating to such nomination, approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of such period or whose election or nomination for election was previously so approved), shall cease for any reason to constitute a majority of the members of the Board of Directors then in office;
(c) the adoption of a plan relating to the liquidation or dissolution of the Borrower; or
(d) the merger (other than a merger permitted under the provisions of Section 6.03) or consolidation of the Borrower with or into another Person or the merger of another Person with or into the Borrower, or the sale of all or substantially all the assets of the Borrower (determined on a Consolidated basis) to another Person, other than a merger or consolidation transaction in which holders of Equity Interests representing 100% of the ordinary voting power represented by the Equity Interests in the Borrower immediately prior to such transaction (or other securities into
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which such securities are converted as part of such merger or consolidation transaction) own directly or indirectly at least a majority of the ordinary voting power represented by the Equity Interests in the surviving Person in such merger or consolidation transaction issued and outstanding immediately after such transaction and in substantially the same proportion as before the transaction.
“Change in Law” means (a) the adoption of any law, rule, regulation or treaty after the date of this Agreement, (b) any change in any law, rule, regulation or treaty or in the interpretation or application thereof by any Governmental Authority after the date of this Agreement or (c) compliance by any Lender (or, for purposes of Section 2.12(b), by any lending office of such Lender or by such Lender's holding company, if any) with any request, guideline or directive (whether or not having the force of law) of any Governmental Authority made or issued after the date of this Agreement; provided, that notwithstanding anything herein to the contrary, the Dodd-Frank Wall Street Reform and Consumer Protection Act and all requests, rules, guidelines or directives in connection therewith shall be deemed to be a “Change in Law”, regardless of the date enacted, adopted or issued.
“Charges” has the meaning set forth in Section 9.13.
“Class”, when used in reference to any Loan or Borrowing, refers to the fact that such Loan, or the Loans comprising such Borrowing, are Revolving Loans.
“Code” means the Internal Revenue Code of 1986, as amended.
“Commitment” means, with respect to each Lender, the commitment of such Lender to make Revolving Loans hereunder, expressed as an amount representing the maximum aggregate amount of such Lender's Revolving Loans, as such commitment may be (a) reduced or increased from time to time pursuant to Section 2.06 and (b) reduced or increased from time to time pursuant to assignments by or to such Lender pursuant to Section 9.04. The initial amount of each Lender's Commitment is set forth on Schedule 2.01, or in the Assignment and Assumption pursuant to which such Lender shall have assumed its Commitment, as applicable. The initial aggregate amount of the Lenders' Commitments is $160,000,000.
“Consolidated” means the Borrower and its Subsidiaries, taken as a whole in accordance with GAAP.
“Consolidated Assets” means, as at the date of any determination, the net book value of all assets of the Borrower and its Subsidiaries as of such date classified as assets in accordance with GAAP and determined on a Consolidated basis.
“Consolidated Liabilities” means, as at any date of determination, all liabilities of the Borrower and its Subsidiaries as of such date classified as liabilities in accordance with GAAP and determined on a Consolidated basis.
“Consolidated Net Worth” means, as at any date of determination, the remainder of (a) all Consolidated Assets (after deducting all applicable reserves and excluding any re-appraisal
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or write-up of assets after the date of this Agreement) as of such date, minus (b) all Consolidated Liabilities as of such date.
“Control” means possession, directly or indirectly, of the power (a) to vote 10% or more of any class of voting securities of a Person or (b) to direct or cause the direction of the management or policies of a Person, whether through the ownership of voting securities, by contract or otherwise. “Controlling” and “Controlled” have meanings correlative thereto.
“Convertible 2004 Debt” has the meaning specified in Section 6.01(a)(iv).
“Convertible 2004 Debt Documents” means the Indenture in respect of the Convertible 2004 Debt dated December 6, 2004 by and between the Borrower and U.S. Bank National Association, as Trustee, as supplemented by the First Supplemental Indenture dated December 30, 2004, the Borrower's 5.25% Contingent Convertible Senior Notes Due 2024 issued thereunder, the Registration Rights Agreement (as defined therein) and related agreements and other documents, as amended and supplemented from time to time pursuant to this Agreement.
“Convertible 2009 Debt” has the meaning specified in Section 6.01(a)(v).
“Convertible 2009 Debt Documents” means the Indenture in respect of the Convertible 2009 Debt dated as of December 22, 2009 by and between the Borrower and U.S. Bank National Association, as Trustee, the Borrower's 5.25% Contingent Convertible Senior Notes Due 2029 issued thereunder, and related instruments, agreements and other documents, as amended and supplemented from time to time pursuant to this Agreement.
“Convertible 2010 Debt” has the meaning specified in Section 6.01(a)(vii).
“Convertible 2010 Debt Documents” means the Indenture in respect of the Convertible 2010 Debt dated as of September 22, 2010 by and between the Borrower and U.S. Bank National Association, as Trustee, the Borrower's 3.5% Convertible Senior Notes Due 2015 issued thereunder, and related instruments, agreements and other documents, as amended and supplemented from time to time pursuant to this Agreement.
“Convertible 2010 Debt Hedges” means each of the call option transaction confirmation letter agreements dated September 16, 2010 and September 17, 2010 referencing the Convertible 2010 Debt Documents between the Borrower and one or more financial institutions, and any additional call option transaction confirmation letter agreements entered into by the Borrower referencing the Convertible 2010 Debt Documents.
“Convertible Debt” means, collectively, the Convertible 2004 Debt, the Convertible 2009 Debt and the Convertible 2010 Debt.
“Convertible Debt Documents” means, collectively, the Convertible 2004 Debt Documents, the Convertible 2009 Debt Documents and the Convertible 2010 Debt Documents.
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“Coverage Ratio” means, as of the end of any Fiscal Quarter, the ratio of (a) Borrower-Only Cash as of such Fiscal Quarter-end to (b) Fixed Charges of the Borrower as of such Fiscal Quarter-end.
“Credit Documents” means this Agreement and, after the execution and delivery thereof pursuant to the terms of this Agreement, each promissory note, if any, delivered pursuant to Section 2.07(e) and any certificate required to be delivered by the Borrower pursuant to Article II or Article V.
“Current Redeemable Equity” means any preferred stock or other Equity Interests, which in either case, is subject to mandatory redemption at any time prior to the first anniversary of the Maturity Date (as it exists on any date of determination).
“Debt” of any Person means, without duplication:
(a)all obligations of such Person for borrowed money or with respect to deposits or advances of any kind (other than unspent cash deposits or securities held in escrow by or in favor of such Person, or in a segregated deposit or securities account, as applicable, controlled by such Person, in each case in the ordinary course of business to secure the performance obligations of, or damages owing from, one or more third parties),
(b)all obligations of such Person evidenced by bonds, debentures, notes (including, without limitation, the Trust Preferred Securities Notes and the Convertible Debt) or similar instruments,
(c)all obligations of such Person on which interest charges are customarily paid (other than obligations where interest is levied only on late or past due amounts),
(d)all obligations of such Person under conditional sale or other title retention agreements relating to property acquired by such Person,
(e)all obligations of such Person in respect of the deferred purchase price of property or services (excluding current accounts payable incurred in the ordinary course of business),
(f)all Debt of others secured by (or for which the holder of such Debt has an existing right, contingent or otherwise, to be secured by) any Lien on property owned or acquired by such Person, whether or not the Debt secured thereby has been assumed,
(g)all Guarantees by such Person of Debt of others,
(h)all Capital Lease Obligations of such Person,
(i)all unpaid obligations, contingent or otherwise, of such Person as an account party in respect of letters of credit and letters of guaranty (other than cash collateralized letters of credit to secure the performance of workers' compensation, unemployment insurance, other social security laws or regulations, bids, trade contracts, leases, environmental and other statutory
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obligations, surety and appeal bonds, performance bonds and other obligations of a like nature, in each case, obtained in the ordinary course of business),
(j)all capital stock of such Person which is required to be redeemed or is redeemable at the option of the holder if certain events or conditions occur or exist or otherwise, and
(k)all obligations, contingent or otherwise, of such Person in respect of bankers' acceptances.
The Debt of any Person shall include the Debt of any other entity (including any partnership in which such Person is a general partner) to the extent that such Person is liable therefor pursuant to law or judicial holding as a result of such Person's ownership interest in or other relationship with such entity, except to the extent that contractual provisions binding on the holder of such Debt provide that such Person is not liable therefor; provided, that Debt shall not include (i) obligations with respect to insurance policies, annuities, guaranteed investment contracts and similar products underwritten by, or Reinsurance Agreements or Retrocession Agreements entered into by, an Insurance Subsidiary in the ordinary course of its business, (ii) obligations with respect to Surplus Relief Reinsurance ceded by an Insurance Subsidiary, (iii) obligations in the ordinary course of business of such Person to purchase securities that arise out of or in connection with the sale of the same or substantially similar securities or to return collateral consisting of securities arising out of or in connection with the loan of the same or substantially similar securities or (iv) other than for the purposes of paragraph (g) of Article VII, any payment obligation under any 2010 Warrants, except to the extent that any such payment obligation, if and when any such payment obligation may arise, is greater than the amount of any concurrent payment or payments received by the Borrower in connection with the termination, cancellation or early unwind of any Convertible 2010 Debt Hedges.
“Default” means any event or condition which constitutes an Event of Default or which upon notice, lapse of time or both would, unless cured or waived, become an Event of Default.
“Defaulting Lender” means any Lender, as reasonably determined by the Administrative Agent, that has (a) failed to fund any portion of its Loans within three Business Days of the date required to be funded by it hereunder, (b) notified the Borrower, the Administrative Agent or any Lender in writing that it does not intend to comply with any of its funding obligations under this Agreement or has made a public statement to the effect that it does not intend to comply with its funding obligations under this Agreement or under other agreements in which it commits to extend credit, (c) failed, within three Business Days after request by the Administrative Agent, to confirm in writing that it will comply with the terms of this Agreement relating to its obligations to fund prospective Loans (provided that such Lender shall cease to be a Defaulting Lender pursuant to this clause (c) upon receipt of such written confirmation by the Administrative Agent), (d) otherwise failed to pay over to the Administrative Agent or any other Lender any other amount required to be paid by it hereunder within three Business Days of the date when due, unless the subject of a good faith dispute, or (e) has, or has a direct or indirect parent company that has, (i) become the subject of a proceeding under any Federal, state or foreign bankruptcy, insolvency, receivership or similar law now or hereafter in effect, or (ii) had appointed for it a receiver, custodian,
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conservator, trustee, administrator, assignee for the benefit of creditors or similar Person charged with reorganization or liquidation of its business or assets, including the Federal Deposit Insurance Corporation or any other state or federal regulatory authority acting in such a capacity; provided that a Lender shall not be a Defaulting Lender solely by virtue of the ownership or acquisition of any equity interest in that Lender or any direct or indirect parent company thereof by a Governmental Authority so long as such ownership interest does not result in or provide such Lender with immunity from the jurisdiction of courts within the United States or from the enforcement of judgments or writs of attachment on its assets or permit such Lender (or such Governmental Authority or instrumentality) to reject, repudiate, disavow or disaffirm any contracts or agreements made with such Lender.
“dollars” or “$” refers to lawful money of the United States of America.
“Effective Date” means the date on which the conditions specified in Section 4.01 are satisfied (or waived in accordance with Section 9.02).
“Effective Date Trust Preferred Securities” means mandatorily redeemable preferred securities issued by any of the following Delaware business trusts that are Affiliates of the Borrower as of the Effective Date: American Equity Capital Trust I, American Equity Capital Trust II, American Equity Capital Trust III, American Equity Capital Trust IV, American Equity Capital Trust V, American Equity Capital Trust VI, American Equity Capital Trust VII, American Equity Capital Trust VIII, American Equity Capital Trust IX, American Equity Capital Trust X, American Equity Capital Trust XI and American Equity Capital Trust XII.
“Environmental Laws” means all laws, rules, regulations, codes, ordinances, orders, decrees, judgments, injunctions, notices or binding agreements issued, promulgated or entered into by any Governmental Authority, relating in any way to the environment, the preservation or reclamation of natural resources, the management, release or threatened release of any Hazardous Material or the effects of the environment on health and safety.
“Environmental Liability” means any liability, contingent or otherwise (including any liability for damages, costs of environmental remediation, fines, penalties or indemnities), of the Borrower or any Subsidiary directly or indirectly resulting from or based upon (a) violation of any Environmental Law, (b) the generation, use, handling, transportation, storage, treatment or disposal of any Hazardous Materials, (c) exposure to any Hazardous Materials, (d) the release or threatened release of any Hazardous Materials into the environment or (e) any contract, agreement or other consensual arrangement pursuant to which liability is assumed or imposed with respect to any of the foregoing.
“Equity Interests” means (a) shares of capital stock, partnership interests, membership interests in a limited liability company, beneficial interests in a trust or other equity ownership interests in a Person or (b) any Equity Rights in such Person.
“Equity Rights” means, with respect to any Person, any subscriptions, options, warrants, commitments, preemptive rights or agreements of any kind (including, without limitation, any stockholders' or voting trust agreements) for the issuance, sale, registration or voting of, or securities convertible into, any additional shares of capital stock of any class, or partnership or other ownership interests of any type in, such Person.
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“ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time.
“ERISA Affiliate” means any trade or business (whether or not incorporated) that, together with the Borrower or any Subsidiary, is treated as a single employer under Section 4 14(b) or (c) of the Code or, solely for purposes of Section 302 of ERISA and Section 412 of the Code, is treated as a single employer under Section 414 of the Code.
“ERISA Event” means (a) any “reportable event”, as defined in Section 4043 of ERISA or the regulations issued thereunder with respect to a Plan (except an event for which the 30-day notice period is waived); (b) the failure to meet the minimum funding standards of Section 412 or 430 of the Code; (c) the filing pursuant to Section 412(c) of the Code or Section 302(c) of ERISA of an application for a waiver of the minimum funding standard with respect to any Plan; (d) the incurrence by the Borrower or any ERISA Affiliate of any liability under Title IV of ERISA with respect to the termination of any Plan; (e) the receipt by the Borrower or any ERISA Affiliate from the PBGC or a plan administrator of any notice relating to an intention to terminate any Plan or Plans or to appoint a trustee to administer any Plan; (f) the adoption of any amendment to a Plan that would require the provision of security pursuant to Section 436(f)(i) of the Code; (g) the conditions exist for the imposition of a lien under Section 303(k) of ERISA; (h) a Plan is considered an “at risk” plan within the meaning of Section 430 of the Code or Section 303 of ERISA; (i) the incurrence by the Borrower or any ERISA Affiliate of any liability with respect to the withdrawal or partial withdrawal from any Plan or Multiemployer Plan; or (j) the receipt by the Borrower or any ERISA Affiliate of any notice, or the receipt by any Multiemployer Plan from the Borrower or any ERISA Affiliate of any notice, concerning the imposition of Withdrawal Liability or a determination that a Multiemployer Plan is, or is expected to be, in endangered status, critical status, insolvent or in reorganization, within the meaning of Title IV of ERISA.
“Eurodollar”, when used in reference to any Loan or Borrowing, refers to whether such Loan, or the Loans comprising such Borrowing, are bearing interest at a rate determined by reference to the Adjusted LIBO Rate.
“Event of Default” has the meaning assigned to such term in Article VII.
“Exchange Act” means the Securities Exchange Act of 1934, as amended from time to time.
“Excluded Taxes” means, with respect to any payment made by the Borrower under this Agreement, any of the following Taxes imposed on or with respect to a Recipient: (a) income or franchise Taxes imposed on (or measured by) its net income by the United States of America, or by the jurisdiction under the laws of which such recipient is organized or in which its principal office is located or, in the case of any Lender, in which its applicable lending office is located (collectively, “Income Taxes”), (b) any branch profits Taxes imposed by the United States of America or any similar tax imposed by any other jurisdiction in which the Borrower is organized or in which
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its principal office is located, (c) in the case of a Non-U.S. Lender (other than an assignee pursuant to a request by the Borrower under Section 2.16(b)), any withholding tax that is imposed on amounts payable to such Non-U.S. Lender at the time such Non-U.S. Lender becomes a party to this Agreement (or designates a new lending office) or is attributable to such Non-U.S. Lender's failure to comply with Section 2.14(e), except to the extent that such Non-U.S. Lender (or its assignor, if any) was entitled, at the time of designation of a new lending office (or assignment), to receive additional amounts from the Borrower with respect to such withholding Tax pursuant to Section 2.14(a) and (d) any Taxes imposed on any “withholdable payment” payable to such recipient as a result of the failure of such recipient to satisfy the applicable requirements as set forth in FATCA after December 31, 2012.
“Existing 2004 Terms” has the meaning specified in Section 6.01(a)(iv).
“Existing 2009 Terms” has the meaning specified in Section 6.01(a)(v).
“Existing 2010 Terms” has the meaning specified in Section 6.01(a)(vii).
“FATCA” means Sections 1471 through 1474 of the Code, as of the date of this Agreement, and any regulations or official interpretations thereof.
“Federal Funds Effective Rate” means, for any day, the weighted average (rounded upwards, if necessary, to the next 1/100 of 1%) of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average (rounded upwards, if necessary, to the next 1/100 of 1%) of the quotations for such day for such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by it.
“Financial Officer” means the chief financial officer or vice president of accounting of the Borrower.
“Fiscal Quarter” means a fiscal quarter of the Borrower.
“Fiscal Year” means a fiscal year of the Borrower.
“Fixed Charges” means, as of any date of determination, the sum, without duplication, of (a) Interest Expense of the Borrower only, less amortization of Debt discount and Debt issuance costs, for the four (4) Fiscal Quarter period ending on such date of determination, (b) Restricted Payments made or incurred by the Borrower only during the four (4) Fiscal Quarter period ending on such date of determination, (c) the cash portion of any expense incurred by Borrower only attributable to interest rate Hedging Agreements related to any Borrower Debt and (d) any principal payments owing in respect of Debt of the Borrower only during the four (4) Fiscal Quarter period immediately following such date of determination, including the value of any Convertible Debt that may be put to the Borrower only in such period.
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“Foreign Subsidiary” means any Subsidiary that is incorporated or organized under the laws of any jurisdiction other than the United States of America, any State thereof or the District of Columbia.
“GAAP” means generally accepted accounting principles as in effect from time to time in the United States of America, applied on a basis consistent (except for changes concurred with by the Borrower's independent public accountants) with the most recent audited Consolidated financial statements of the Borrower and its Consolidated Subsidiaries delivered to the Lenders.
“Governmental Authority” means the government of the United States of America or any other nation or any political subdivision thereof, whether state or local, and any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative powers or functions of or pertaining to government.
“Guarantee” by any Person (the “guarantor”) means any obligation, contingent or otherwise, of the guarantor guaranteeing or having the economic effect of guaranteeing any Debt or other debt-like obligations of any other Person (the “primary obligor”) in any manner, whether directly or indirectly, and including any obligation of the guarantor, direct or indirect, (a) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt or other obligation or to purchase (or advance or supply funds for the purchase of) any security for the payment thereof, (b) to purchase or lease property, securities or services for the purpose of assuring the owner of such Debt or other obligation of the payment thereof, (c) to maintain working capital, equity capital or any other financial statement condition or liquidity of the primary obligor so as to enable the primary obligor to pay such Debt or other obligation or (d) as an account party in respect of any letter of credit or letter of guaranty issued to support such Debt or other obligation; provided that the term “Guarantee” shall not include endorsements for collection or deposit in the ordinary course of business.
“Hazardous Materials” means all explosive or radioactive substances or wastes and all hazardous or toxic substances, wastes or other pollutants, including petroleum or petroleum distillates, asbestos or asbestos-containing materials, polychlorinated biphenyls, radon gas, infectious or medical wastes and all other substances or wastes of any nature regulated pursuant to any Environmental Law.
“Hedging Agreement” means any interest rate protection agreement, foreign currency exchange agreement, commodity price protection agreement, option or index option derivative agreement or other interest rate, currency exchange rate, commodity price, or option or index option hedging arrangement.
“Income Taxes” has the meaning specified in clause (a) of the definition of Excluded Taxes.
“Indemnified Taxes” means (a) Taxes, other than Excluded Taxes, imposed on or with respect to any payment made by the Borrower under this Agreement, and (b) Other Taxes.
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“Index Debt” means senior, unsecured, long-term indebtedness for borrowed money of the Borrower that is not guaranteed by any other Person or subject to any other credit enhancement.
“Insurance Subsidiary” means a Subsidiary that is a regulated insurance company. As of the date of this Agreement, American Equity Investment Life Insurance Company, American Equity Investment Life Insurance Company of New York and Eagle Life Insurance Company constitute the Insurance Subsidiaries.
“Interest Election Request” means a request by the Borrower to convert or continue a Revolving Borrowing in accordance with Section 2.05.
“Interest Expense” means, for any fiscal period, all expense of the Borrower or any of its Subsidiaries for such fiscal period classified as interest expense for such period, including interest on capitalized interest and interest under “synthetic” leases, in accordance with GAAP; provided, that Interest Expense shall not include any interest expense in respect of obligations in the ordinary course of business of the Borrower or any of its Subsidiaries to purchase securities that arise out of or in connection with the sale of the same or substantially similar securities or to return collateral consisting of securities arising out of or in connection with the loan of the same or substantially similar securities.
“Interest Payment Date” means (a) with respect to any ABR Loan, the last day of each March, June, September and December and (b) with respect to any Eurodollar Loan, the last day of the Interest Period applicable to the Borrowing of which such Loan is a part and, in the case of a Eurodollar Borrowing with an Interest Period of more than three months' duration, each day prior to the last day of such Interest Period that occurs at intervals of three months' duration after the first day of such Interest Period.
“Interest Period” means with respect to any Eurodollar Borrowing, the period commencing on the date of such Borrowing and ending on the numerically corresponding day in the calendar month that is one, two, three or six months thereafter, as the Borrower may elect; provided, that (i) if any Interest Period would end on a day other than a Business Day, such Interest Period shall be extended to the next succeeding Business Day unless such next succeeding Business Day would fall in the next calendar month, in which case such Interest Period shall end on the next preceding Business Day and (ii) any Interest Period pertaining to a Eurodollar Borrowing that commences on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the last calendar month of such Interest Period) shall end on the last Business Day of the last calendar month of such Interest Period. For purposes hereof, the date of a Borrowing initially shall be the date on which such Borrowing is made and thereafter shall be the effective date of the most recent conversion or continuation of such Borrowing.
“Investment” means, for any Person: (a) the acquisition (whether for cash, Property, services or securities or otherwise) of capital stock, bonds, notes, debentures, partnership or other ownership interests or other securities of any other Person or any agreement to make any such acquisition (including, without limitation, any “short sale” or any sale of any securities at a time when such securities are not owned by the Person entering into such sale); (b) the making of any
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deposit with, or advance, loan or other extension of credit or capital contribution to, any other Person (including the purchase of property from another Person subject to an understanding or agreement, contingent or otherwise, to resell such property to such Person), but excluding any such advance, loan or extension of credit having a term not exceeding 90 days arising in connection with the sale of inventory or supplies by such Person in the ordinary course of business; (c) the entering into of any Guarantee of, or other contingent obligation with respect to, Debt or other liability of any other Person and (without duplication) any amount committed to be advanced, lent or extended to such Person; or (d) the entering into of any Hedging Agreement.
"IRS" means the United States Internal Revenue Service.
“Lead Arrangers” means each of J.P. Morgan Securities LLC and SunTrust Robinson Humphrey, Inc. in its capacity as a joint lead arranger.
“Lenders” means the Persons listed on Schedule 2.01 and any other Person that shall have become a party hereto pursuant to an Assignment and Assumption or pursuant to Section 2.06(d), other than any such Person that ceases to be a party hereto pursuant to an Assignment and Assumption.
“LIBO Rate” means, with respect to any Eurodollar Borrowing for any Interest Period, the rate appearing on Reuters Screen LIBOR01 Page 1 (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Administrative Agent from time to time for purposes of providing quotations of interest rates applicable to dollar deposits in the London interbank market) at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period, as the rate for dollar deposits with a maturity comparable to such Interest Period. In the event that such rate is not available at such time for any reason, then the “LIBO Rate” with respect to such Eurodollar Borrowing for such Interest Period shall be the rate at which dollar deposits of $5,000,000 and for a maturity comparable to such Interest Period are offered by the principal London office of the Administrative Agent in immediately available funds in the London interbank market at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period.
“License” has the meaning set forth in Section 3.05.
“Lien” means, with respect to any asset, (a) any mortgage, deed of trust, lien, pledge, hypothecation, encumbrance, charge or security interest in, on or of such asset, (b) the interest of a vendor or a lessor under any conditional sale agreement, capital lease or title retention agreement (or any financing lease having substantially the same economic effect as any of the foregoing) relating to such asset and (c) in the case of securities, any purchase option, call or similar right of a third party with respect to such securities.
“Loan” means a Revolving Loan.
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“Material Adverse Effect” means a material adverse effect on (a) the business, properties, assets, condition (financial or otherwise) or prospects of the Borrower and its Subsidiaries taken as a whole, (b) the ability of the Borrower to perform any of its obligations under any Credit Document or (c) the rights of or benefits available to Administrative Agent or any Lender under, or the validity or enforceability of, any Credit Document.
“Material Debt” means Debt (other than obligations in respect of the Loans) or obligations in respect of one or more Hedging Agreements, of any one or more of the Borrower and its Subsidiaries in an aggregate principal amount exceeding $25,000,000; provided, that at any time that the Borrower or any Subsidiary is a party to any agreement with respect to Debt with a principal amount outstanding in excess of $25,000,000 which includes a provision comparable to paragraph (g) of Article VII hereof with a smaller threshold, then such smaller threshold shall be substituted therefor. For purposes of determining Material Debt, the “principal amount” of the obligations of the Borrower or any Subsidiary in respect of any Hedging Agreement at any time will be the maximum aggregate amount (after giving effect to any netting agreements) that the Borrower or such Subsidiary would be required to pay if such Hedging Agreement were terminated at such time.
“Material Insurance Subsidiary” means a Material Subsidiary that is also an Insurance Subsidiary. As of the date of this Agreement, American Equity Investment Life Insurance Company constitutes the only Material Insurance Subsidiary.
“Material Subsidiary” means a Subsidiary that holds, directly or indirectly, more than 5% of the Consolidated assets of the Borrower and its Subsidiaries at such time or that accounts for more than 5% of the consolidated revenues of the Borrower and its Subsidiaries at such time, in each instance determined in accordance with GAAP.
“Maturity Date” means January 28, 2014.
“Maximum Rate” has the meaning set forth in Section 9.13.
“Moody's” means Moody's Investors Service, Inc.
“Multiemployer Plan” means a multiemployer plan as defined in Section 4001(a)(3) of ERISA.
“NAIC” means the National Association of Insurance Commissioners and any successor thereto.
“Net Available Proceeds” means, with respect to the sale or other disposition of any Equity Interests of the Borrower or a Material Subsidiary, the aggregate amount of all cash received by the Borrower and its Material Subsidiaries in respect of such sale or other disposition, net of reasonable expenses incurred by the Borrower and its Material Subsidiaries in connection therewith.
“Non-U.S. Lender” means a Lender that is not a U.S. Person.
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“Other Connection Taxes” means, with respect to any Recipient, Taxes imposed as a result of a present or former connection between such Recipient and the jurisdiction imposing such Taxes (other than a connection arising from such Recipient having executed, delivered, enforced, become a party to, performed its obligations under, received payments under, received or perfected a security interest under, or engaged in any other transaction pursuant to, or enforced this Agreement or any other Credit Document, or sold or assigned an interest in this Agreement.
“Other Taxes” means any present or future stamp, court, documentary, intangible, recording, filing or similar excise or property Taxes that arise from any payment made under, from the execution, delivery, performance, enforcement or registration of, or from the registration, receipt or perfection of a security interest under, or otherwise with respect to, this Agreement or any other Credit Document, except any such Taxes that are Other Connection Taxes imposed with respect to an assignment (other than an assignment under Section 2.16(b)).
“Participant” has the meaning assigned to such term in Section 9.04.
“Participant Register” has the meaning assigned to such term in Section 9.04(c).
“PBGC” means the Pension Benefit Guaranty Corporation referred to and defined in ERISA and any successor entity performing similar functions.
“Permitted Investments” means any of the following: (a) Cash Equivalents; and (b) any other investment permitted by the Applicable Insurance Regulatory Authority.
“Permitted Liens” means:
(a) Liens imposed by law for taxes that are not yet due or are being contested in compliance with Section 5.05;
(b) carriers', warehousemen's, mechanics', materialmen's, repairmen's and other like Liens imposed by law, arising in the ordinary course of business and securing obligations that are not overdue by more than 30 days or are being contested in compliance with Section 5.05;
(c) pledges and deposits made in the ordinary course of business in compliance with workers' compensation, unemployment insurance and other social security laws or regulations (including, without limitation, deposits made in the ordinary course of business to cash collateralize letters of credit described in the parenthetical in clause (i) of the definition of “Debt”);
(d) deposits to secure the performance of bids, trade contracts, leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature, and Liens imposed by statutory or common law relating to banker's liens or rights of setoff or similar rights relating to deposit accounts, in each case in the ordinary course of business;
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(e) Liens arising under escrows, trusts, custodianships, separate accounts, funds withheld procedures, and similar deposits, arrangements, or agreements established with respect to insurance policies, annuities, guaranteed investment contracts and similar products underwritten by, or Reinsurance Agreements entered into by, any Insurance Subsidiary in the ordinary course of business;
(f) deposits with insurance regulatory authorities in the ordinary course of business; and
(g) easements, zoning restrictions, rights-of-way, licenses, reservations, minor irregularities of title and similar encumbrances on real property imposed by law or arising in the ordinary course of business that do not secure any monetary obligation and do not materially detract from the value of the affected property or interfere with the ordinary conduct of business of the Borrower or any Material Subsidiary;
provided that, except as provided in clause (c), above, the term “Permitted Liens” shall not include any Lien that secures Debt.
“Person” means any natural person, corporation, limited liability company, trust, joint venture, association, company, partnership, Governmental Authority or other entity.
“Plan” means any employee pension benefit plan (except a Multiemployer Plan) subject to the provisions of Title IV of ERISA or Section 412 of the Code or Section 302 of ERISA, and in respect of which the Borrower or any ERISA Affiliate is (or, if such plan were terminated, would under Section 4069 of ERISA be deemed to be) a “contributing sponsor” as defined in Section 400 l(a)(13) of ERISA.
“Prime Rate” means the rate of interest per annum publicly announced from time to time by JPMorgan Chase Bank, National Association as its prime rate in effect at its office located at 270 Park Avenue, New York, New York; each change in the Prime Rate shall be effective from and including the date such change is publicly announced as being effective.
“Recipient” means, as applicable, (a) the Administrative Agent and (b) any Lender.
“Register” has the meaning assigned to such term in Section 9.04.
“Regulation U” means Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time.
“Reinsurance Agreement” means any agreement, contract, treaty or other arrangement providing for Ceded Reinsurance by any Insurance Subsidiary or any Subsidiary of such Insurance Subsidiary.
“Related Parties” means, with respect to any specified Person, such Person's Affiliates and the respective directors, officers, employees, agents and advisors of such Person and such Person's Affiliates.
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“Required Lenders” means, at any time, Lenders having Revolving Loans and unused Commitments representing more than 50% of the sum of the total Revolving Loans and unused Commitments at such time.
“Restricted Payment” means, without duplication, (a) any dividend or other distribution (whether in cash, securities or other property) with respect to any Equity Interest in the Borrower or with respect to any Trust Preferred Securities or (b) any payment (whether in cash, securities or other property) or incurrence of an obligation by the Borrower or any of its Subsidiaries, including any sinking fund or similar deposit, on account of the purchase, redemption, retirement, acquisition, cancellation or termination of any Equity Interest in the Borrower or any Trust Preferred Securities.
“Retrocession Agreement” means any agreement, contract, treaty or other arrangement (other than Surplus Relief Reinsurance) whereby any Insurance Subsidiary or any Subsidiary of such Insurance Subsidiary cedes reinsurance to other insurers (other than to another Insurance Subsidiary or any of its Subsidiaries).
“Revolving Loan” means a Loan made by the Lenders to the Borrower pursuant to Article II hereof.
“Risk-Based Capital Ratio” means, as of the end of any Fiscal Quarter, the ratio of (a) Total Adjusted Capital as of such Fiscal Quarter-end to (b) an amount equal to (i) Authorized Control Level Risk-Based Capital (as prescribed or defined by the Applicable Insurance Regulatory Authority from time to time) as of such Fiscal Quarter-end, times (ii) two (2).
“Sale-Leaseback Transaction” has the meaning specified in Section 6.07.
“SAP” means, with respect to any Insurance Subsidiary, the accounting procedures and practices prescribed or permitted by the Applicable Insurance Regulatory Authority from time to time, applied on a basis consistent with those that, in accordance with the second sentence of Section 1.04(a) hereof, are to be used in making the calculations for purposes of determining compliance with this Agreement.
“S&P” means Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc., and its successors and assigns or, if it shall be dissolved or shall no longer assign credit ratings to long term debt, then any other nationally recognized statistical rating agency designated by the Administrative Agent.
“SEC” means the United States Securities and Exchange Commission.
“Statutory Reserve Rate” means a fraction (expressed as a decimal), the numerator of which is the number one and the denominator of which is the number one minus the aggregate of the maximum reserve percentages (including any marginal, special, emergency or supplemental reserves) expressed as a decimal established by the Board to which the Administrative Agent is subject, with respect to the Adjusted LIBO Rate, for eurocurrency funding (currently referred to as “Eurocurrency Liabilities” in Regulation D of the Board). Such reserve percentages shall include
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those imposed pursuant to such Regulation D. Eurodollar Loans shall be deemed to constitute eurocurrency funding and to be subject to such reserve requirements without benefit of or credit for proration, exemptions or offsets that may be available from time to time to any Lender under such Regulation D or any comparable regulation. The Statutory Reserve Rate shall be adjusted automatically on and as of the effective date of any change in any reserve percentage.
“Statutory Statement” means, as to any Insurance Subsidiary, a statement of the condition and affairs of such Insurance Subsidiary, prepared in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority and filed with the Applicable Insurance Regulatory Authority.
“Statutory Surplus” means, as at any date for any Insurance Subsidiary, the aggregate amount of surplus as regards policyholders (determined without duplication in accordance with SAP) of such Insurance Subsidiary, as set forth on page 3, line 38, of the most recent Statutory Statement of such Insurance Subsidiary (or equivalent page, line, or statement, to the extent that any thereof is modified or replaced).
“Subordinated Debt” means the Debt of the Borrower evidenced by the Trust Preferred Securities Notes and any other Debt of the Borrower (a) no part of the principal of which is required to be paid (whether by way of mandatory sinking fund, mandatory redemption, mandatory prepayment or otherwise) prior to the date that is twelve months after the Maturity Date and (b) that has been subordinated to the Loans and other obligations of the Borrower under the Credit Documents in right and time of payment upon terms that are satisfactory to the Required Lenders, which terms may, in the Required Lenders' determination, include (without limitation) limitations or restrictions on the right of the holder of such Debt to receive payments and exercise remedies.
“subsidiary” means, with respect to any Person (the “parent”) at any date, (a) any corporation, limited liability company, partnership or other entity the accounts of which would be consolidated with those of the parent in the parent's consolidated financial statements if such financial statements were prepared in accordance with GAAP as of such date and (b) any other corporation, limited liability company, partnership or other entity (i) of which securities or other ownership interests (A) representing more than 50% of the ordinary voting power or, in the case of a partnership, more than 50% of the general partnership voting interests or (B) otherwise having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions, are, as of such date, owned, controlled or held, or (ii) that is otherwise Controlled (pursuant to clause (b) of the definition of “Control”) as of such date, by the parent and/or one or more of its subsidiaries, but excluding any such entity that is required to be consolidated under GAAP solely by reason of FASB Interpretation No. 46.
“Subsidiary” means any subsidiary of the Borrower. As of the date of this Agreement, American Equity Investment Life Insurance Company, American Equity Investment Life Insurance Company of New York, American Equity Advisors, Inc., American Equity Capital, Inc., American Equity Properties, L.C., AERL, L.C., Eagle Life Insurance Company, American Equity Investment Service Company, American Equity Capital Trust I, American Equity Capital Trust II, American Equity Capital Trust III, American Equity Capital Trust IV, American Equity Capital Trust V,
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American Equity Capital Trust VI, American Equity Capital Trust VII, American Equity Capital Trust VIII, American Equity Capital Trust IX, American Equity Capital Trust X, American Equity Capital Trust XI and American Equity Capital Trust XII are the Subsidiaries of the Borrower.
“Surplus Relief Reinsurance” means any transaction in which any Insurance Subsidiary or any Subsidiary of such Insurance Subsidiary cedes business under a Reinsurance Agreement that would be considered a “financing-type” reinsurance agreement as determined in accordance with GAAP.
“Taxes” means any present or future taxes, levies, imposts, duties, deductions, withholdings, assessments, fees or other charges imposed by any Governmental Authority, including any interest, additions to tax or penalties applicable thereto.
“Total Adjusted Capital” as of any date, has the meaning set forth on page 22, line 30, column 1 of the annual Statutory Statement most recently filed by American Equity Life and each other Insurance Subsidiary (or, the equivalent page, line, column or statement, to the extent that any thereof is modified or replaced).
“Total Capitalization” means, as of any date, the aggregate of, without duplication, (a) Consolidated Debt of the Borrower, of the type described in any or all of clauses (a), (b), (c), (d), (e), (h) and (i) of the definition of Debt (but with respect to clause (i), only to the extent that it is an unpaid obligation in respect of a letter of credit or letter of guaranty that is then due and payable and not contingent on such date), and (b) Consolidated Net Worth of the Borrower, on such date.
“Trailing Borrower-Only EBITDA” means, as of the end of any Fiscal Quarter for the trailing four (4) Fiscal Quarter period then ended, the Borrower-only after-tax gain (loss) before equity in undistributed income of Subsidiaries for such period, as determined in accordance with GAAP, plus, without duplication, (a) Interest Expense of the Borrower only for such period, (b) depreciation of the Borrower only for such period, as determined in accordance with GAAP, (c) amortization of the Borrower only for such period, as determined in accordance with GAAP, (d) Borrower-only deferred income tax (or less benefits) during such period, (e) expense (or less benefits) of the Borrower only attributable to interest rate Hedging Agreements for such period, as determined in accordance with GAAP, (f) non-cash compensation expense of the Borrower only for such period, as determined in accordance with GAAP, and (g) losses (or less gains) attributable to the retirement of Debt of the Borrower only for such period, as determined in accordance with GAAP.
“Transactions” means the execution, delivery and performance by the Borrower of this Agreement and the other Credit Documents to which it is a party, the borrowing of Loans and the use of the proceeds thereof.
“Trust Preferred Securities” means mandatorily redeemable preferred securities issued by one or more Delaware business trusts that are Affiliates of the Borrower (including, without limitation, Effective Date Trust Preferred Securities), to which trusts the Borrower has issued Trust
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Preferred Securities Notes, provided, that no such preferred securities shall be mandatorily redeemable earlier than November 18, 2014.
“Trust Preferred Securities Notes” means (a) the unsecured junior subordinated deferrable interest notes issued by the Borrower to evidence loans made to the Borrower by the issuers of the Trust Preferred Securities from the proceeds of the sale of such Trust Preferred Securities under and pursuant to any of the Effective Date Trust Preferred Securities and (b) any subsequent unsecured junior subordinated deferrable interest notes issued by the Borrower to evidence loans made to the Borrower by the issuers of the Trust Preferred Securities from the proceeds of the sale of such Trust Preferred Securities, which notes are governed by indentures in all material respects equivalent (other than the face amount of such debentures) to that certain Junior Subordinated Indenture dated June 15, 2005 between the Borrower and JPMorgan Chase Bank, N.A., as trustee.
“Type”, when used in reference to any Loan or Borrowing, refers to whether the rate of interest on such Loan, or on the Loans comprising such Borrowing, is determined by reference to the Adjusted LIBO Rate or the Alternate Base Rate.
“U.S. Person” means a "United States" person within the meaning of Section 7701(a)(30) of the Code.
“U.S. Tax Certificate” has the meaning assigned to such term in Section 2.14(f)(ii)(D)(2).
“USA Patriot Act” means the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Public Law 107-56, as the same has been, or shall hereafter be, renewed, extended, amended or replaced.
“Wholly-Owned Subsidiary” means, with respect to any Person, any corporation, partnership or other entity of which all of the equity securities or other ownership interests (other than, in the case of a corporation, directors' qualifying shares) are directly or indirectly owned or controlled by such Person or one or more Wholly Owned Subsidiaries of such Person or by such Person and one or more Wholly Owned Subsidiaries of such Person.
“Withdrawal Liability” means liability to a Multiemployer Plan as a result of a complete or partial withdrawal from such Multiemployer Plan, as such terms are defined in Part I of Subtitle E of Title IV of ERISA.
“Withholding Agent” means the Borrower and the Administrative Agent.
SECTION 1.02. Classification of Loans and Borrowings. For purposes of this Agreement, Loans may be classified and referred to by Class (e.g., a “Revolving Loan”) or by Type (e.g., a “Eurodollar Loan”) or by Class and Type (e.g., a “Eurodollar Revolving Loan”). Borrowings also may be classified and referred to by Class (e.g., a “Revolving Borrowing”) or by Type (e.g., a “Eurodollar Borrowing”) or by Class and Type (e.g., a “Eurodollar Revolving Borrowing”).
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SECTION 1.03. Terms Generally. The definitions of terms herein shall apply equally to the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words “include”, “includes” and “including” shall be deemed to be followed by the phrase “without limitation”. The word “will” shall be construed to have the same meaning and effect as the word “shall”. Unless the context requires otherwise (a) any definition of or reference to any agreement, instrument or other document herein shall be construed as referring to such agreement, instrument or other document as from time to time amended, supplemented or otherwise modified (subject to any restrictions on such amendments, supplements or modifications set forth herein), (b) any reference to any statute or regulation shall be construed as including all statutory and regulatory provisions amending, replacing, supplementing or interpreting such statute or regulation, (c) any reference herein to any Person shall be construed to include such Person's successors and assigns, (d) the words “herein”, “hereof” and “hereunder”, and words of similar import, shall be construed to refer to this Agreement in its entirety and not to any particular provision hereof, (e) all references herein to Articles, Sections, Exhibits and Schedules shall be construed to refer to Articles and Sections of, and Exhibits and Schedules to, this Agreement and (f) the words “asset” and “property” shall be construed to have the same meaning and effect and to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights.
SECTION 1.04. Accounting Terms.
(a) Except as otherwise expressly provided herein, all accounting terms used herein shall be interpreted, and all financial statements and certificates and reports as to financial matters required to be delivered to the Administrative Agent hereunder shall (unless otherwise disclosed to the Administrative Agent in writing at the time of delivery thereof in the manner described in subsection (b) below) be prepared in accordance with accounting principles or with statutory accounting practices applied on a basis consistent with those used in the preparation of the latest financial statements furnished to the Administrative Agent hereunder (which, prior to the delivery of the first financial statements under Section 5.01 hereof, shall mean the audited, or annual statutory, financial statements as at December 31, 2009 referred to in Section 3.04 hereof). All calculations made for the purposes of determining compliance with this Agreement shall (except as otherwise expressly provided herein) be made by application of accounting principles or with statutory accounting practices applied on a basis consistent with those used in the preparation of the latest annual or quarterly financial statements furnished to the Administrative Agent pursuant to Section 5.01 hereof (or, prior to the delivery of the first financial statements under Section 5.01 hereof, used in the preparation of the audited, or annual statutory, financial statements as at December 31, 2009 referred to in Section 3.04 hereof) or as promulgated by the Applicable Insurance Regulatory Authority on or prior to such date unless (i) the Borrower shall have objected to determining such compliance on such basis at the time of delivery of such financial statements or (ii) the Required Lenders (through the Administrative Agent) shall so object in writing within 30 days after delivery of such financial statements, in either of which events such calculations shall be made on a basis consistent with those used in the preparation of the latest financial statements as to which such objection shall not have been made (which, if objection is made in respect of the first financial statements delivered under Section 5.01 hereof, shall mean the audited, or annual statutory, financial statements referred to in Section 3.04 hereof) or, alternatively, such financial covenant (or related
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definition) shall be amended in a manner satisfactory to Borrower and Required Lenders to reflect such changed calculation. Notwithstanding the foregoing, all financial statements delivered hereunder shall be prepared, and all financial covenants contained herein shall be calculated, without giving effect to any election under accounting principles permitting a Person to value its financial liabilities or Indebtedness at the fair value thereof.
(b) The Borrower shall deliver to the Administrative Agent at the same time as the delivery of any annual or quarterly financial statements under Section 5.01 hereof (i) a description in reasonable detail of any material variation between the application of accounting principles or statutory accounting practices employed in the preparation of such statements and the application of accounting principles or statutory accounting practices employed in the preparation of the next preceding annual or quarterly financial statements as to which no objection has been made in accordance with the last sentence of subsection (a) above and (ii) reasonable estimates of the difference between such statements arising as a consequence thereof.
ARTICLE II
The Credits
SECTION 2.01. Commitments. Subject to the terms and conditions set forth herein, each Lender agrees to make Revolving Loans to the Borrower from time to time during the Availability Period in an aggregate principal amount that will not result in (a) such Lender's Revolving Loans exceeding such Lender's Commitment or (b) the sum of the total Revolving Loans exceeding the total Commitments. Within the foregoing limits and subject to the terms and conditions set forth herein, the Borrower may borrow, prepay and reborrow Revolving Loans.
SECTION 2.02. Loans and Borrowings. (a) Each Revolving Loan shall be made as part of a Borrowing consisting of Revolving Loans made by the Lenders ratably in accordance with their respective Commitments. The failure of any Lender to make any Loan required to be made by it shall not relieve any other Lender of its obligations hereunder; provided that the Commitments of the Lenders are several and no Lender shall be responsible for any other Lender's failure to make Loans as required.
(b) Subject to Section 2.11, each Revolving Borrowing shall be comprised entirely of ABR Loans or Eurodollar Loans as the Borrower may request in accordance herewith. Each Lender at its option may make any Eurodollar Loan by causing any domestic or foreign branch or Affiliate of such Lender to make such Loan; provided that any exercise of such option shall not affect the obligation of the Borrower to repay such Loan in accordance with the terms of this Agreement.
(c) At the commencement of each Interest Period for any Eurodollar Revolving Borrowing, such Borrowing shall be in an aggregate amount that is an integral multiple of $500,000 and not less than $2,500,000. At the time that each ABR Revolving Borrowing is made, such Borrowing shall be in an aggregate amount that is an integral multiple of $500,000 and not less
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than $2,500,000; provided that an ABR Revolving Borrowing may be in an aggregate amount that is equal to the entire unused balance of the total Commitments. Borrowings of more than one Type may be outstanding at the same time; provided that there shall not at any time be more than a total of five (5) Eurodollar Revolving Borrowings outstanding.
(d) Notwithstanding any other provision of this Agreement, the Borrower shall not be entitled to request, or to elect to convert or continue, any Borrowing if the Interest Period requested with respect thereto would end after the Maturity Date.
SECTION 2.03. Requests for Revolving Borrowings. To request a Revolving Borrowing, the Borrower shall notify the Administrative Agent of such request by telephone (a) in the case of a Eurodollar Borrowing, not later than 11:00 a.m., New York City time, three Business Days before the date of the proposed Borrowing or (b) in the case of an ABR Borrowing, not later than 11:00 a.m., New York City time, one Business Day before the date of the proposed Borrowing. Each such telephonic Borrowing Request shall be irrevocable and shall be confirmed promptly by hand delivery or telecopy to the Administrative Agent of a written Borrowing Request in a form approved by the Administrative Agent and signed by the Borrower. Each such telephonic and written Borrowing Request shall be in the form of Exhibit B and shall specify the following information in compliance with Section 2.02:
(i)the aggregate amount of the requested Borrowing;
(ii)the date of such Borrowing, which shall be a Business Day;
(iii)whether such Borrowing is to be an ABR Borrowing or a Eurodollar Borrowing;
(iv)in the case of a Eurodollar Borrowing, the initial Interest Period to be applicable thereto, which shall be a period contemplated by the definition of the term “Interest Period”; and
(v)the location and number of the Borrower's account to which funds are to be disbursed, which shall comply with the requirements of Section 2.04.
If no election as to the Type of Revolving Borrowing is specified, then the requested Revolving Borrowing shall be an ABR Borrowing. If no Interest Period is specified with respect to any requested Eurodollar Revolving Borrowing, then the Borrower shall be deemed to have selected an Interest Period of one month's duration. Promptly following receipt of a Borrowing Request in accordance with this Section, the Administrative Agent shall advise each Lender of the details thereof and of the amount of such Lender's Loan to be made as part of the requested Borrowing.
SECTION 2.04. Funding of Borrowings. (a) Each Lender shall make each Loan to be made by it hereunder on the proposed date thereof by wire transfer of immediately available funds by 12:00 noon, New York City time, to the account of the Administrative Agent most recently designated by it for such purpose by notice to the Lenders. The Administrative Agent will make such Loans available to the Borrower by promptly crediting the amounts so received, in like funds,
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to an account of the Borrower maintained with the Administrative Agent in New York City and designated by the Borrower in the applicable Borrowing Request.
(b) Unless the Administrative Agent shall have received notice from a Lender prior to the proposed date of any Borrowing that such Lender will not make available to the Administrative Agent such Lender's share of such Borrowing, the Administrative Agent may assume that such Lender has made such share available on such date in accordance with paragraph (a) of this Section and may, in reliance upon such assumption, make available to the Borrower a corresponding amount. In such event, if a Lender has not in fact made its share of the applicable Borrowing available to the Administrative Agent, then the applicable Lender and the Borrower severally agree to pay to the Administrative Agent forthwith on demand such corresponding amount with interest thereon, for each day from and including the date such amount is made available to the Borrower to but excluding the date of payment to the Administrative Agent, at (i) in the case of such Lender, the greater of the Federal Funds Effective Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation or (ii) in the case of the Borrower, the interest rate applicable to ABR Loans. If such Lender pays such amount to the Administrative Agent, then such amount shall constitute such Lender's Loan included in such Borrowing.
SECTION 2.05. Interest Elections. (a) Each Revolving Borrowing initially shall be of the Type specified in the applicable Borrowing Request and, in the case of a Eurodollar Revolving Borrowing, shall have an initial Interest Period as specified in such Borrowing Request. Thereafter, the Borrower may elect to convert such Borrowing to a different Type or to continue such Borrowing and, in the case of a Eurodollar Revolving Borrowing, may elect Interest Periods therefor, all as provided in this Section. Subject to the requirements of Section 2.02(c), the Borrower may elect different options with respect to different portions of the affected Borrowing, in which case each such portion shall be allocated ratably among the Lenders holding the Loans comprising such Borrowing, and the Loans comprising each such portion shall be considered a separate Borrowing.
(b) To make an election pursuant to this Section, the Borrower shall notify the Administrative Agent of such election by telephone by the time that a Borrowing Request would be required under Section 2.03 if the Borrower were requesting a Revolving Borrowing of the Type resulting from such election to be made on the effective date of such election. Each such telephonic Interest Election Request shall be irrevocable and shall be confirmed promptly by hand delivery or telecopy to the Administrative Agent of a written Interest Election Request in a form approved by the Administrative Agent and signed by the Borrower.
(c) Each telephonic and written Interest Election Request shall specify the following information in compliance with Section 2.02:
(i) the Borrowing to which such Interest Election Request applies and, if different options are being elected with respect to different portions thereof, the portions thereof to be allocated to each resulting Borrowing (in which case the information to be specified pursuant to clauses (iii) and (iv) below shall be specified for each resulting Borrowing);
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(ii) the effective date of the election made pursuant to such Interest Election Request, which shall be a Business Day;
(iii) whether the resulting Borrowing is to be an ABR Borrowing or a Eurodollar Borrowing; and
(iv) if the resulting Borrowing is a Eurodollar Borrowing, the Interest Period to be applicable thereto after giving effect to such election, which shall be a period contemplated by the definition of the term “Interest Period”.
If any such Interest Election Request requests a Eurodollar Borrowing but does not specify an Interest Period, then the Borrower shall be deemed to have selected an Interest Period of one month's duration.
(d) Promptly following receipt of an Interest Election Request, the Administrative Agent shall advise each Lender of the details thereof and of such Lender's portion of each resulting Borrowing.
(e) If the Borrower fails to deliver a timely Interest Election Request with respect to a Eurodollar Revolving Borrowing prior to the end of the Interest Period applicable thereto, then, unless such Borrowing is repaid as provided herein, at the end of such Interest Period such Borrowing shall be converted to an ABR Borrowing. Notwithstanding any contrary provision hereof, if an Event of Default has occurred and is continuing and the Administrative Agent, at the request of the Required Lenders, so notifies the Borrower, then, so long as an Event of Default is continuing (i) no outstanding Revolving Borrowing may be converted to or continued as a Eurodollar Borrowing and (ii) unless repaid, each Eurodollar Revolving Borrowing shall be converted to an ABR Borrowing at the end of the Interest Period applicable thereto.
SECTION 2.06. Termination and Reduction of Commitments. (a) Unless previously terminated, the Commitments shall terminate on the Maturity Date.
(b) The Borrower may at any time terminate, or from time to time reduce, the Commitments; provided that (i) each reduction of the Commitments shall be in an amount that is an integral multiple of $1,000,000 and not less than $5,000,000, and (ii) the Borrower shall not terminate or reduce the Commitments if, after giving effect to any concurrent prepayment of the Loans in accordance with Section 2.08, the sum of the Revolving Loans then outstanding would exceed the total Commitments.
(c) The Borrower shall notify the Administrative Agent of any election to terminate or reduce the Commitments under paragraph (b) of this Section at least three Business Days prior to the effective date of such termination or reduction, specifying such election and the effective date thereof. Promptly following receipt of any notice, the Administrative Agent shall advise the Lenders of the contents thereof. Each notice delivered by the Borrower pursuant to this Section shall be irrevocable; provided that a notice of termination of the Commitments delivered by the Borrower may state that such notice is conditioned upon the effectiveness of other credit facilities, in which case such notice may be revoked by the Borrower (by notice to the Administrative Agent
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on or prior to the specified effective date) if such condition is not satisfied. Any termination or reduction of the Commitments shall be permanent. Each reduction of the Commitments shall be made ratably among the Lenders in accordance with their respective Commitments.
(d) The Borrower may, from time to time, on up to three occasions, at its option, seek to increase the total Commitments by up to an aggregate amount of $50,000,000 (resulting in maximum total Commitments of $200,000,000) upon at least thirty (30) days' prior written notice to the Administrative Agent, which notice shall specify the amount of any such increase and shall be delivered at a time when no Default has occurred and is continuing. After delivery of such notice, the Administrative Agent or the Borrower, in consultation with the Administrative Agent, may offer the increase (which may be declined by any Lender in its sole discretion) in the total Commitments on either a ratable basis to the Lenders or on a non pro-rata basis to one or more Lenders and/or to other Lenders or entities reasonably acceptable to the Administrative Agent and the Borrower. No increase in the total Commitments shall become effective until the existing or new Lenders extending such incremental Commitment amount and the Borrower shall have delivered to the Administrative Agent a document in form reasonably satisfactory to the Administrative Agent (which shall include the Borrower's representation that the conditions set forth in Section 4.02 are then satisfied) pursuant to which any such existing Lender states the amount of its Commitment increase, any such new Lender states its Commitment amount and agrees to assume and accept the obligations and rights of a Lender hereunder and the Borrower accepts such incremental Commitments. Upon the effectiveness of any increase in the total Commitments pursuant hereto, each Lender (new or existing) with an increased or new Commitment shall be deemed to have accepted an assignment from the existing Lenders, and the existing Lenders shall be deemed to have made an assignment to each new or existing Lender accepting a new or increased Commitment, of a ratable interest in each then outstanding Revolving Loan (in each case, on the terms and conditions set forth in the Assignment and Assumption). Assignments pursuant to the preceding sentence shall be made in exchange for, and substantially contemporaneously with the payment to the assigning Lenders of, the principal amount assigned plus accrued and unpaid interest and commitment fees. Payments received by assigning Lenders pursuant to this Section in respect of the principal amount of any Eurodollar Loan shall, for purposes of Section 2.13, be deemed prepayments of such Loan. Any increase of the total Commitments pursuant to this Section shall be subject to receipt by the Administrative Agent from the Borrower of such supplemental opinions, resolutions, certificates and other documents as the Administrative Agent may reasonably request.
SECTION 2.07. Repayment of Loans; Evidence of Debt. (a) The Borrower hereby unconditionally promises to pay to the Administrative Agent for the account of each Lender the then unpaid principal amount of each Revolving Loan on the Maturity Date.
(b) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Borrower to such Lender resulting from each Loan made by such Lender, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder.
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(c) The Administrative Agent shall maintain accounts in which it shall record (i) the amount of each Loan made hereunder, the Class and Type thereof and the Interest Period applicable thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iii) the amount of any sum received by the Administrative Agent hereunder for the account of the Lenders and each Lender's share thereof.
(d) The entries made in the accounts maintained pursuant to paragraph (b) or (c) of this Section shall be prima facie evidence of the existence and amounts of the obligations recorded therein; provided that the failure of any Lender or the Administrative Agent to maintain such accounts or any error therein shall not in any manner affect the obligation of the Borrower to repay the Loans in accordance with the terms of this Agreement.
(e) Any Lender may request that Loans made by it be evidenced by a promissory note in the form of Exhibit C hereto. In such event, the Borrower shall prepare, execute and deliver to such Lender a promissory note payable to the order of such Lender (or, if requested by such Lender, to such Lender and its registered assigns) and in such form or as otherwise approved by the Administrative Agent and such Lender. Thereafter, the Loans evidenced by such promissory note and interest thereon shall at all times (including after assignment pursuant to Section 9.04) be represented by one or more promissory notes in such form payable to the order of the payee named therein (or, if such promissory note is a registered note, to such payee and its registered assigns).
(f) If at any time the aggregate Revolving Loans of the Lenders exceeds the aggregate Commitments of the Lenders, the Borrower shall immediately prepay the Revolving Loans in the amount of such excess.
SECTION 2.08. Prepayment of Loans. (a) The Borrower shall have the right at any time and from time to time to prepay any Borrowing in whole or in part, subject to prior notice in accordance with paragraph (b) of this Section.
(b) The Borrower shall notify the Administrative Agent by telephone (confirmed by telecopy) of any prepayment hereunder (i) in the case of prepayment of a Eurodollar Revolving Borrowing, not later than 11:00 a.m., New York City time, three Business Days before the date of prepayment or (ii) in the case of prepayment of an ABR Revolving Borrowing, not later than 11:00 a.m., New York City time, one Business Day before the date of prepayment. Each such notice shall be irrevocable and shall specify the prepayment date and the principal amount of each Borrowing or portion thereof to be prepaid; provided that, if a notice of prepayment is given in connection with a conditional notice of termination of the Commitments as contemplated by Section 2.06(c), then such notice of prepayment may be revoked if such notice of termination is revoked in accordance with Section 2.06(c). Promptly following receipt of any such notice relating to a Revolving Borrowing, the Administrative Agent shall advise the Lenders of the contents thereof. Each partial prepayment of any Revolving Borrowing shall be in an amount that would be permitted in the case of an advance of a Revolving Borrowing of the same Type as provided in Section 2.02. Each prepayment of a Revolving Borrowing shall be applied ratably to the Loans included in the prepaid Borrowing. Prepayments shall be accompanied by accrued interest to the extent required by Section 2.10.
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SECTION 2.09. Fees. (a) The Borrower agrees to pay to the Administrative Agent for the account of each Lender a commitment fee, which shall accrue at the Applicable Rate on the daily amount of the difference between the Commitment of such Lender and the outstanding principal balance of the Loans of such Lender during the period from and including the Effective Date to but excluding the date on which such Commitment terminates. Accrued commitment fees shall be payable in arrears on the last day of March, June, September and December of each year and on the date on which the Commitments terminate, commencing on the first such date to occur after the date hereof. All commitment fees shall be computed on the basis of a year of 360 days and shall be payable for the actual number of days elapsed (including the first day but excluding the last day).
(b) The Borrower agrees to pay to the Administrative Agent, for its own account, fees payable in the amounts and at the times separately agreed upon between the Borrower and the Administrative Agent.
(c) The Borrower agrees to pay to SunTrust Bank, for its own account, fees payable in the amounts and at the times separately agreed upon between the Borrower, SunTrust Robinson Humphrey, Inc. and SunTrust Bank.
(d) All commitment fees payable hereunder shall be paid on the dates due, in immediately available funds, to the Administrative Agent for distribution to the Lenders. Fees paid shall not be refundable under any circumstances.
SECTION 2.10. Interest. (a) The Loans comprising each ABR Borrowing shall bear interest at the Alternate Base Rate plus the Applicable Rate.
(b) The Loans comprising each Eurodollar Borrowing shall bear interest at the Adjusted LIBO Rate for the Interest Period in effect for such Borrowing plus the Applicable Rate.
(c) Notwithstanding the foregoing, if any principal of or interest on any Loan or any fee or other amount payable by the Borrower hereunder is not paid when due, whether at stated maturity, upon acceleration or otherwise, such overdue amount shall bear interest, after as well as before judgment, at a rate per annum equal to (i) in the case of overdue principal of any Loan, 2% plus the rate otherwise applicable to such Loan as provided in the preceding paragraphs of this Section or (ii) in the case of any other amount, 2% plus the rate applicable to ABR Loans as provided in paragraph (a) of this Section.
(d) Accrued interest on each Loan shall be payable in arrears on each Interest Payment Date for such Loan and upon termination of the Commitments; provided that (i) interest accrued pursuant to paragraph (c) of this Section shall be payable on demand, (ii) in the event of any repayment or prepayment of any Loan (other than a prepayment of an ABR Loan prior to the end of the Availability Period), accrued interest on the principal amount repaid or prepaid shall be payable on the date of such repayment or prepayment and (iii) in the event of any conversion of any Eurodollar Loan prior to the end of the current Interest Period therefor, accrued interest on such Loan shall be payable on the effective date of such conversion.
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(e) All interest hereunder shall be computed on the basis of a year of 360 days, except that interest computed by reference to the Alternate Base Rate at times when the Alternate Base Rate is based on the Prime Rate shall be computed on the basis of a year of 365 days (or 366 days in a leap year), and in each case shall be payable for the actual number of days elapsed (including the first day but excluding the last day). The applicable Alternate Base Rate or Adjusted LIBO Rate shall be determined by the Administrative Agent, and such determination shall be conclusive absent manifest error.
SECTION 2.11. Alternate Rate of Interest. If prior to the commencement of any Interest Period for a Eurodollar Borrowing:
(a) the Administrative Agent determines (which determination shall be conclusive absent manifest error) that adequate and reasonable means do not exist for ascertaining the Adjusted LIBO Rate for such Interest Period; or
(b) the Administrative Agent is advised by the Required Lenders that the Adjusted LIBO Rate for such Interest Period will not adequately and fairly reflect the cost to such Lenders (or Lender) of making or maintaining their Loans (or its Loan) included in such Borrowing for such Interest Period;
then the Administrative Agent shall give notice thereof to the Borrower and the Lenders by telephone or telecopy as promptly as practicable thereafter and, until the Administrative Agent notifies the Borrower and the Lenders that the circumstances giving rise to such notice no longer exist, (i) any Interest Election Request that requests the conversion of any Revolving Borrowing to, or continuation of any Revolving Borrowing as, a Eurodollar Borrowing shall be ineffective and (ii) if any Borrowing Request requests a Eurodollar Revolving Borrowing, such Borrowing shall be made as an ABR Borrowing; provided that if the circumstances giving rise to such notice affect only one Type of Borrowings, then the other Type of Borrowings shall be permitted.
SECTION 2.12. Increased Costs. (a) If any Change in Law shall:
(i) impose, modify or deem applicable any reserve, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender (except any such reserve requirement reflected in the Adjusted LIBO Rate);
(ii) impose on any Lender or the London interbank market any other condition affecting this Agreement or Eurodollar Loans made by such Lender; or
(iii) subject any Recipient to any Taxes (other than (A) Indemnified Taxes and (B) Other Connection Taxes on gross or net income, profits or revenue (including value-added or similar Taxes)) on its loans, loan principal, letters of credit, commitments, or other obligations, or its deposits, reserves, other liabilities or capital attributable thereto;
and the result of any of the foregoing shall be to increase the cost to such Lender or such other Recipeint of making or maintaining any Eurodollar Loan (or of maintaining its obligation to make any such Loan) or to increase the cost to such Lender or such other Recipient or to reduce the amount
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of any sum received or receivable by such Lender or such other Recipient hereunder (whether of principal, interest or otherwise), then the Borrower will pay to such Lender or such other Recipient, as the case may be, such additional amount or amounts as will compensate such Lender or other Recipient for such additional costs incurred or reduction suffered.
(b) If any Lender determines that any Change in Law regarding capital requirements has or would have the effect of reducing the rate of return on such Lender's capital or on the capital of such Lender's holding company, if any, as a consequence of this Agreement or the Loans made by such Lender, to a level below that which such Lender or such Lender's holding company could have achieved but for such Change in Law (taking into consideration such Lender's policies and the policies of such Lender's holding company with respect to capital adequacy), then from time to time the Borrower will pay to such Lender such additional amount or amounts as will compensate such Lender or such Lender's holding company for any such reduction suffered.
(c) A certificate of a Lender setting forth the amount or amounts necessary to compensate such Lender or its holding company, as the case may be, as specified in paragraph (a) or (b) of this Section shall be delivered to the Borrower and shall be conclusive absent manifest error. The Borrower shall pay such Lender the amount shown as due on any such certificate within 10 days after receipt thereof.
(d) Failure or delay on the part of any Lender to demand compensation pursuant to this Section shall not constitute a waiver of such Lender's right to demand such compensation; provided that the Borrower shall not be required to compensate a Lender pursuant to this Section for any increased costs or reductions incurred more than 270 days prior to the date that such Lender notifies the Borrower of the Change in Law giving rise to such increased costs or reductions and of such Lender's intention to claim compensation therefor; provided further that, if the Change in Law giving rise to such increased costs or reductions is retroactive, then the 270-day period referred to above shall be extended to include the period of retroactive effect thereof.
SECTION 2.13. Break Funding Payments. In the event of (a) the payment of any principal of any Eurodollar Loan other than on the last day of an Interest Period applicable thereto (including as a result of an Event of Default), (b) the conversion of any Eurodollar Loan other than on the last day of the Interest Period applicable thereto, (c) the failure to borrow, convert, continue or prepay any Eurodollar Loan on the date specified in any notice delivered pursuant hereto (regardless of whether such notice may be revoked under Section 2.08(b) and is revoked in accordance therewith) or (d) the assignment of any Eurodollar Loan other than on the last day of the Interest Period applicable thereto as a result of a request by the Borrower pursuant to Section 2.16, then, in any such event, the Borrower shall compensate each Lender for the loss, cost and expense attributable to such event. In the case of a Eurodollar Loan, such loss, cost or expense to any Lender shall be deemed to include an amount determined by such Lender to be the excess, if any, of (i) the amount of interest which would have accrued on the principal amount of such Loan had such event not occurred, at the Adjusted LIBO Rate that would have been applicable to such Loan, for the period from the date of such event to the last day of the then current Interest Period therefor (or, in the case of a failure to borrow, convert or continue, for the period that would have been the Interest Period for such Loan), over (ii) the amount of interest which would accrue on such
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principal amount for such period at the interest rate which such Lender would bid were it to bid, at the commencement of such period, for dollar deposits of a comparable amount and period from other banks in the eurodollar market. A certificate of any Lender setting forth any amount or amounts that such Lender is entitled to receive pursuant to this Section shall be delivered to the Borrower and shall be conclusive absent manifest error. The Borrower shall pay such Lender the amount shown as due on any such certificate within 10 days after receipt thereof.
SECTION 2.14 Taxes. (a) Each payment by the Borrower under this Agreement shall be made without withholding for any Taxes, unless such withholding is required by any law. If any Withholding Agent determines, in its sole discretion exercised in good faith, that it is so required to withhold Taxes, then such Withholding Agent may so withhold and shall timely pay the full amount of withheld Taxes to the relevant Governmental Authority in accordance with applicable law. If such Taxes are Indemnified Taxes, then the amount payable by the Borrower shall be increased as necessary so that, net of such withholding (including such withholding applicable to additional amounts payable under this Section), the applicable Recipient receives the amount it would have received had no such withholding been made.
(b) The Borrower shall timely pay any Other Taxes to the relevant Governmental Authority in accordance with applicable law.
(c) As soon as practicable after any payment of Indemnified Taxes by the Borrower to a Governmental Authority, such Borrower shall deliver to the Administrative Agent the original or a certified copy of a receipt issued by such Governmental Authority evidencing such payment, a copy of the return reporting such payment or other evidence of such payment reasonably satisfactory to the Administrative Agent.
(d) The Borrower shall indemnify each Recipient for any Indemnified Taxes that are paid or payable by such Recipient in connection with this Agreement (including amounts paid or payable under this Section 2.14(d)) and any reasonable expenses arising therefrom or with respect thereto, whether or not such Indemnified Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. The indemnity under this Section 2.14(d) shall be paid within 10 days after the Recipient delivers to the Borrower a certificate stating the amount of any Indemnified Taxes so paid or payable by such Recipient and describing the basis for the indemnification claim. Such certificate shall be conclusive of the amount so paid or payable absent manifest error. Such Recipient shall deliver a copy of such certificate to the Administrative Agent.
(e) Each Lender shall severally indemnify the Administrative Agent for any Taxes (but, in the case of any Indemnified Taxes, only to the extent that the Borrower has not already indemnified the Administrative Agent for such Indemnified Taxes and without limiting the obligation of the Borrower to do so) attributable to such Lender that are paid or payable by the Administrative Agent in connection with this Agreement and any reasonable expenses arising therefrom or with respect thereto, whether or not such Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. The indemnity under this Section 2.14(e) shall be paid within 10 days after the Administrative Agent delivers to the applicable Lender a certificate stating the amount of Taxes so paid or payable by the Administrative Agent. Such certificate shall
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be conclusive of the amount so paid or payable absent manifest error.
(f)Status of Lenders.
(i) Any Lender that is entitled to an exemption from, or reduction of, any applicable withholding Tax with respect to any payments under this Agreement shall deliver to the Borrower and the Administrative Agent, at the time or times reasonably requested by the Borrower or the Administrative Agent, such properly completed and executed documentation reasonably requested by the Borrower or the Administrative Agent as will permit such payments to be made without, or at a reduced rate of, withholding. In addition, any Lender, if requested by the Borrower or the Administrative Agent, shall deliver such other documentation prescribed by law or reasonably requested by the Borrower or the Administrative Agent as will enable the Borrower or the Administrative Agent to determine whether or not such Lender is subject to any withholding (including backup withholding) or information reporting requirements. Notwithstanding anything to the contrary in the preceding two sentences, the completion, execution and submission of such documentation (other than such documentation set forth in Section 2.14(f)(ii)(A) through (E) below) shall not be required if in the Lender's judgment such completion, execution or submission would subject such Lender to any material unreimbursed cost or expense (or, in the case of a Change in Law, any incremental material unreimbursed cost or expense) or would materially prejudice the legal or commercial position of such Lender. Upon the reasonable request of such Borrower or the Administrative Agent, any Lender shall update any form or certification previously delivered pursuant to this Section 2.14(f). If any form or certification previously delivered pursuant to this Section expires or becomes obsolete or inaccurate in any respect with respect to a Lender, such Lender shall promptly (and in any event within 10 days after such expiration, obsolescence or inaccuracy) notify such Borrower and the Administrative Agent in writing of such expiration, obsolescence or inaccuracy and update the form or certification if it is legally eligible to do so.
(ii) Without limiting the generality of the foregoing, if the Borrower is a U.S. Person, any Lender with respect to such Borrower shall, if it is legally eligible to do so, deliver to such Borrower and the Administrative Agent (in such number of copies reasonably requested by such Borrower and the Administrative Agent) on or prior to the date on which such Lender becomes a party hereto, duly completed and executed copies of whichever of the following is applicable:
(A) in the case of a Lender that is a U.S. Person, IRS Form W-9 certifying that such Lender is exempt from U.S. Federal backup withholding tax;
(B) in the case of a Non-U.S. Lender claiming the benefits of an income tax treaty to which the United States is a party (1) with respect to payments of interest under this Agreement, IRS Form W-8BEN establishing an exemption from, or reduction of, U.S. Federal withholding Tax pursuant to the "interest" article of such tax treaty and (2) with respect to any other applicable payments under this Agreement, IRS Form W-8BEN establishing an exemption from, or reduction of,
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U.S. Federal withholding Tax pursuant to the "business profits" or "other income" article of such tax treaty;
(C) in the case of a Non-U.S. Lender for whom payments under this Agreement constitute income that is effectively connected with such Lender's conduct of a trade or business in the United States, IRS Form W-8ECI;
(D) in the case of a Non-U.S. Lender claiming the benefits of the exemption for portfolio interest under Section 881(c) of the Code both (1) IRS Form W-8BEN and (2) a certificate substantially in the form of Exhibit D (a "U.S. Tax Certificate") to the effect that such Lender is not (a) a "bank" within the meaning of Section 881(c)(3)(A) of the Code, (b) a "10 percent shareholder" of the Borrower within the meaning of Section 881(c)(3)(B) of the Code (c) a "controlled foreign corporation" described in Section 881(c)(3)(C) of the Code and (d) conducting a trade or business in the United States with which the relevant interest payments are effectively connected;
(E) in the case of a Non-U.S. Lender that is not the beneficial owner of payments made under this Agreement (including a partnership or a participating Lender) (1) an IRS Form W-8IMY on behalf of itself and (2) the relevant forms prescribed in clauses (A), (B), (C), (D) and (F) of this paragraph (f)(ii) that would be required of each such beneficial owner or partner of such partnership if such beneficial owner or partner were a Lender; provided, however, that if the Lender is a partnership and one or more of its partners are claiming the exemption for portfolio interest under Section 881(c) of the Code, such Lender may provide a U.S. Tax Certificate on behalf of such partners; or
(F) any other form prescribed by law as a basis for claiming exemption from, or a reduction of, U.S. Federal withholding Tax together with such supplementary documentation necessary to enable the Borrower or the Administrative Agent to determine the amount of Tax (if any) required by law to be withheld.
(iii) If a payment made to a Lender under this Agreement would be subject to U.S. Federal withholding Tax imposed by FATCA if such Lender were to fail to comply with the applicable reporting requirements of FATCA (including those contained in Section 1471(b) or 1472(b) of the Code, as applicable), such Lender shall deliver to the Withholding Agent, at the time or times prescribed by law and at such time or times reasonably requested by the Withholding Agent, such documentation prescribed by applicable law (including as prescribed by Section 1471(b)(3)(C)(i) of the Code) and such additional documentation reasonably requested by the Withholding Agent as may be necessary for the Withholding Agent to comply with its obligations under FATCA, to determine that such Lender has or has not complied with such Lender's obligations under FATCA or to determine the amount to deduct and withhold from such payment. Solely for purposes of this Section 2.17(f)(iii), “FATCA” shall include any amendments made to FATCA after the date of this Agreement.
(g) If any party determines, in its sole discretion exercised in good faith, that it has received a refund of any Taxes as to which it has been indemnified pursuant to this Section 2.14
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(including additional amounts paid pursuant to this Section 2.14), it shall pay to the indemnifying party an amount equal to such refund (but only to the extent of indemnity payments made under this Section with respect to the Taxes giving rise to such refund), net of all out-of-pocket expenses (including any Taxes) of such indemnified party and without interest (other than any interest paid by the relevant Governmental Authority with respect to such refund). Such indemnifying party, upon the request of such indemnified party, shall repay to such indemnified party the amount paid to such indemnified party pursuant to the previous sentence (plus any penalties, interest or other charges imposed by the relevant Governmental Authority) in the event such indemnified party is required to repay such refund to such Governmental Authority. Notwithstanding anything to the contrary in this Section 2.14(g), in no event will any indemnified party be required to pay any amount to any indemnifying party pursuant to this Section 2.14(g) if such payment would place such indemnified party in a less favorable position (on a net after-Tax basis) than such indemnified party would have been in if the indemnification payments or additional amounts giving rise to such refund had never been paid. This Section 2.14(g) shall not be construed to require any indemnified party to make available its Tax returns (or any other information relating to its Taxes which it deems confidential) to the indemnifying party or any other Person.
(h) Each party's obligations under this Section 2.14 shall survive any assignment of rights by, or the replacement of, a Lender, the termination of the Commitments and the repayment, satisfaction or discharge of all other obligations under this Agreement.
SECTION 2.15. Payments Generally; Pro Rata Treatment; Sharing of Set-offs. (a) The Borrower shall make each payment required to be made by it hereunder (whether of principal, interest or fees, or of amounts payable under Section 2.12, 2.13 or 2.14, or otherwise) prior to 12:00 noon, New York City time, on the date when due, in immediately available funds, without set off or counterclaim. Any amounts received after such time on any date may, in the discretion of the Administrative Agent, be deemed to have been received on the next succeeding Business Day for purposes of calculating interest thereon. All such payments shall be made to the Administrative Agent at its offices at 270 Park Avenue, New York, New York, except that payments pursuant to Sections 2.12, 2.13, 2.14 and 9.03 shall be made directly to the Persons entitled thereto. The Administrative Agent shall distribute any such payments received by it for the account of any other Person to the appropriate recipient promptly following receipt thereof. If any payment hereunder shall be due on a day that is not a Business Day, the date for payment shall be extended to the next succeeding Business Day, and, in the case of any payment accruing interest, interest thereon shall be payable for the period of such extension. All payments hereunder shall be made in dollars.
(b) If at any time insufficient funds are received by and available to the Administrative Agent to pay fully all amounts of principal, interest and fees then due hereunder, such funds shall be applied (i) first, towards payment of interest and fees then due hereunder, ratably among the parties entitled thereto in accordance with the amounts of interest and fees then due to such parties, and (ii) second, towards payment of principal then due hereunder, ratably among the parties entitled thereto in accordance with the amounts of principal then due to such parties.
(c) If any Lender shall, by exercising any right of set off or counterclaim or otherwise, obtain payment in respect of any principal of or interest on any of its Loans hereunder resulting in
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such Lender receiving payment of a greater proportion of the aggregate amount of its Loans hereunder and accrued interest thereon than the proportion received by any other Lender, then the Lender receiving such greater proportion shall purchase (for cash at face value) participations in the Loans hereunder of other Lenders to the extent necessary so that the benefit of all such payments shall be shared by the Lenders ratably in accordance with the aggregate amount of principal of and accrued interest on their respective Loans hereunder; provided that (i) if any such participations are purchased and all or any portion of the payment giving rise thereto is recovered, such participations shall be rescinded and the purchase price restored to the extent of such recovery, without interest, and (ii) the provisions of this paragraph shall not be construed to apply to any payment made by the Borrower pursuant to and in accordance with the express terms of this Agreement or any payment obtained by a Lender as consideration for the assignment of or sale of a participation in any of its Loans hereunder to any assignee or participant, other than to the Borrower or any Subsidiary or Affiliate thereof (as to which the provisions of this paragraph shall apply). The Borrower consents to the foregoing and agrees, to the extent it may effectively do so under applicable law, that any Lender acquiring a participation pursuant to the foregoing arrangements may exercise against the Borrower rights of set-off and counterclaim with respect to such participation as fully as if such Lender were a direct creditor of the Borrower in the amount of such participation.
(d) Unless the Administrative Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Administrative Agent for the account of the Lenders that the Borrower will not make such payment, the Administrative Agent may assume that the Borrower has made such payment on such date in accordance herewith and may, in reliance upon such assumption, distribute to the Lenders, the amount due. In such event, if the Borrower has not in fact made such payment, then each of the Lenders severally agrees to repay to the Administrative Agent forthwith on demand the amount so distributed to such Lender with interest thereon, for each day from and including the date such amount is distributed to it to but excluding the date of payment to the Administrative Agent, at the greater of the Federal Funds Effective Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation.
(e) If any Lender shall fail to make any payment required to be made by it pursuant to Section 2.04(b), 2.15(d) or 9.03(c), then the Administrative Agent may, in its discretion (notwithstanding any contrary provision hereof), apply any amounts thereafter received by the Administrative Agent for the account of such Lender to satisfy such Lender's obligations under such Sections until all such unsatisfied obligations are fully paid.
SECTION 2.16. Mitigation Obligations; Replacement of Lenders. (a) If any Lender requests compensation under Section 2.12, or if the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 2.14, then such Lender shall use reasonable efforts to designate a different lending office for funding or booking its Loans hereunder or to assign its rights and obligations hereunder to another of its offices, branches or affiliates, if, in the judgment of such Lender, such designation or assignment (i) would eliminate or reduce amounts payable pursuant to Section 2.12 or 2.14, as the case may be, in the future and (ii) would not subject such Lender to any unreimbursed cost or expense and would not otherwise be disadvantageous to such Lender. The Borrower hereby agrees
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to pay all reasonable costs and expenses incurred by any Lender in connection with any such designation or assignment.
(b) If (i) any Lender requests compensation under Section 2.12 hereof, (ii) the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 2.14 hereof, (iii) any Lender becomes a Defaulting Lender or (iv) any Lender shall fail to consent to a departure or waiver of any provision of the Credit Documents or fail to agree to any amendment thereto, which waiver, consent or amendment requires the consent of all Lenders or of all Lenders directly affected thereby and has been consented to by the Required Lenders, then the Borrower may, at its sole expense and effort, upon notice to such Lender and the Administrative Agent, require such Lender to assign and delegate, without recourse (in accordance with and subject to the restrictions contained in Section 9.04 hereof, with the Borrower obligated to pay any applicable processing and recordation fee), all its interests, rights and obligations under this Agreement to an assignee that shall assume such obligations (which assignee may be another Lender, if a Lender accepts such assignment); provided that (A) the Borrower shall have received the prior written consent of the Administrative Agent, which consent shall not unreasonably be withheld, (B) such Lender shall have received payment of an amount equal to the outstanding principal of its Loans, accrued interest thereon, accrued fees and all other amounts payable to it hereunder, from the assignee (to the extent of such outstanding principal and accrued interest and fees) or the Borrower (in the case of all other amounts); provided however, that in the case of the Borrower's replacement of a Defaulting Lender for failure to fund Loans hereunder, the assignee or the Borrower, as the case may be, shall hold back from such amounts payable to such Lender and pay directly to the Administrative Agent, any payments due to the Administrative Agent or the non-Defaulting Lenders by the Defaulting Lender under this Agreement, (C) in the case of any such assignment resulting from a claim for compensation under Section 2.12 hereof or payments required to be made pursuant to Section 2.14 hereof, such assignment will result in a reduction in such compensation or payments, and (D) in the case of clause (iv) above, the applicable Assignee shall have agreed to the applicable departure, waiver or amendment of the Credit Documents. A Lender shall not be required to make any such assignment and delegation if, prior thereto, as a result of a waiver by such Lender or otherwise, the circumstances entitling the Borrower to require such assignment and delegation cease to apply.
SECTION 2.17. Defaulting Lenders.
Notwithstanding any provision of this Agreement to the contrary, if any Lender becomes a Defaulting Lender, then the following provisions shall apply for so long as such Lender is a Defaulting Lender:
(a) fees shall cease to accrue on the unfunded portion of the Commitment of such Defaulting Lender pursuant to Section 2.09(a); and
(b) the Commitment and outstanding principal amount of Revolving Loans of such Defaulting Lender shall not be included in determining whether all Lenders or the Required Lenders have taken or may take any action hereunder (including any consent to any amendment or waiver pursuant to Section 9.02), provided that any waiver, amendment or modification requiring the
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consent of all Lenders or each affected Lender which affects such Defaulting Lender differently than other affected Lenders shall require the consent of such Defaulting Lender, and provided further, that any waiver, amendment or modification requiring the consent of all Lenders or each affected Lender made pursuant to clause (i), (ii) or (iii) of the first proviso to Section 9.02(b) (but, in respect of such clauses (ii) and (iii), only to the extent relating to principal or interest) shall also require the consent of any such Lender which has become a Defaulting Lender.
ARTICLE IARTICLE III
Representations and Warranties
The Borrower represents and warrants to the Administrative Agent and the Lenders that:
SECTION 3.01. Organization; Powers. The Borrower and each of its Material Subsidiaries is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, has all requisite power and authority to carry on its business as now conducted and, except where failures to do so, in the aggregate, could not reasonably be expected to result in a Material Adverse Effect, is qualified to do business in, and is in good standing in, every jurisdiction where such qualification is required.
SECTION 3.02. Authorization; Enforceability. The Transactions to be entered into by the Borrower are within its corporate powers and have been duly authorized by all necessary corporate action and, if required, stockholder or equity holder action. This Agreement has been duly executed and delivered by the Borrower and constitutes, and each other Credit Document to which the Borrower is to be a party, when executed and delivered by the Borrower, will constitute, a legal, valid and binding obligation of the Borrower, as the case may be, in each case enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium and other laws affecting creditors' rights generally and subject to general principles of equity, regardless of whether considered in a proceeding in equity or at law.
SECTION 3.03. Governmental Approvals; No Conflicts. The Transactions and the use of the proceeds thereof (a) do not require any consent or approval of, registration or filing with, or other action by, any Governmental Authority, except such as have been obtained or made and are in full force and effect, (b) will not violate any applicable law or regulation or the articles of incorporation, by-laws or other organizational documents of the Borrower or any order of any Governmental Authority, (c) will not violate or result in a default under any indenture, agreement or other instrument binding upon the Borrower or any of its properties, or give rise to a right thereunder to require the Borrower to make any payment, where such default or payment reasonably can be expected to have a Material Adverse Effect and (d) will not result in the creation or imposition of any Lien on any property of the Borrower.
SECTION 3.04. Financial Statements; No Material Adverse Change. (a) The Borrower has heretofore furnished to the Lenders (i) the audited Consolidated balance sheet of the Borrower and its Subsidiaries as of December 31, 2009 and the related Consolidated statements of income and cash flows for the Fiscal Year then ended, reported on by KPMG LLP, independent
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public accountants, and (ii) the unaudited Consolidated balance sheet of the Borrower and its Subsidiaries as of September 30, 2010 and the related Consolidated statements of income and cash flows for the Fiscal Quarter then ended and for the portion of the Fiscal Year then ended, all certified by the Borrower's chief financial officer. Such financial statements present fairly, in all material respects, the Consolidated financial position of the Borrower and its Subsidiaries as of such dates and its Consolidated results of operations and cash flows for such periods in accordance with GAAP, subject to the absence of footnotes in the case of the statements referred to in clause (ii) above. None of the Borrower or any of its Material Subsidiaries has on the date hereof any material contingent liabilities, material liabilities for taxes, material unusual forward or long-term commitments or material unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in said balance sheets as at said dates.
(b) Since December 31, 2009, there has been no material adverse change in the business, properties, assets, condition (financial or otherwise) or prospects of the Borrower and its Subsidiaries, taken as a whole.
(c) The Borrower has heretofore furnished to each of the Lenders the annual Statutory Statement of each Insurance Subsidiary for the fiscal year ended December 31, 2009, and the quarterly Statutory Statement of each Insurance Subsidiary for the partial year ended September 30, 2010, in each case as filed with the Applicable Insurance Regulatory Authority. All such Statutory Statements present fairly in all material respects the financial condition of each Insurance Subsidiary as at, and the results of operations for, the fiscal year ended December 31, 2009 and the partial year ended September 30, 2010, in accordance with statutory accounting practices prescribed or permitted by the Applicable Insurance Regulatory Authority. Since December 31, 2009, there has been no material adverse change in the financial condition of any Material Insurance Subsidiary from that set forth in its respective Statutory Statement as at December 31, 2009.
SECTION 3.05. Insurance Licenses. Schedule T to the most recent annual Statutory Statement of each Insurance Subsidiary lists, as of the Effective Date, all of the jurisdictions in which such Insurance Subsidiary holds active licenses (including, without limitation, licenses or certificates of authority from Applicable Insurance Regulatory Authorities), permits or authorizations to transact insurance and reinsurance business or to act as an insurance agent or broker (collectively, the “Licenses”). Each Insurance Subsidiary is in compliance in all material respects with each License held by it. No License (to the extent material) is the subject of a proceeding for suspension or revocation or any similar proceedings, there is no sustainable basis for such a suspension or revocation, and to the knowledge of the Borrower no such suspension or revocation has been threatened by any Applicable Insurance Regulatory Authority except in any such case where such proceedings would not have a Material Adverse Effect.
SECTION 3.06. Properties. (a) Each of the Borrower and its Subsidiaries has good title to, or valid leasehold interests in, all its real and personal property material to its business, except for minor defects in title that do not interfere with its ability to conduct its business as currently conducted or to utilize such properties for their intended purposes.
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(b) Each of the Borrower and its Subsidiaries owns, or is licensed to use, all trademarks, tradenames, copyrights, patents and other intellectual property material to its business.
SECTION 3.07. Borrower's Subsidiaries; Investments.
(a) As of the Effective Date, the Borrower has no Subsidiaries, other than those set forth on Part A of Schedule 3.07. Part A of Schedule 3.07 accurately identifies the jurisdiction under the laws of which each such Subsidiary is formed and whether such Subsidiary is or is not, as the case may be, a Material Subsidiary as of the Effective Date.
(b) Set forth on Part B of Schedule 3.07 is a complete and correct list of all Investments (other than (i) Investments disclosed in Part A of said Schedule 3.07 and any other Investments existing as of the date hereof permitted under Section 6.04 and (ii) Guarantees of Debt the aggregate principal or face amount of which Debt is less than $5,000,000) held by the Borrower or any of its Subsidiaries in any Person on the date hereof and, for each such Investment, (A) the identity of the Person or Persons holding such Investment and (B) the nature of such Investment. Except as disclosed in Part B of Schedule 3.07, each of the Borrower and its Subsidiaries owns, free and clear of all Liens, all such Investments.
SECTION 3.08. Litigation. There is no action, suit, arbitration proceeding or other proceeding, inquiry or investigation, at law or in equity, before or by any arbitrator or Governmental Authority pending against the Borrower or any Subsidiary or of which the Borrower or any Subsidiary has otherwise received notice or which, to the knowledge of the Borrower, is threatened against the Borrower or any Subsidiary (i) as to which, but after giving effect to any applicable insurance claim reserve, there is a reasonable possibility of an unfavorable decision, ruling or finding which would reasonably be expected to result in a Material Adverse Effect or (ii) that involves any of the Credit Documents or the Transactions or the use of the proceeds thereof.
SECTION 3.09. Compliance with Laws and Agreements; Foreign Asset Control Regulations.
(a) The Borrower is in compliance with all laws, regulations and orders of any Governmental Authority applicable to it or its property (including (i) all Environmental Laws, (ii) ERISA, (iii) applicable laws, regulations and orders dealing with intellectual property, and (iv) the Fair Labor Standards Act and other applicable law dealing with such matters) and all indentures, agreements and other instruments binding on it or its property, except where failures to do so, in the aggregate, would not reasonably be expected to result in a Material Adverse Effect. No Default has occurred and is continuing.
(b) The Borrower is and will remain in full compliance with all laws and regulations applicable to it ensuring that no person who owns a controlling interest in or otherwise controls the Borrower is or shall be (A) listed on the Specially Designated Nationals and Blocked Person List maintained by the Office of Foreign Assets Control (“OFAC”). Department of the Treasury, and/or any other similar lists maintained by OFAC pursuant to any authorizing statute, Executive Order or regulation or (B) a person designated under Section 1(b), (c) or (d) of Executive Order No. 13224
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(September 23, 2001), any related enabling legislation or any other similar Executive Orders.
SECTION 3.10. Investment Company Status. The Borrower is not an “investment company” or a company “controlled” by an “investment company” within the meaning of the Investment Company Act of 1940, as amended.
SECTION 3.11. Taxes. The Borrower and its Subsidiaries (other than Eagle Life Insurance Company) are members of an affiliated group of corporations filing consolidated returns for Federal income tax purposes, of which the Borrower is the “common parent” (within the meaning of Section 1504 of the Code) of such group. The Borrower and its Material Subsidiaries have filed all Federal income tax returns and all other material tax returns that are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any assessment received by the Borrower or any of its Material Subsidiaries. The charges, accruals and reserves on the books of the Borrower and its Material Subsidiaries in respect of taxes and other governmental charges are, in the opinion of the Borrower, adequate. The Borrower has not given or been requested to give a waiver of the statute of limitations relating to the payment of any Federal, state, local and foreign taxes or other impositions.
SECTION 3.12. Material Agreements and Liens.
(a) Part A of Schedule 3.12 is a complete and correct list of each credit agreement, loan agreement, indenture, purchase agreement, guarantee, letter of credit or other arrangement providing for or otherwise relating to any Debt or any extension of credit (or commitment for any extension of credit) to, or Guarantee by, the Borrower or any of its Subsidiaries, outstanding on the date hereof the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $5,000,000, and the aggregate principal or face amount outstanding or that may become outstanding under each such arrangement is correctly described in Part A of said Schedule 3.12.
(b) Part B of Schedule 3.12 is a complete and correct list of each Lien securing Debt of any Person outstanding on the date hereof the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $5,000,000 and covering any property of the Borrower or any of its Subsidiaries, and the aggregate Debt secured (or that may be secured) by each such Lien and the Property covered by each such Lien is correctly described in Part B of said Schedule 3.12.
SECTION 3.13. Environmental Matters. Each of the Borrower and its Subsidiaries has obtained all environmental, health and safety permits, licenses and other authorizations required under all Environmental Laws to carry on its business as now being or as proposed to be conducted, except to the extent failure to have any such permit, license or authorization would not (either individually or in the aggregate) have a Material Adverse Effect. Each of such permits, licenses and authorizations is in full force and effect and each of the Borrower and its Subsidiaries is in compliance with the terms and conditions thereof, and is also in compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in any applicable Environmental Law or in any regulation, code, plan, order, decree, judgment, injunction, notice or demand letter issued, entered, promulgated or approved thereunder, except to
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the extent failure to comply therewith would not (either individually or in the aggregate) have a Material Adverse Effect.
SECTION 3.14. Capitalization. The authorized capital stock of the Borrower consists, on the date hereof, of an aggregate of 127,000,000 shares consisting of (a) 125,000,000 shares of common stock, $1 par value, of which (as of September 30, 2010) 58,623,726 shares were duly and validly issued and outstanding, each of which shares is fully paid and non-assessable, and (b) 2,000,000 shares of preferred stock, $1 par value, of which (as of September 30, 2010) no shares were issued and outstanding. As of the date hereof, (i) except as set forth in Part A of Schedule 3.14, there are no outstanding Equity Rights with respect to the Borrower and (ii) except as set forth in Part B of Schedule 3.14, there are no outstanding obligations of the Borrower or any of its Subsidiaries to repurchase, redeem, or otherwise acquire any shares of capital stock of the Borrower nor are there any outstanding obligations of the Borrower or any of its Subsidiaries to make payments to any Person, such as “phantom stock” payments, where the amount thereof is calculated with reference to the fair market value or equity value of the Borrower or any of its Subsidiaries.
SECTION 3.15. No Reliance. The Borrower has made, independently and without reliance upon the Administrative Agent or any Lender, and based on such documents and information as it has deemed appropriate, its own decision to enter into this Agreement and has made (and will continue to make), independently and without reliance upon the Administrative Agent or any Lender, and based on such documents and information as it has deemed appropriate (or shall deem appropriate at the time), its own legal, credit and tax analysis of the transactions contemplated hereby.
SECTION 3.16. ERISA. No ERISA Event has occurred or is reasonably expected to occur that, when taken together with all other ERISA Events for which liability is reasonably expected to occur, would reasonably be expected to result in a Material Adverse Effect.
SECTION 3.17. Regulation U. Neither the Borrower nor any of its Subsidiaries is engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U).
SECTION 3.18. Disclosure. The Borrower has disclosed to the Lenders all agreements, instruments and corporate or other restrictions to which it is subject, and all other matters known to it, that, individually or in the aggregate, would reasonably be expected to result in a Material Adverse Effect. All of the reports, financial statements, certificates and other written information (other than projected financial information) that have been made available by or on behalf of the Borrower to the Administrative Agent or any Lender in connection with the negotiation of this Agreement or any other Credit Document or delivered hereunder or thereunder, are complete and correct in all material respects and do not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein not materially misleading in light of the circumstances under which such statements are made; provided that, with respect to projected financial information, the Borrower represents only that such information was prepared in good faith based on assumptions believed to be reasonable at the time.
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SECTION 3.19. Solvency. Immediately after the Transactions to occur on the Effective Date are consummated and after giving effect to the application of the proceeds of each Loan made on the Effective Date and after giving effect to the application of the proceeds of each Loan made on any other date, (a) the fair value of the assets of the Borrower, at a fair valuation, will exceed its debts and liabilities, subordinated, contingent or otherwise; (b) the Borrower will be able to pay its debts and liabilities, subordinated, contingent or otherwise, as such debts and liabilities become absolute and matured; and (c) the Borrower will not have unreasonably small capital with which to conduct the business in which it is engaged as such business is now conducted and proposed to be conducted after the Effective Date.
SECTION 3.20. Anti-Terrorism Requirements.
(a) Neither the Borrower nor any Affiliate of the Borrower, is in violation in any material respect of any Anti-Terrorism Law or engages in or conspires to engage in any transaction that evades or avoids, or has the purpose of evading or avoiding, or attempts to violate, any of the prohibitions set forth in any Anti-Terrorism Law.
(b) Neither the Borrower nor any Affiliate of the Borrower or their respective agents acting or benefiting in any capacity in connection with the Loans or other transactions hereunder, is any of the following (each a “Blocked Person”):
(i) a Person that is listed in the annex to, or is otherwise subject to the provisions of, the Executive Order No. 13224;
(ii) a Person owned or controlled by, or acting for or on behalf of, any Person that is listed in the annex to, or is otherwise subject to the provisions of, the Executive Order No. 13224;
(iii) a Person with which any Lender is prohibited from dealing or otherwise engaging in any transaction by any Anti-Terrorism Law;
(iv) a Person that commits, threatens or conspires to commit or supports “terrorism” as defined in the Executive Order No. 13224;
(v) a Person that is named as a “specially designated national” on the most current list published by the U.S. Treasury Department Office of Foreign Asset Control at its official website or any replacement website or other replacement official publication of such list, or
(vi) a Person that is affiliated or associated with a Person listed above.
(c) Neither the Borrower or, to the knowledge of the Borrower, any of its agents acting or benefiting in any capacity in connection with the Loans or other transactions hereunder, (i) conducts any business or engages in making or receiving any contribution of funds, goods or services to or for the benefit of any Blocked Person, or (ii) deals in, or otherwise engages in any transaction relating to, any property or interests in property blocked pursuant to the Executive Order No. 13224.
ARTICLE IV
Conditions
SECTION 4.01. Effective Date. The obligations of the Lenders to make Loans hereunder shall not become effective until the date on which each of the following conditions is satisfied (or waived in accordance with Section 9.02):
(a) The Administrative Agent (or its counsel) shall have received from each party hereto either (i) a counterpart of this Agreement signed on behalf of such party or (ii) written evidence satisfactory to the Administrative Agent (which may include telecopy transmission of a signed signature page of this Agreement) that such party has signed a counterpart of this Agreement.
(b) The Administrative Agent shall have received favorable written opinions (addressed to the Administrative Agent and the Lenders and dated the Effective Date) of each of (i) Marla G. Lacey, Associate General Counsel for the Borrower and (ii) Skadden Arps, Slate, Meagher & Flom LLP, special counsel for the Borrower, which opinions shall cover such matters relating to the Borrower, this Agreement, the other Credit Documents and the Transactions (including the subordination of the Borrower's Debt and obligations under each indenture governing the Trust Preferred Securities Notes to its Debt and obligations hereunder) and otherwise shall be in such form and substance, as the Administrative Agent shall reasonably request. The Borrower hereby requests each such counsel to deliver such opinions.
(c) The Administrative Agent shall have received such documents and certificates as the Administrative Agent or its counsel may reasonably request relating to the organization, existence and good standing of the Borrower, the authorization for and the validity of the Transactions and any other legal matters relating to the Borrower, this Agreement, the other Credit Documents or the Transactions, all in form and substance satisfactory to the Administrative Agent and its counsel.
(d) The Administrative Agent shall have received a certificate, dated the Effective Date and signed by the President, a Vice President or a Financial Officer of the Borrower, confirming compliance with the conditions set forth in paragraphs (a) and (b) of Section 4.02.
(e) The Administrative Agent, the Lenders and the Lead Arrangers shall have received all fees and other amounts due and payable on or prior to the Effective Date, including, to the extent invoiced, reimbursement or payment of all out-of-pocket expenses (including fees, charges and disbursements of counsel) required to be reimbursed or paid by the Borrower under the Credit Documents.
(f) All consents and approvals (including, without limitation, consents and approvals required for insurance and regulatory compliance) required to be obtained from any Governmental Authority or other Person in connection with the Transactions shall have
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been obtained and be in full force and effect, except where failure to obtain such approval or consent would not have a Material Adverse Effect.
(g) The Borrower shall have delivered to the Administrative Agent evidence reasonably satisfactory to the Administrative Agent that the Credit Agreement among the Borrower, various lender parties thereto, and KeyBank National Association, as administrative agent, dated November 20, 2006, as thereafter amended or supplemented, shall have expired or been terminated and that all of the respective Debt and other obligations of the Borrower and its Subsidiaries thereunder shall have been paid and satisfied in full.
(h) The Administrative Agent and the Lenders shall have received from the Borrower such other certificates and other documents as the Administrative Agent or any Lender may reasonably have requested, including the promissory note complying with Section 2.07(e) of any Lender requesting such promissory note.
The Administrative Agent shall notify the Borrower and the Lenders of the Effective Date, and such notice shall be conclusive and binding. Notwithstanding the foregoing, the obligations of the Lenders to make Loans shall not become effective unless each of the foregoing conditions is satisfied (or waived pursuant to Section 9.02) at or prior to 3:00 p.m., New York City time, on January 31, 2011 (and, in the event such conditions are not so satisfied or waived, the Commitments shall terminate at such time).
SECTION 4.02. Each Credit Event. The obligation of each Lender to make a Loan on the occasion of any Borrowing is subject to the satisfaction of the following conditions:
(a) The representations and warranties of the Borrower set forth in this Agreement and the other Credit Documents shall be true and correct on and as of the date of such Borrowing.
(b) At the time of and immediately after giving effect to such Borrowing, no Default shall have occurred and be continuing.
Each Borrowing shall be deemed to constitute a representation and warranty by the Borrower on the date thereof as to the matters specified in paragraphs (a) and (b) of this Section.
ARTICLE V
Affirmative Covenants
Until all the Commitments have expired or terminated and the principal of and interest on each Loan and all fees and other amounts payable hereunder have been paid in full, the Borrower covenants and agrees with the Lenders that:
SECTION 5.01. Financial Statements; and Other Information. The Borrower shall furnish to the Administrative Agent (for delivery to each Lender):
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(a) as soon as available and in any event within 90 days after the end of each Fiscal Year, its audited Consolidated balance sheet as of the end of such Fiscal Year and the related Consolidated statements of income and cash flows for such Fiscal Year, setting forth in each case in comparative form the figures for the previous Fiscal Year, all reported on by KPMG LLP or other independent public accountants of recognized national standing (without qualification or exception and without any qualification or exception as to the scope of such audit) as presenting fairly in all material respects the financial position, results of operations and cash flows of the Borrower and its Subsidiaries on a Consolidated basis in accordance with generally accepted auditing standards;
(b) as soon as available and in any event within 45 days after the end of each of the first three Fiscal Quarters of each Fiscal Year, its Consolidated balance sheet as of the end of such Fiscal Quarter, the related Consolidated statements of income for such Fiscal Quarter and for the then elapsed portion of such Fiscal Year, and the related Consolidated statements of cash flows for the then elapsed portion of such Fiscal Year, setting forth in each case in comparative form the figures for the corresponding period or periods of (or, in the case of the balance sheet, as of the end of) the previous Fiscal Year, all certified by a Financial Officer as (i) reflecting all adjustments (which adjustments are normal and recurring unless otherwise disclosed) necessary for a fair presentation of the results for the period covered and (ii) having been prepared in accordance with the applicable rules of the SEC;
(c) concurrently with each delivery of financial statements under clause (a) or (b) above, a certificate of a Financial Officer in the form of Exhibit E (i) certifying as to whether a Default has occurred and is continuing and, if a Default has occurred and is continuing, specifying the details thereof and any action taken or proposed to be taken with respect thereto, (ii) setting forth reasonably detailed calculations demonstrating compliance with Sections 6.11 through Section 6.14, inclusive, and (iii) identifying any change(s) in GAAP or in the application thereof that have become effective since the date of, and have had an effect on, the Borrower's most recent audited financial statements referred to in Section 3.04 or delivered pursuant to this Section (and, if any such change has become effective, specifying the effect of such change on the financial statements accompanying such certificate);
(d) concurrently with each delivery of financial statements under clause (a) above, (i) a certificate of the accounting firm that reported on such financial statements stating whether during the course of their examination of such financial statements they obtained knowledge of any Default (which certificate may be limited to the extent required by accounting rules or guidelines) and (ii) a certificate of a Financial Officer identifying any Subsidiary that has been formed or acquired during the Fiscal Year covered by such financial statements;
(e) promptly after the same become publicly available, copies of all periodic and other material reports and proxy statements filed by the Borrower or any Material Subsidiary with the SEC, or any Governmental Authority succeeding to any or all of the functions of the SEC;
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(f) promptly upon the effectiveness of any material amendment or modification of, or any waiver of the rights of the Borrower or any Material Subsidiary under, the certificate of formation, limited liability company agreement, certificate of incorporation, by-laws or other organizational documents of the Borrower or any Material Subsidiary, copies of any such documents; and
(g) promptly following any request therefor, such other information regarding the operations, business affairs and financial condition of the Borrower and its Subsidiaries, or compliance with the terms of any Credit Document, as the Administrative Agent or any Lender may reasonably request;
provided, that any information or document that is required to be furnished by any of clauses (a), (b), (e), (f) and (g) of this Section 5.01 and that is filed with the SEC via the EDGAR filing system shall be deemed to be furnished so long as the Borrower provides to the Administrative Agent and the Lenders electronic or written notice of the posting of such information or document.
SECTION 5.02. Notices of Material Events. The Borrower shall furnish to the Administrative Agent and each Lender prompt written notice of the following:
(a) the occurrence of any Default;
(b) the filing or commencement of any action, suit or proceeding by or before any arbitrator or Governmental Authority or Applicable Insurance Regulatory Authority against or affecting the Borrower or any Subsidiary that, if adversely determined, could reasonably be expected to result in a Material Adverse Effect or the filing of any other legal or arbitral proceedings, and any material development in respect of such legal or other proceedings, affecting the Borrower or any of its Subsidiaries, except proceedings that, if adversely determined, would not (either individually or in the aggregate) have a Material Adverse Effect;
(c) the occurrence of any ERISA Event that, alone or together with any other ERISA Events that have occurred, could reasonably be expected to result in liabilities of the Borrower and its Material Subsidiaries in an aggregate amount exceeding $5,000,000;
(d) the occurrence of any change in the Borrower's S&P Rating;
(e) at least five Business Days prior to the effectiveness of any amendment to the terms of any of the Convertible Debt, or the effectiveness of any agreement governing any Debt in replacement, refinance or exchange thereof, a copy of such amendment or agreement;
(f) any actual or proposed change in any Applicable Insurance Code that could reasonably be expected to have a Material Adverse Effect, promptly upon the Borrower's or any Insurance Subsidiary's becoming aware of such actual or proposed change;
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(g) any change in the published rating by Best of any Person to which any Insurance Subsidiary has ceded risk pursuant to a Reinsurance Agreement if such change causes such published rating to be “B+” or lower; and
(h) any other development that results in, or would reasonably be expected to result in, a Material Adverse Effect.
Each notice delivered under this Section shall be accompanied by a statement of a Financial Officer or other executive officer of the Borrower setting forth the details of the event or development requiring such notice and any action taken or proposed to be taken with respect thereto.
SECTION 5.03. Insurance Subsidiary Reporting. The Borrower shall furnish to the Administrative Agent and each Lender copies of the following:
(a)promptly after filing with the Applicable Insurance Regulatory Authority and in any event within 45 days after the end of each of the first three quarterly fiscal periods of each fiscal year of each Material Insurance Subsidiary, the quarterly Statutory Statement of such Material Insurance Subsidiary for such quarterly fiscal period, together with the opinion thereon of a senior financial officer of such Material Insurance Subsidiary stating that such Statutory Statement presents the financial condition of such Material Insurance Subsidiary for such quarterly fiscal period in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority;
(b)promptly after filing with the Applicable Insurance Regulatory Authority and in any event within 90 days after the end of each fiscal year of each Material Insurance Subsidiary, the annual Statutory Statement of such Material Insurance Subsidiary for the recently completed fiscal year, together with (i) the opinion thereon of a senior financial officer of such Material Insurance Subsidiary stating that said annual Statutory Statement presents the financial condition of such Material Insurance Subsidiary for such fiscal year in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority, and (ii) a copy of the “Statement of Actuarial Opinion” for such Material Insurance Subsidiary which is provided to the Applicable Insurance Regulatory Authority (or equivalent information should such Applicable Insurance Regulatory Authority no longer require such a statement), which statement shall be in the format prescribed by the Applicable Insurance Code of the state of domicile of such Material Insurance Subsidiary;
(c)within 180 days after the end of each fiscal year of each Material Insurance Subsidiary, the report of KPMG LLP (or other independent certified public accountants of recognized national standing) on the annual Statutory Statements delivered pursuant to clause (b), above;
(d)promptly after any Material Insurance Subsidiary receives the results of a triennial examination by the NAIC of the financial condition and operations of such Insurance Subsidiary or any of its Material Subsidiaries, a copy thereof;
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(e)promptly following the delivery or receipt by the Borrower or any of its Material Insurance Subsidiaries of any correspondence, notice or report to or from any Applicable Insurance Regulatory Authority that relates, to any material extent, to the financial viability of any of its Material Subsidiaries, a copy thereof;
(f)within five Business Days after receipt, notice from any Applicable Insurance Regulatory Authority of any threatened or actual proceeding for suspension or revocation of any License of any Insurance Subsidiary or any similar proceeding with respect to any such License; and
(g)promptly, notice of any denial of coverage, litigation, or arbitration arising out of any Reinsurance Agreements to which any Insurance Subsidiary is a party which denial, litigation or arbitration involves $10,000,000 or more.
SECTION 5.04. Existence; Conduct of Business. Except as otherwise permitted under Section 6.03, the Borrower shall, and shall cause each of its Material Subsidiaries to, do or cause to be done all things necessary to preserve, renew and keep in full force and effect its legal existence and the rights, licenses, permits, privileges, franchises, patents, copyrights, trademarks and trade names material to the conduct of its business.
SECTION 5.05. Payment of Obligations. The Borrower shall, and shall cause each of its Material Subsidiaries to, pay all of its Material Debt and other material obligations, including Tax liabilities, before the same shall become delinquent or in default, except where (a) the validity or amount thereof is being contested in good faith by appropriate proceedings, (b) the Borrower or such Subsidiary has set aside on its books adequate reserves with respect thereto in accordance with GAAP, (c) such contest effectively suspends collection of the contested obligation and the enforcement of any Lien securing such obligation and (d) the failure to make payment pending such contest would not reasonably be expected to result in a Material Adverse Effect.
SECTION 5.06. Maintenance of Properties. The Borrower will, and will cause each of its Subsidiaries to keep and maintain all property material to the conduct of its business in good working order and condition, ordinary wear and tear excepted.
SECTION 5.07. Insurance. The Borrower shall keep itself and all of its insurable properties, and shall cause each Material Subsidiary to keep itself and all of its insurable properties, insured at all times to such extent, by such insurers, and against such hazards and liabilities as is customarily carried by prudent businesses of like size and enterprise; and promptly upon the Administrative Agent's written request upon and during the continuance of an Event of Default, the Borrower shall furnish to the Administrative Agent such information about any such insurance as the Administrative Agent may from time to time reasonably request; provided that, nothing in this Section 5.07 shall be deemed to require any of the Borrower's Material Subsidiaries to enter into any Reinsurance Agreement and provided, further, that the Borrower and its Material Subsidiaries may self-insure against such hazards and risks, and in such amounts as is customary for corporations of a similar size and in similar lines of business.
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SECTION 5.08. Proper Records; Rights to Inspect and Appraise. The Borrower shall, and shall cause each of its Material Subsidiaries to, keep proper books of record and accounts in which complete and correct entries are made of all transactions relating to its business and activities. The Borrower shall, and shall cause each of its Material Subsidiaries to, permit any representatives designated by the Administrative Agent or any Lender, upon reasonable prior notice, to visit and inspect its properties, to examine and make extracts from its books and records, and to discuss its affairs, finances and condition with its officers, directors and employees, all at such reasonable times and as often as reasonably requested, but, other than in exigent circumstances, taking into account periodic accounting and regulatory compliance demands on the Borrower and its Subsidiaries.
SECTION 5.09. Compliance with Laws.
(h)The Borrower shall, and shall cause each of its Material Subsidiaries to, comply with all laws, rules, regulations and orders of any Governmental Authority (including all Environmental Laws and ERISA and the respective rules and regulations thereunder) applicable to it or its property, other than such laws, rules or regulations (a) the validity or applicability of which the Borrower or any Subsidiary is contesting in good faith by appropriate proceedings or (b) the failure to comply with which cannot reasonably be expected to result in a Material Adverse Effect.
(i)Without limiting the generality of the foregoing, the Borrower and its Affiliates and agents shall not (i) conduct any business or engage in any transaction or dealing with any Blocked Person, including the making or receiving of any contribution of funds, goods or services to or for the benefit of any Blocked Person, (ii) deal in, or otherwise engage in any transaction relating to, any property or interests in property blocked pursuant to the Executive Order No. 13224; or (iii) engage in or conspire to engage in any transaction that evades or avoids, or has the purpose of evading or avoiding, or attempts to violate, any of the prohibitions set forth in the Executive Order No. 13224, the USA Patriot Act or any other Anti-Terrorism Law. The Borrower shall deliver to the Lenders any certification or other evidence reasonably requested from time to time by any Lender in its reasonable discretion, confirming the Borrower's compliance with this Section 5.09.
SECTION 5.10. Use of Proceeds. The proceeds of the Loans will be used only to finance the general corporate purposes of the Borrower and its Subsidiaries (including, without limitation, refinancing, replacing or exchanging existing Debt, repurchasing capital stock, making capital contributions to Subsidiaries and providing for the liquidity needs of the Borrower and its Subsidiaries). No part of the proceeds of any Loan will be used, directly or indirectly, for any purpose that entails a violation of any of the Regulations of the Board, including Regulations T, U and X.
SECTION 5.11. Licenses. The Borrower shall, and shall cause each of its Insurance Subsidiaries to, do all things necessary to renew, extend and continue in effect all Licenses which may at any time and from time to time be necessary for any Insurance Subsidiary to operate its insurance business in compliance with all applicable laws and regulations except for any License the loss of which could not reasonably be expected to have a Material Adverse Effect; provided, that any Insurance Subsidiary may withdraw from one or more states (other than its state of domicile)
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as an admitted insurer if such withdrawal is determined by the Borrower's Board of Directors to be in the best interest of the Borrower and would not reasonably be expected to have a Material Adverse Effect.
ARTICLE VI
Negative Covenants
Until all the Commitments have expired or terminated and the principal of and interest on each Loan and all fees and other amounts payable hereunder have been paid in full, the Borrower covenants and agrees with the Lenders that:
SECTION 6.01. Debt; Certain Equity Securities.
(j)The Borrower shall not, and shall not permit any of its Subsidiaries to, create, incur, assume or permit to exist any Debt, except:
(i)Debt created under the Credit Documents;
(ii)Debt existing on the date hereof and listed in Schedule 6.01;
(iii)Debt of Wholly-Owned Subsidiaries to the Borrower or to other Subsidiaries;
(iv)Debt of $74,494,000 in aggregate principal amount outstanding issued under the Convertible 2004 Debt Documents (the “Convertible 2004 Debt”), and any Debt, not greater than $74,494,000 in principal amount and otherwise on terms not more restrictive on or otherwise less favorable to the Borrower in any material respect than the terms contained in the Convertible 2004 Debt Documents (the “Existing 2004 Terms”), in replacement, refinancing or exchange therefor, whether or not the notes, debentures or other instruments evidencing such replacement, refinancing or exchange Debt are exempt from registration requirements (without limiting the generality of the foregoing, it is the intention hereby that the terms of the Convertible 2004 Debt, including the effect of any modification thereof, and the terms of any Debt in exchange, refinancing or replacement thereof, (i) provide for a final scheduled maturity not earlier than the first anniversary of the Maturity Date and (ii) otherwise shall not be more restrictive on, or otherwise less favorable to, the Borrower in any material respect than the Existing 2004 Terms);
(v)Debt of $115,839,000 in aggregate principal amount outstanding issued under the Convertible 2009 Debt Documents (the “Convertible 2009 Debt”), and any Debt, not greater than $115,839,000 in principal amount and otherwise on terms not more restrictive on or otherwise less favorable to the Borrower in any material respect than the terms contained in the Convertible 2009 Debt Documents (the “Existing 2009 Terms”), in replacement, refinancing or exchange therefor, whether or not the notes, debentures or other instruments evidencing such replacement, refinancing or exchange Debt are exempt from registration requirements (without limiting the generality of the foregoing, it is the intention
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hereby that the terms of the Convertible 2009 Debt, including the effect of any modification thereof, and the terms of any Debt in exchange, refinancing or replacement thereof, (i) provide for a final scheduled maturity not earlier than the first anniversary of the Maturity Date and (ii) otherwise shall not be more restrictive on, or otherwise less favorable to, the Borrower in any material respect than the Existing 2009 Terms);
(vi)Subordinated Debt;
(vii)Debt of $200,000,000 in aggregate principal amount issued under the Convertible 2010 Debt Documents (the “Convertible 2010 Debt”), and any Debt, not greater than $200,000,000 in principal amount and otherwise on terms not more restrictive on or otherwise less favorable to the Borrower in any material respect than the terms contained in the Convertible 2010 Debt Documents (the “Existing 2010 Terms”), in replacement, refinancing or exchange therefor, whether or not the notes, debentures or other instruments evidencing such replacement, refinancing or exchange Debt are exempt from registration requirements (without limiting the generality of the foregoing, it is the intention hereby that the terms of the Convertible 2010 Debt, including the effect of any modification thereof, and the terms of any Debt in exchange, refinancing or replacement thereof, (i) provide for a final scheduled maturity not earlier than September 15, 2015 and (ii) otherwise shall not be more restrictive on, or otherwise less favorable to, the Borrower in any material respect than the Existing 2010 Terms);
(viii)Debt arising under agreements of the Borrower to maintain a specified net worth of Eagle Life Insurance Company, as required by one or more insurance regulatory authorities; and
(ix)additional Debt not to exceed $50,000,000 in aggregate principal amount at any time outstanding as to the Borrower and its Subsidiaries on a Consolidated basis, of which no more than $25,000,000 in the aggregate shall be Debt secured by Liens permitted under Section 6.02 hereof.
(b)The Borrower shall not issue Current Redeemable Equity.
SECTION 6.02. Liens. The Borrower shall not, and shall not permit any of its Subsidiaries to, create or permit to exist any Lien on any property now owned or hereafter acquired by it, or assign or sell any income or revenues (including accounts receivable) or rights in respect of any thereof, except:
(a)Permitted Liens;
(b)any Lien on any property of the Borrower or any Subsidiary existing on the date hereof and listed in Schedule 6.02; provided, that (A) such Lien shall not apply to any other property of the Borrower or any Subsidiary and (B) such Lien shall secure only those obligations which it secures on the date hereof and extensions, renewals and replacements thereof that do not increase the outstanding principal amount thereof;
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(c)any Lien existing on any property or asset before the acquisition thereof by the Borrower or any Subsidiary or existing on any property or asset of any Person that first becomes a Subsidiary after the date hereof before the time such Person becomes a Subsidiary; provided, that (A) such Lien is not created in contemplation of or in connection with such acquisition or such Person becoming a Subsidiary, (B) such Lien will not apply to any other property or asset of the Borrower or any Subsidiary, (C) such Lien will secure only those obligations which it secures on the date of such acquisition or the date such Person first becomes a Subsidiary permitted hereunder, as the case may be, and extensions, renewals and replacements thereof that do not increase the outstanding principal amount thereof, and (D) the principal amount of Debt secured by any such Lien shall at no time exceed 80% of the fair market value (as determined in good faith by a senior financial officer of the Borrower) of such property at the time it was acquired (by purchase, construction or otherwise);
(d)Liens on fixed or capital assets acquired, constructed or improved by the Borrower or any Subsidiary; provided, that (A) the Debt secured by such Liens is permitted by, as applicable, Section 6.01, (B) such Liens and the Debt secured thereby are incurred before or within 90 days after such acquisition or the completion of such construction or improvement, (C) the Debt secured thereby does not exceed the cost of acquiring, constructing or improving such fixed or capital assets, and (D) such Liens will not apply to any other property of the Borrower or any Subsidiary;
(e)Liens to secure a Debt owing to the Borrower;
(f)Liens in favor of clearing agencies or securities trading exchanges in connection with option derivative transactions arising due to the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations promulgated thereunder;
(g)Liens securing obligations under Hedging Agreements entered into by the Borrower or any Subsidiary for bona fide hedging purposes and not for speculation; and
(h)any Lien arising out of the refinancing, extension, renewal or refunding of any Debt secured by a Lien permitted by any of clauses (b), (c), (d) or (e) of this Section; provided, that such Debt is not increased (except by the amount of fees, expenses and premiums required to be paid in connection with such refinancing, extension, renewal or refunding) and is not secured by any additional assets.
SECTION 6.03. Fundamental Changes. (a) The Borrower shall not, nor shall it permit any of its Subsidiaries to, enter into any transaction of merger or consolidation or amalgamation, or liquidate, wind up or dissolve itself (or suffer any liquidation or dissolution).
(b)The Borrower shall not, nor shall it permit any of its Subsidiaries to, acquire any business or property from, or capital stock of, or be a party to any acquisition of, any Person except for purchases of property to be used in the ordinary course of business, Assumed Reinsurance in the ordinary course of business, Investments permitted under Section 6.04, and capital expenditures in the ordinary course of business.
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(c)The Borrower shall not, nor shall it permit any of its Subsidiaries to, convey, sell, lease, transfer or otherwise dispose of, in one transaction or a series of transactions, all or a substantial part of its business or Property, whether now owned or hereafter acquired.
(d)Neither the Borrower nor any Subsidiary will engage in any business other than the providing of insurance (including insurance agency) and other financial services (including banking and investment advisory services) and businesses related or incidental thereto; provided, that at least one-half of the Borrower's Consolidated revenues, determined in accordance with GAAP, shall be derived from the providing of insurance (including insurance agency).
Notwithstanding the foregoing provisions of this Section 6.03:
(i)any Subsidiary of the Borrower may be merged or consolidated with or into: (A) the Borrower if the Borrower shall be the continuing or surviving corporation or (B) any other Subsidiary; provided, that if any such transaction shall be between a Subsidiary and a Wholly-Owned Subsidiary, the Wholly-Owned Subsidiary shall be the continuing or surviving corporation;
(ii)any Subsidiary of the Borrower may sell, lease, transfer or otherwise dispose of any or all of its property (upon voluntary liquidation or otherwise) to the Borrower or a Wholly-Owned Subsidiary of the Borrower; and
(iii)the Borrower or any Subsidiary may merge, consolidate with or acquire any other Person so long as (A) the surviving corporation is the Borrower or such Subsidiary, (B) no Default is in existence or would occur after giving effect to such merger, consolidation or acquisition, (C) the business activity engaged in by such other Person would be permitted under Section 6.03(d) hereof if such other Person were a Subsidiary of the Borrower prior to such merger, consolidation or acquisition, (D) after giving effect to such merger, consolidation or acquisition, the Borrower shall be in compliance on a pro forma basis with the financial covenants set forth in Sections 6.11, 6.12, 6.13 and 6.14 for the most recently ended Fiscal Quarter and (E) the aggregate consideration in connection with all such mergers, consolidations and acquisitions during any calendar year shall not exceed $50,000,000.
SECTION 6.04. Investments. The Borrower shall not, nor shall it permit any of its Material Subsidiaries to, make or permit to remain outstanding any Investments except (i) Investments outstanding on the date hereof and identified in Part B of Schedule 3.07, (ii) operating deposit accounts with banks, (iii) Permitted Investments, (iv) Investments by the Borrower and its Material Subsidiaries in their respective Wholly-Owned Subsidiaries, (v) Hedging Agreements entered into in the ordinary course of the Borrower's or such Subsidiary's business and not for speculative purposes, (vi) any Convertible 2010 Debt Hedges and (vii) as to the Borrower, any investment that would be permitted to be made by any of its Insurance Subsidiaries.
SECTION 6.05. Asset Sales. The Borrower shall not, and shall not permit any of its Subsidiaries to, sell, transfer, lease or otherwise dispose of any property, including any Equity
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Interest owned by it, nor will any Subsidiary issue any additional Equity Interest in such Subsidiary, except:
(a)sales of used or surplus equipment and Permitted Investments in the ordinary course of business;
(b)Sale-Leaseback Transactions permitted pursuant to Section 6.07; and;
(c)other sales of assets, other than any Equity Interest in a Material Subsidiary, so long as (i) immediately before and after giving effect thereto, no Default shall have occurred and be continuing, and (ii) the Borrower's S&P Rating immediately following the sale becoming known publicly is not more than one level or category lower than the Borrower's S&P Rating immediately prior to the sale becoming known publicly.
SECTION 6.06. Ceded Reinsurance. The Borrower shall not, nor shall it permit any Insurance Subsidiary to:
(a)enter into any Reinsurance Agreement in respect of ceded risk in excess of $10,000,000 with any Person other than (i) another Insurance Subsidiary, (ii) any Person for which the most recently published rating by Best is “B++” or higher or, if such Person is not rated by Best, which has a Statutory Surplus (or the equivalent thereof) of not less than $500,000,000, (iii) any Person that posts security under such Reinsurance Agreement in an amount equal to the total liabilities assumed by such Person, through a letter of credit issued by an “authorized bank” (as such term is defined by the Applicable Insurance Regulatory Authority) or a cash collateral deposit or a funds withheld trust as allowed by the Applicable Insurance Regulatory Authority or (iv) any other reinsurers acceptable to the Administrative Agent, provided however, that for purposes of the foregoing clause (ii), any “NA” designation shall not be considered a rating by Best;
(b)enter into any Reinsurance Agreement or Reinsurance Agreements with Lloyd's of London if the aggregate amount of reinsurance ceded thereby would exceed 15% of the aggregate premium volume of reinsurance ceded by the Insurance Subsidiaries;
(c)enter into any Surplus Relief Reinsurance except with another Insurance Subsidiary; provided, that the Insurance Subsidiaries may, so long as in each case the requirements in clause (a) above are satisfied, (i) continue to maintain and from time to time amend or replace the Surplus Relief Reinsurance in effect on the date hereof and described on Schedule 6.06, (ii) enter into new Surplus Relief Reinsurance arrangements so long as the aggregate amount of any increased amount arising from any amendments or replacements undertaken pursuant to clause (i), when added to the amount arising from any new arrangements, does not provide more than $75,000,000 in after-tax surplus relief benefit to the Insurance Subsidiaries and (iii) continue to maintain and from time to time amend the 2005 Reinsurance Treaty entered into by American Equity Life with Hannover Life Reassurance Company of America described on Schedule 6.06 providing reinsurance coverage for certain partial free withdrawal provisions of certain American Equity Life policies; or
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(d)enter into any Reinsurance Agreement or Reinsurance Agreements if such Reinsurance Agreements will result in a 35% or more reduction of annuity deposits for the Insurance Subsidiaries in any 12-month period.
SECTION 6.07. Sale-Leaseback Transactions. The Borrower shall not, nor shall it permit any of its Material Subsidiaries to, enter into any an arrangement with any Person (other than the Borrower or any of its Material Subsidiaries) providing for the leasing to the Borrower or any of its Material Subsidiaries for a period of more than five years of any property which has been or is to be sold or transferred by the Borrower or such Material Subsidiary to such Person or to any other Person (other than the Borrower or any of its Material Subsidiaries), to which funds have been or are to be advanced by such Person on the security of the property subject to such lease (a “Sale-Leaseback Transaction”) if, after giving effect thereto, the Value (as defined below) of all Sale-Leaseback Transactions at such time would exceed 10% of the Consolidated Net Worth of the Borrower at such time. For purposes of this Section 6.07, “Value” shall mean, with respect to any Sale-Leaseback Transaction as at any time, the amount equal to the greater of (a) the net proceeds of the sale or transfer of the property subject to such Sale-Leaseback Transaction and (b) the fair value, in the opinion of the board of directors of the Borrower of such property at the time of entering into such Sale-Leaseback Transaction, in either case divided first by the number of full years of the term of the lease and then multiplied by the number of full years of such term remaining at the time of determination, without regard to any renewal or extension options contained in such lease; provided, that all obligations under such sale-leaseback agreements shall constitute Debt for purposes of calculating compliance with the covenants set forth in this Article VI.
SECTION 6.08. Restricted Payments. The Borrower shall not declare or make, or agree to pay or make, directly or indirectly, any Restricted Payment, or incur any obligation (contingent or otherwise) to do so unless, both immediately before and after giving effect to such Restricted Payment, no Default exists.
SECTION 6.09. Transactions with Affiliates. Except as expressly permitted by this Agreement, the Borrower shall not, nor shall it permit any of its Subsidiaries to, directly or indirectly: (a) make any Investment in an Affiliate; (b) transfer, sell, lease, assign or otherwise dispose of any property to an Affiliate; (c) merge into or consolidate with or purchase or acquire property from an Affiliate; or (d) enter into any other transaction directly or indirectly with or for the benefit of an Affiliate (including, without limitation, Guarantees and assumptions of obligations of an Affiliate); provided, that (i) any Affiliate who is an individual may serve as a director, officer or employee of the Borrower or any of its Subsidiaries and receive reasonable compensation for his or her services in such capacity, (ii) the Borrower and its Subsidiaries may enter into transactions (other than extensions of credit by the Borrower or any of its Subsidiaries to an Affiliate) providing for the leasing of property, the rendering or receipt of services or the purchase or sale of inventory and other property in the ordinary course of business if the monetary or business consideration arising therefrom would be substantially as advantageous to the Borrower and its Material Subsidiaries as the monetary or business consideration that would be obtained in a comparable transaction with a Person not an Affiliate (or in the case of any management agreement or investment advisory agreement among or between the Borrower and its Insurance Subsidiaries, that is approved by the Applicable Insurance Regulatory Authorities) as determined by the Borrower and (iii) the Borrower
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or any Wholly-Owned Subsidiary of the Borrower may enter into any transaction with any other Wholly-Owned Subsidiary of the Borrower.
SECTION 6.10. Restrictive Agreements. The Borrower shall not and shall not permit any of its Material Subsidiaries to, directly or indirectly, enter into or permit to exist any agreement or other arrangement that prohibits, restricts or imposes any condition on (a) the ability of the Borrower or any Material Subsidiary to create or permit to exist any Lien on any of its property or (b) the ability of any Material Subsidiary to pay dividends or other distributions with respect to any shares of its capital stock or to make or repay loans or advances to the Borrower or any other Material Subsidiary or to Guarantee Debt of the Borrower or any other Material Subsidiary; provided, that (i) the foregoing shall not apply to restrictions and conditions imposed by law or by any Credit Document, (ii) the foregoing shall not apply to restrictions and conditions existing on the date hereof and identified on Schedule 6.10 (but shall apply to any amendment or modification expanding the scope of, or any extension or renewal of, any such restriction or condition), (iii) the foregoing shall not apply to customary restrictions and conditions contained in agreements relating to the sale of a Subsidiary pending such sale, provided, that such restrictions and conditions apply only to the Subsidiary that is to be sold and such sale is permitted hereunder, (iv) clause (a) of this Section shall not apply to restrictions or conditions imposed by any agreement relating to secured Debt permitted by this Agreement if such restrictions or conditions apply only to the property securing such Debt and (v) clause (a) of this Section shall not apply to customary provisions in leases and other contracts restricting the assignment thereof.
SECTION 6.11. Maximum Ratio of Debt to Capital. The Borrower shall not, as of the end of any Fiscal Quarter, permit the ratio of (a) its Adjusted Consolidated Debt as of such Fiscal Quarter-end to (b) its Adjusted Total Capitalization as of such Fiscal Quarter-end to be greater than 0.35 to 1.00.
SECTION 6.12. Minimum Risk-Based Capital Ratio. The Borrower shall cause American Equity Life and each other Material Insurance Subsidiary to maintain a Risk-Based Capital Ratio as of the end of any Fiscal Quarter of not less than two hundred and seventy five percent (275%).
SECTION 6.13. Minimum Coverage Ratio. The Borrower shall not permit the Coverage Ratio as of the end of any Fiscal Quarter to be less than 1.00 to 1.00.
SECTION 6.14. Minimum Statutory Surplus. At all times after the Effective Date, the Borrower shall cause American Equity Life to maintain a Statutory Surplus in an amount equal to the sum of (i) eighty percent (80%) of the Statutory Surplus of American Equity Life as of December 31, 2010, plus (ii) fifty percent (50%) of the statutory net income (positive) of American Equity Life for each Fiscal Quarter ending after the Effective Date, plus (iii) fifty percent (50%) of all capital contributed to American Equity Life following the Fiscal Quarter-end immediately preceding the Effective Date.
SECTION 6.15. Amendment of Material Documents; Prepayments.
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(k)The Borrower shall not, and shall not permit any of its Material Subsidiaries to, without the prior written consent of the Required Lenders, amend, modify, supplement or waive any of its rights under its certificate of formation, limited liability company agreement, certificate of incorporation, by-laws or other organizational documents, in each case in any manner that would reasonably be expected to have a Material Adverse Effect.
(l)The Borrower shall not, and shall not permit any Subsidiary to, enter into any amendment, waiver or other modification of any of the Convertible Debt Documents, any of the Trust Preferred Securities Notes or any indenture or other agreement governing the Trust Preferred Securities Notes, or of any document evidencing or otherwise governing any Material Debt (i) if the effect of such amendment, waiver or other modification is to increase the interest rate on such Debt, increase the amount of principal due on any date, change (to earlier dates) any dates upon which payments of principal or interest are due thereon, change any event of default or condition to an event of default with respect thereto (other than to eliminate or make less onerous any such event or default or increase any grace period related thereto), change the redemption, prepayment or defeasance provisions thereof, or change any collateral therefor (other than to release such collateral), or (ii) if the effect of such amendment or change, together with all other amendments or changes made, is to increase in any material respect the obligations of the obligor thereunder or to confer any additional rights on the holders of such Debt (or a trustee or other representative on their behalf).
(m)The Borrower shall not, and shall not permit any Subsidiary to, enter into any amendment, waiver or other modification of any of the Convertible 2010 Debt Hedges or any of the 2010 Warrants (i) if the effect of such amendment, waiver or other modification is to increase the amount of any payment in cash due on any date that is earlier than December 31, 2014, change (to a date earlier than December 31, 2014) any dates upon which any such payment in cash is due thereunder, change any event of default or termination event or condition to an event of default or termination event with respect thereto (other than to eliminate or make less onerous any such event or default or termination event or increase any grace period related thereto) or (ii) if the effect of such amendment, waiver or other modification, together with all other amendments, waivers or other modifications made, is to increase in any material respect the obligations of the Borrower thereunder or to confer any additional rights on the counterparties thereto (or a trustee or other representative on their behalf).
(n)The Borrower shall not, and shall not permit any Subsidiary to, make or agree to pay or make, directly or indirectly, any payment or other distribution (whether in cash, securities or other property) of or in respect of principal of or interest on any Subordinated Debt, or any payment or other distribution (whether in cash, securities or other property), including any sinking fund or similar deposit, on account of the purchase, redemption, retirement, acquisition, cancellation, defeasance or termination of any Subordinated Debt, except:
(i)payments (other than optional or voluntary prepayments) as and when due in respect of such Subordinated Debt but only to the extent, if any, permitted by the subordination terms, subordination agreement or intercreditor agreement (or equivalent agreement otherwise named) applicable to such Subordinated Debt; and
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(ii)refinancings, replacements or exchanges of such Subordinated Debt with the proceeds of other Subordinated Debt.
SECTION 6.16. Lines of Business. The Borrower shall not, nor shall it permit any of its Subsidiaries to, engage in any line or lines of business activity other than the business of owning and operating life insurance companies and providing other financial services (including banking and investment advisory services) and businesses related or incidental thereto (it being understood that the businesses of American Equity Capital, Inc., AERL, L.C., American Equity Advisors, Inc. and American Equity Investment Properties, L.C., to the extent conducted as of the date hereof, are related to the business of owning and operating life insurance companies); provided, that at least one-half of the Borrower's Consolidated revenues, determined in accordance with GAAP, shall be derived from the business of owning and operating insurance companies (including insurance agencies).
SECTION 6.17. Fiscal Year. The Borrower shall not, nor shall it permit any Subsidiary to, change its fiscal year to end on any date other than December 31 of each year or the last days of the first three fiscal quarters in each of its fiscal years from March 31, June 30 and September 30 of each year, respectively.
ARTICLE VII
Events of Default
If any of the following events (“Events of Default”) shall occur:
(a)the Borrower shall fail to pay any principal of any Loan when the same shall become due, whether at the due date thereof or at a date fixed for prepayment thereof or otherwise;
(b)the Borrower shall fail to pay when due any interest on any Loan or any fee or other amount (except an amount referred to in clause (a) above) payable under any Credit Document, and such failure shall continue unremedied for a period of five (5) Business Days;
(c)any material representation, warranty or certification made or deemed made by or on behalf of the Borrower or any Material Subsidiary in or in connection with any Credit Document or any amendment or modification thereof or waiver thereunder, or in any report, certificate, financial statement or other document furnished pursuant to or in connection with any Credit Document or any amendment or modification thereof or waiver thereunder, shall prove to have been incorrect in any material respect when made or deemed made;
(d)the Borrower shall fail to observe or perform any covenant or agreement contained in Section 5.0l(a), Section 5.0l(b), Section 5.0l(c), Section 5.0l(d), Section 5.02, Section 5.03, Section 5.04, Section 5.09 or Section 5.10 or in Article VI;
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(e)the Borrower shall fail to observe or perform any provision of any Credit Document (other than those failures covered by clauses (a), (b), (c) and (d) of this Article VII) and such failure shall continue for 15 days after the earlier of notice of such failure to the Borrower from the Administrative Agent or knowledge of such failure by an officer of the Borrower;
(f)the Borrower or any of its Material Subsidiaries shall fail to make a payment or payments (whether of principal or interest and regardless of amount) in respect of any Material Debt when the same shall become due, whether at the due date thereof or at a date fixed for prepayment thereof or otherwise;
(g)any event or condition occurs that (i) results in any Material Debt becoming due before its scheduled maturity or (ii) enables or permits (with or without the giving of notice, the lapse of time or both) the holder or holders of Material Debt or any trustee or agent on its or their behalf to cause any Material Debt to become due, or to require the prepayment, repurchase, redemption or defeasance thereof, before its scheduled maturity or (iii) results in the termination of or enables one or more banks or financial institutions to terminate commitments to provide in excess of $10,000,000 aggregate principal amount of credit to the Borrower or its Subsidiaries; provided that, in the case of any event described in clauses (ii) or (iii) that would permit Material Debt to be accelerated or would permit termination of such commitments, as applicable, only after the lapse of any applicable cure period, so long as the Borrower has notified the Administrative Agent immediately upon occurrence of such event, shall such event give rise to an Event of Default hereunder; and provided, further, that none of (A) the occurrence of an event or condition that requires a mandatory payment of cash, or the mandatory payment of cash, in each case, required by Section 10.01 of the Indenture described in the definition of Convertible 2004 Debt Documents (as it provides on the date hereof), (B) the occurrence of an event or condition that requires a mandatory payment of cash, or the mandatory payment of cash, in each case, required by Article 10 of the Indenture described in the definition of Convertible 2009 Debt Documents (as it provides on the date hereof), (C) the occurrence of an event or condition that requires a mandatory payment of cash, or the mandatory payment of cash, in each case, pursuant to Article 14 of the Indenture described in the definition of Convertible 2010 Debt Documents, (D) any event or condition enabling or permitting the termination, cancellation or early unwind of any 2010 Warrants, or any mandatory payment of cash upon any termination, cancellation or early unwind of any 2010 Warrants to the extent that the amount of such mandatory payment is less than or equal to the amount of any concurrent payment or payments received by the Borrower in connection with the termination, cancellation or early unwind of any Convertible 2010 Debt Hedges, nor (E) the occurrence of an event or condition that requires a mandatory prepayment of Material Debt, or the mandatory prepayment of Material Debt, in each case, required to be made by reason of the sale or other disposition (including, without limitation, condemnation or insured casualty) of assets securing such Material Debt, shall be deemed to be an event or condition described in any of clauses (i), (ii) and (iii) above;
(h)an involuntary proceeding shall be commenced or an involuntary petition shall be filed seeking (i) liquidation, reorganization or other relief in respect of the Borrower
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or any of its Subsidiaries or its debts, or of a substantial part of its assets, under any Federal, state or foreign bankruptcy, insolvency, receivership or similar law now or hereafter in effect or (ii) the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for the Borrower or any of its Subsidiaries or for a substantial part of its assets, and, in any such case, such proceeding or petition shall continue undismissed for 30 days or an order or decree approving or ordering any of the foregoing shall
be entered;
(i)the Borrower or any of its Subsidiaries shall (i) voluntarily commence any proceeding or file any petition seeking liquidation, reorganization or other relief under any Federal, state or foreign bankruptcy, insolvency, receivership or similar law now or hereafter in effect, (ii) consent to the institution of, or fail to contest in a timely and appropriate manner, any proceeding or petition described in clause (h) above, (iii) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for any the Borrower or any of its Subsidiaries or for a substantial part of its assets, (iv) file an answer admitting the material allegations of a petition filed against it in any such proceeding, (v) make a general assignment for the benefit of creditors or (vi) take any action for the purpose of effecting any of the foregoing;
(j)the Borrower or any of its Subsidiaries shall become unable, admit in writing its inability or fail generally to pay its debts as they become due;
(k)one or more judgments for the payment of money, not covered by insurance, in an aggregate amount exceeding $30,000,000, after giving effect to any insurance, shall be rendered against the Borrower or any of its Subsidiaries and shall remain unpaid, unvacated or undischarged for a period of 45 consecutive days during which execution shall not be effectively stayed pending appeal or settlement thereof, or any action shall be legally taken by a judgment creditor to attach or levy upon any asset of the Borrower or any of its Subsidiaries to enforce any such judgment;
(l)an ERISA Event shall have occurred that, in the opinion of the Required Lenders, when taken together with all other ERISA Events that have occurred, would reasonably be expected to result in a Material Adverse Effect;
(m)any Governmental Authority revokes or fails to renew any material License, permit or franchise of any Borrower or any Insurance Subsidiary, or the Borrower or any Insurance Subsidiary for any reason loses any material License, permit or franchise, or the Borrower or any Insurance Subsidiary suffers the imposition of any restraining order, escrow, suspension or impound of funds in connection with any proceeding (judicial or administrative) with respect to any material License, permit or franchise, which could reasonably be expected to result in losses or liability of the Borrower or any of the Insurance Subsidiaries, individually or in the aggregate, in excess of $10,000,000, and such event shall continue unremedied for a period of ten (10) Business Days;
(n)a Change in Control shall occur; or
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(o)any material provision of any Credit Document after delivery thereof shall for any reason cease to be valid and binding on or enforceable against the Borrower, or the Borrower shall so state in writing;
then, and in every such event (except an event with respect to the Borrower described in clause (h) or (i) above), and at any time thereafter during the continuance of such event, the Administrative Agent may, and at the request of the Required Lenders shall, by notice to the Borrower, take either or both of the following actions, at the same or different times: (i) terminate the Commitments, and thereupon the Commitments shall terminate immediately, and (ii) declare the Loans then outstanding to be due and payable in whole (or in part, in which case any principal not so declared to be due and payable may thereafter be declared to be due and payable), and thereupon the principal of the Loans so declared to be due and payable, together with accrued interest thereon and all fees and other obligations of the Borrower accrued hereunder, shall become due and payable immediately, without presentment, demand, protest or other notice of any kind, all of which are waived by the Borrower; and in the case of any event with respect to the Borrower described in clause (h) or (i) above, the Commitments shall automatically terminate and the principal of the Loans then outstanding, together with accrued interest thereon and all fees and other obligations of the Borrower accrued hereunder, shall automatically become due and payable, without presentment, demand, protest or other notice of any kind, all of which are waived by the Borrower.
ARTICLE VIII
The Administrative Agent
Each of the Lenders hereby irrevocably appoints the Administrative Agent as its agent and authorizes the Administrative Agent to take such actions on its behalf and to exercise such powers as are delegated to the Administrative Agent by the terms hereof, together with such actions and powers as are reasonably incidental thereto.
The bank serving as the Administrative Agent hereunder shall have the same rights and powers in its capacity as a Lender as any other Lender and may exercise the same as though it were not the Administrative Agent, and such bank and its Affiliates may accept deposits from, lend money to and generally engage in any kind of business with the Borrower or any Subsidiary or other Affiliate thereof as if it were not the Administrative Agent hereunder.
The Administrative Agent shall not have any duties or obligations except those expressly set forth herein. Without limiting the generality of the foregoing, (a) the Administrative Agent shall not be subject to any fiduciary or other implied duties, regardless of whether a Default has occurred and is continuing, (b) the Administrative Agent shall not have any duty to take any discretionary action or exercise any discretionary powers, except discretionary rights and powers expressly contemplated hereby that the Administrative Agent is required to exercise in writing as directed by the Required Lenders (or such other number or percentage of the Lenders as shall be necessary under the circumstances as provided in Section 9.02), and (c) except as expressly set forth herein, the Administrative Agent shall not have any duty to disclose, and shall not be liable for the failure to disclose, any information relating to the Borrower or any of its Subsidiaries that is communicated to or obtained by the bank serving as Administrative Agent or any of its Affiliates
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in any capacity. The Administrative Agent shall not be liable for any action taken or not taken by it with the consent or at the request of the Required Lenders (or such other number or percentage of the Lenders as shall be necessary under the circumstances as provided in Section 9.02) or in the absence of its own gross negligence or willful misconduct. The Administrative Agent shall be deemed not to have knowledge of any Default unless and until written notice thereof is given to the Administrative Agent by the Borrower or a Lender, and the Administrative Agent shall not be responsible for or have any duty to ascertain or inquire into (i) any statement, warranty or representation made in or in connection with this Agreement, (ii) the contents of any certificate, report or other document delivered hereunder or in connection herewith, (iii) the performance or observance of any of the covenants, agreements or other terms or conditions set forth herein, (iv) the validity, enforceability, effectiveness or genuineness of this Agreement or any other agreement, instrument or document, or (v) the satisfaction of any condition set forth in Article IV or elsewhere herein, other than to confirm receipt of items expressly required to be delivered to the Administrative Agent.
The Administrative Agent shall be entitled to rely upon, and shall not incur any liability for relying upon, any notice, request, certificate, consent, statement, instrument, document or other writing believed by it to be genuine and to have been signed or sent by the proper Person. The Administrative Agent also may rely upon any statement made to it orally or by telephone and believed by it to be made by the proper Person, and shall not incur any liability for relying thereon. The Administrative Agent may consult with legal counsel (who may be counsel for the Borrower), independent accountants and other experts selected by it, and shall not be liable for any action taken or not taken by it in accordance with the advice of any such counsel, accountants or experts.
The Administrative Agent may perform any and all its duties and exercise its rights and powers by or through any one or more sub-agents appointed by the Administrative Agent. The Administrative Agent and any such sub-agent may perform any and all its duties and exercise its rights and powers through their respective Related Parties. The exculpatory provisions of the preceding paragraphs shall apply to any such sub-agent and to the Related Parties of the Administrative Agent and any such sub-agent, and shall apply to their respective activities in connection with the syndication of the credit facilities provided for herein as well as activities as Administrative Agent.
Subject to the appointment and acceptance of a successor Administrative Agent as provided in this paragraph, the Administrative Agent may resign at any time by notifying the Lenders and the Borrower. Upon any such resignation, the Required Lenders shall have the right, in consultation with the Borrower, to appoint a successor. If no successor shall have been so appointed by the Required Lenders and shall have accepted such appointment within 30 days after the retiring Administrative Agent gives notice of its resignation, then the retiring Administrative Agent may, on behalf of the Lenders, appoint a successor Administrative Agent which shall be a bank with an office in New York, New York, or an Affiliate of any such bank. Upon the acceptance of its appointment as Administrative Agent hereunder by a successor, such successor shall succeed to and become vested with all the rights, powers, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations hereunder. The fees payable by the Borrower to a successor Administrative Agent shall be the same as those
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payable to its predecessor unless otherwise agreed between the Borrower and such successor. After the Administrative Agent's resignation hereunder, the provisions of this Article and Section 9.03 shall continue in effect for the benefit of such retiring Administrative Agent, its sub-agents and their respective Related Parties in respect of any actions taken or omitted to be taken by any of them while it was acting as Administrative Agent.
Each Lender acknowledges that it has, independently and without reliance upon the Administrative Agent or any other Lender and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Administrative Agent or any other Lender and based on such documents and information as it shall from time to time deem appropriate, continue to make its own decisions in taking or not taking action under or based upon this Agreement, any related agreement or any document furnished hereunder or thereunder.
None of the Lenders identified in this Agreement as the “Syndication Agent” or as the "Documentation Agent" shall have any right, power, obligation, liability, responsibility or duty under this Agreement other than those applicable to all Lenders as such. Without limiting the foregoing, no such Lender shall have or be deemed to have a fiduciary relationship with any other Lender. Each Lender hereby makes the same acknowledgments with respect to each such Lender as it makes with respect to the Administrative Agent in the preceding paragraph.
ARTICLE IX
Miscellaneous
SECTION 9.01. Notices. (a) Except in the case of notices and other communications expressly permitted to be given by telephone (and subject to paragraph (b) below), all notices and other communications provided for herein shall be in writing and shall be delivered by hand or overnight courier service, mailed by certified or registered mail or sent by telecopy, as follows:
(i)if to the Borrower, to it at 6000 Westown Parkway, West Des Moines, Iowa 50266, Attention of John M. Matovina, Chief Financial Officer (Telecopy No. (515) 221-9947);
(ii)if to the Administrative Agent, to JPMorgan Chase Bank, National Association, Loan and Agency Services Group, 10 S. Dearborn, 7th Floor, Chicago, Illinois 60603, Attention of Darren Cunningham (Telecopy No. (888) 292-9533), with a copy to JPMorgan Chase Bank, National Association, 10 S. Dearborn, 9th Floor, Suite IL1-0364, Chicago, Illinois 60603, Attention of Thomas A. Kiepura (Telecopy No. (312) 794-7684); and
(iii)if to any other Lender, to it at its address (or telecopy number) set forth in its Administrative Questionnaire.
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(b)Notices and other communications to the Lenders hereunder may be delivered or furnished by electronic communications pursuant to procedures approved by the Administrative Agent; provided that the foregoing shall not apply to notices pursuant to Article II unless otherwise agreed by the Administrative Agent and the applicable Lender. The Administrative Agent or the Borrower may, in its discretion, agree to accept notices and other communications to it hereunder by electronic communications pursuant to procedures approved by it; provided that approval of such procedures may be limited to particular notices or communications.
(c)Any party hereto may change its address or telecopy number for notices and other communications hereunder by notice to the other parties hereto. All notices and other communications given to any party hereto in accordance with the provisions of this Agreement shall be deemed to have been given on the date of receipt.
SECTION 9.02. Waivers; Amendments. (a) No failure or delay by the Administrative Agent or any Lender in exercising any right or power hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the Administrative Agent and the Lenders hereunder are cumulative and are not exclusive of any rights or remedies that they would otherwise have. No waiver of any provision of this Agreement or consent to any departure by the Borrower therefrom shall in any event be effective unless the same shall be permitted by paragraph (b) of this Section, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. Without limiting the generality of the foregoing, the making of a Loan shall not be construed as a waiver of any Default, regardless of whether the Administrative Agent or any Lender may have had notice or knowledge of such Default at the time.
(b)Neither this Agreement nor any provision hereof may be waived, amended or modified except pursuant to an agreement or agreements in writing entered into by the Borrower and the Required Lenders or by the Borrower and the Administrative Agent with the consent of the Required Lenders; provided that no such agreement shall (i) increase the Commitment of any Lender without the written consent of such Lender, (ii) reduce the principal amount of any Loan or reduce the rate of interest thereon, or reduce any fees payable hereunder, without the written consent of each Lender affected thereby, (iii) postpone the scheduled date of payment of the principal amount of any Loan, or any interest thereon, or any fees payable hereunder, or reduce the amount of, waive or excuse any such payment, or postpone the scheduled date of expiration of any Commitment, without the written consent of each Lender affected thereby, (iv) change Section 2.15(b) or (c) in a manner that would alter the pro rata sharing of payments required thereby, without the written consent of each Lender, or (v) change any of the provisions of this Section or the definition of “Required Lenders” or any other provision hereof specifying the number or percentage of Lenders required to waive, amend or modify any rights hereunder or make any determination or grant any consent hereunder, without the written consent of each Lender; provided further, that no such agreement shall amend, modify or otherwise affect the rights or duties of the Administrative Agent without the prior written consent of the Administrative Agent.
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(c)Notwithstanding the foregoing, upon the execution and delivery of all documentation required by Section 2.06(d) to be delivered in connection with an increase to the aggregate Commitments, the Administrative Agent, the Borrower and the new or existing Lenders whose Commitments have been affected may and shall enter into an amendment hereof (which shall be binding on all parties hereto and the new Lenders) solely for the purpose of reflecting any new Lenders and their new Revolving Commitments and any increase in the Commitment of any existing Lender.
SECTION 9.03. Expenses; Indemnity; Damage Waiver. (a) The Borrower shall pay (i) all reasonable out of pocket expenses incurred by (x) the Administrative Agent and its Affiliates and the Lead Arrangers, including the reasonable fees, charges and disbursements of counsel for the Administrative Agent and the Lead Arrangers, in connection with the syndication of the credit facilities provided for herein and (y) the Administrative Agent associated with the preparation and administration of this Agreement and the other Credit Documents or any amendments, modifications or waivers of the provisions hereof (whether or not the transactions contemplated hereby or thereby shall be consummated) and (ii) all out-of-pocket expenses incurred by the Administrative Agent or any Lender, including the fees, charges and disbursements of any counsel for the Administrative Agent or any Lender, in connection with the enforcement or protection of its rights in connection with this Agreement and the other Credit Documents, including its rights under this Section, or in connection with the Loans made hereunder, including all such out-of pocket expenses incurred during any workout, restructuring or negotiations in respect of such Loans.
(b)The Borrower shall indemnify the Administrative Agent, the Lead Arrangers and each Lender, and each Related Party of any of the foregoing Persons (each such Person being called an “Indemnitee”) against, and hold each Indemnitee harmless from, any and all losses, claims, damages, liabilities and related expenses, including the fees, charges and disbursements of any counsel for any Indemnitee, incurred by or asserted against any Indemnitee arising out of, in connection with, or as a result of (i) the execution or delivery of this Agreement, the other Credit Documents or any agreement or instrument contemplated hereby, the performance by the parties hereto of their respective obligations thereunder or the consummation of the Transactions or any other transactions contemplated hereby, (ii) any Loan or the use of the proceeds therefrom, (iii) any actual or alleged presence or release of Hazardous Materials on or from any property owned or operated by the Borrower or any of its Subsidiaries, or any Environmental Liability related in any way to the Borrower or any of its Subsidiaries, or (iv) any actual or prospective claim, litigation, investigation or proceeding relating to any of the foregoing, whether based on contract, tort or any other theory and regardless of whether any Indemnitee is a party thereto; provided that such indemnity shall not, as to any Indemnitee, be available to the extent that such losses, claims, damages, liabilities or related expenses are determined by a court of competent jurisdiction by final and nonappealable judgment to have resulted from the gross negligence or willful misconduct of such Indemnitee. This Section 9.03(b) shall not apply with respect to Taxes other than any Taxes that represent losses or damages arising from any non-Tax claim.
(c)To the extent that the Borrower fails to pay any amount required to be paid by it to the Administrative Agent under paragraph (a) or (b) of this Section (and without limiting its obligation to do so), each Lender severally agrees to pay to the Administrative Agent such
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Lender's Applicable Percentage (determined as of the time that the applicable unreimbursed expense or indemnity payment is sought) of such unpaid amount; provided that the unreimbursed expense or indemnified loss, claim, damage, liability or related expense, as the case may be, was incurred by or asserted against the Administrative Agent in its capacity as such.
(d)To the extent permitted by applicable law, the Borrower shall not assert, and hereby waives, any claim against any Indemnitee, on any theory of liability, for special, indirect, consequential or punitive damages (as opposed to direct or actual damages) arising out of, in connection with, or as a result of, this Agreement, the other Credit Documents or any agreement or instrument contemplated hereby, the Transactions, any Loan or the use of the proceeds thereof.
(e)All amounts due under this Section shall be payable not later than five (5) Business Days after written demand therefor.
SECTION 9.04. Successors and Assigns. (a) The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns permitted hereby except that (i) the Borrower may not assign or otherwise transfer any of its rights or obligations hereunder without the prior written consent of each Lender (and any attempted assignment or transfer by the Borrower without such consent shall be null and void) and (ii) no Lender may assign or otherwise transfer its rights or obligations hereunder except in accordance with this Section. Nothing in this Agreement, expressed or implied, shall be construed to confer upon any Person (other than the parties hereto, their respective successors and assigns permitted hereby, Participants (to the extent provided in paragraph (c) of this Section) and, to the extent expressly contemplated hereby, the Related Parties of each of the Administrative Agent and the Lenders) any legal or equitable right, remedy or claim under or by reason of this Agreement.
(b)(i) Subject to the conditions set forth in paragraph (b)(ii) below, any Lender may assign to one or more assignees all or a portion of its rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans at the time owing to it) with the prior written consent of:
(A)the Borrower (such consent not to be unreasonably withheld), provided that the Borrower shall be deemed to have consented to any such assignment unless it shall object thereto by written notice to the Administrative Agent within five (5) Business Days after having received notice thereof, and provided further that no consent of the Borrower shall be required for an assignment to a Lender, an Affiliate of a Lender, an Approved Fund or, if an Event of Default has occurred and is continuing, any other assignee; and
(B)the Administrative Agent (such consent not to be unreasonably withheld or delayed), provided that no consent of the Administrative Agent shall be required for an assignment of any Commitment to an assignee that is a Lender with a Commitment immediately prior to giving effect to such assignment.
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(ii)Assignments shall be subject to the following additional conditions:
(A)except in the case of an assignment to a Lender, an Affiliate of a Lender or an Approved Fund or an assignment of the entire remaining amount of the assigning Lender's Commitment or Loans of any Class, the amount of the Commitment or Loans of the assigning Lender subject to each such assignment (determined as of the date the Assignment and Assumption with respect to such assignment is delivered to the Administrative Agent) shall not be less than $5,000,000 unless each of the Borrower and the Administrative Agent otherwise consent, provided that no such consent of the Borrower shall be required if an Event of Default has occurred and is continuing;
(B)each partial assignment shall be made as an assignment of a proportionate part of all the assigning Lender's rights and obligations under this Agreement;
(C)the parties to each assignment shall execute and deliver to the Administrative Agent an Assignment and Assumption, together with a processing and recordation fee of $3,500 payable by the assignor or the assignee upon the effectiveness thereof; and
(D)the assignee, if it shall not be a Lender, shall deliver to the Administrative Agent an Administrative Questionnaire in which the assignee designates one or more “credit contacts” to whom all syndicate-level information (which may contain material non-public information about the Borrower and its Subsidiaries and affiliates and their Related Parties or their respective securities) will be made available and who may receive such information in accordance with the assignee's compliance procedures and applicable laws, including Federal and state securities laws.
For the purposes of this Section 9.04(b), the term “Approved Fund” has the following meaning:
“Approved Fund” means any Person (other than a natural person) that is engaged in making, purchasing, holding or investing in bank loans and similar extensions of credit in the ordinary course of its business and that is administered or managed by (a) a Lender, (b) an Affiliate of a Lender or (c) an entity or an Affiliate of an entity that administers or manages a Lender.
(iii)Subject to acceptance and recording thereof pursuant to paragraph (b)(iv) of this Section, from and after the effective date specified in each Assignment and Assumption the assignee thereunder shall be a party hereto and, to the extent of the interest assigned by such Assignment and Assumption, have the rights and obligations of a Lender under this Agreement, and the assigning Lender thereunder shall, to the extent of the interest assigned by such Assignment and Assumption, be released from its obligations under this Agreement (and, in the case of an Assignment and Assumption covering all of the assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto but shall continue to be entitled to the benefits of Sections 2.12, 2.13, 2.14 and 9.03). Any assignment or transfer by a Lender of rights or obligations under this Agreement that does
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not comply with this Section 9.04 shall be treated for purposes of this Agreement as a sale by such Lender of a participation in such rights and obligations in accordance with paragraph (c) of this Section.
(iv)The Administrative Agent, acting for this purpose as an agent of the Borrower, shall maintain at one of its offices a copy of each Assignment and Assumption delivered to it and a register for the recordation of the names and addresses of the Lenders, and the Commitment of, and principal amount of the Loans owing to, each Lender pursuant to the terms hereof from time to time (the “Register”). The entries in the Register shall be conclusive, and the Borrower, the Administrative Agent and the Lenders shall treat each Person whose name is recorded in the Register pursuant to the terms hereof as a Lender hereunder for all purposes of this Agreement, notwithstanding notice to the contrary. The Register shall be available for inspection by the Borrower and any Lender, at any reasonable time and from time to time upon reasonable prior notice.
(v)Upon its receipt of a duly completed Assignment and Assumption executed by an assigning Lender and an assignee, the assignee's completed Administrative Questionnaire (unless the assignee shall already be a Lender hereunder), the processing and recordation fee referred to in paragraph (b) of this Section and any written consent to such assignment required by paragraph (b) of this Section, the Administrative Agent shall accept such Assignment and Assumption and record the information contained therein in the Register; provided that if either the assigning Lender or the assignee shall have failed to make any payment required to be made by it pursuant to Section 2.04(b), 2.15(d) or 9.03(c), the Administrative Agent shall have no obligation to accept such Assignment and Assumption and record the information therein in the Register unless and until such payment shall have been made in full, together with all accrued interest thereon. No assignment shall be effective for purposes of this Agreement unless it has been recorded in the Register as provided in this paragraph.
(c)Any Lender may, without the consent of the Borrower or the Administrative Agent, sell participations to one or more banks or other entities (a "Participant") in all or a portion of such Lender's rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans owing to it); provided that (A) such Lender's obligations under this Agreement shall remain unchanged; (B) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations; and (C) the Borrower, the Administrative Agent and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement. Any agreement or instrument pursuant to which a Lender sells such a participation shall provide that such Lender shall retain the sole right to enforce this Agreement and to approve any amendment, modification or waiver of any provision of this Agreement; provided that such agreement or instrument may provide that such Lender will not, without the consent of the Participant, agree to any amendment, modification or waiver described in the first proviso to Section 9.02(b) that affects such Participant. Borrower agrees that each Participant shall be entitled to the benefits of Sections 2.12, 2.13 and 2.14 (subject to the requirements and limitations therein, including the requirements under Section 2.14(f) (it being understood that the documentation required under Section 2.14(f) shall be delivered to the participating Lender)) to the same extent as if it were a Lender and had acquired its interest by
71
assignment pursuant to paragraph (b) of this Section.; provided that such Participant (A) agrees to be subject to the provisions of Sections 2.15 and 2.16 as if it were an assignee under paragraph (b) of this Section; and (B) shall not be entitled to receive any greater payment under Sections 2.12 or 2.14, with respect to any participation, than its participating Lender would have been entitled to receive, except to the extent such entitlement to receive a greater payment results from a Change in Law that occurs after the Participant acquired the applicable participation. To the extent permitted by law, each Participant also shall be entitled to the benefits of Section 9.08 as though it were a Lender, provided such Participant agrees to be subject to Section 2.15(c) as though it were a Lender. Each Lender that sells a participation shall, acting solely for this purpose as an agent of the Borrower, maintain a register on which it enters the name and address of each Participant and the principal amounts (and stated interest) of each Participant's interest in the Loans or other obligations under this Agreement (the "Participant Register"); provided that no Lender shall have any obligation to disclose all or any portion of the Participant Register to any Person (including the identity of any Participant or any information relating to a Participant's interest in any Commitments, Loans or its other obligations under any Loan Document) except to the extent that such disclosure is necessary to establish that such Commitment, Loan, or other obligation is in registered form under Section 5f.103-1(c) of the United States Treasury Regulations. The entries in the Participant Register shall be conclusive absent manifest error, and such Lender shall treat each person whose name is recorded in the Participant Register as the owner of such participation for all purposes of this Agreement notwithstanding any notice to the contrary.
(d)Any Lender may at any time pledge or assign a security interest in all or any portion of its rights under this Agreement to secure obligations of such Lender, including without limitation any pledge or assignment to secure obligations to a Federal Reserve Bank, and this Section shall not apply to any such pledge or assignment of a security interest; provided that no such pledge or assignment of a security interest shall release a Lender from any of its obligations hereunder or substitute any such pledgee or assignee for such Lender as a party hereto.
SECTION 9.05. Survival. All covenants, agreements, representations and warranties made by the Borrower herein and in the certificates or other instruments delivered in connection with or pursuant to this Agreement shall be considered to have been relied upon by the other parties hereto and shall survive the execution and delivery of this Agreement and the making of any Loans, regardless of any investigation made by any such other party or on its behalf and notwithstanding that the Administrative Agent or any Lender may have had notice or knowledge of any Default or incorrect representation or warranty at the time any credit is extended hereunder, and shall continue in full force and effect as long as the principal of or any accrued interest on any Loan or any fee or any other amount payable under this Agreement is outstanding and unpaid and so long as the Commitments have not expired or terminated. The provisions of Sections 2.12, 2.14, 2.15, 2.16, 2.17 and 9.03 and Article VIII shall survive and remain in full force and effect regardless of the consummation of the transactions contemplated hereby, the repayment of the Loans, the expiration or termination of the Commitments or the termination of this Agreement or any provision hereof.
SECTION 9.06. Counterparts; Integration; Effectiveness. This Agreement may be executed in counterparts (and by different parties hereto on different counterparts), each of which
72
shall constitute an original, but all of which when taken together shall constitute a single contract. This Agreement and any separate letter agreements with respect to fees payable to the Administrative Agent constitute the entire contract among the parties relating to the subject matter hereof and supersede any and all previous agreements and understandings, oral or written, relating to the subject matter hereof. Except as provided in Section 4.01, this Agreement shall become effective when it shall have been executed by the Administrative Agent and when the Administrative Agent shall have received counterparts hereof which, when taken together, bear the signatures of each of the other parties hereto, and thereafter shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. Delivery of an executed counterpart of a signature page of this Agreement by telecopy shall be effective as delivery of a manually executed counterpart of this Agreement.
SECTION 9.07. Severability. Any provision of this Agreement held to be invalid, illegal or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity, illegality or unenforceability without affecting the validity, legality and enforceability of the remaining provisions hereof; and the invalidity of a particular provision in a particular jurisdiction shall not invalidate such provision in any other jurisdiction.
SECTION 9.08. Right of Setoff. If an Event of Default shall have occurred and be continuing, each Lender and each of its Affiliates is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other obligations at any time owing by such Lender or Affiliate to or for the credit or the account of the Borrower against any of and all the obligations of the Borrower now or hereafter existing under this Agreement and the other Credit Documents held by such Lender, irrespective of whether or not such Lender shall have made any demand under this Agreement and although such obligations may be unmatured. The rights of each Lender under this Section are in addition to other rights and remedies (including other rights of setoff) which such Lender may have.
SECTION 9.09 Governing Law; Jurisdiction; Consent to Service of Process. (a) This Agreement shall be construed in accordance with and governed by the law of the State of New York.
(b)The Borrower hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of the Supreme Court of the State of New York sitting in New York County and of the United States District Court of the Southern District of New York, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or the other Credit Documents, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in such New York State or, to the extent permitted by law, in such Federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that the Administrative Agent or any Lender may otherwise have to bring any action or proceeding relating to this Agreement and the other Credit Documents against the Borrower or its properties in the courts of any jurisdiction.
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(c)The Borrower hereby irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection which it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement and the other Credit Documents in any court referred to in paragraph (b) of this Section. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court.
(d)Each party to this Agreement irrevocably consents to service of process in the manner provided for notices in Section 9.01. Nothing in this Agreement will affect the right of any party to this Agreement to serve process in any other manner permitted by law.
SECTION 9.10. WAIVER OF JURY TRIAL. EACH PARTY HERETO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AGREEMENT, THE OTHER CREDIT DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED HEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.
SECTION 9.11. Headings. Article and Section headings and the Table of Contents used herein are for convenience of reference only, are not part of this Agreement and shall not affect the construction of, or be taken into consideration in interpreting, this Agreement.
SECTION 9.12. Confidentiality. Each of the Administrative Agent and the Lenders agrees to maintain the confidentiality of the Information (as defined below), except that Information may be disclosed (a) to its and its Affiliates' directors, officers, employees and agents, including accountants, legal counsel and other advisors (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Information and instructed to keep such Information confidential), (b) to the extent requested by any regulatory authority or self-regulatory body, (c) to the extent required by applicable laws or regulations or by any subpoena or similar legal process, (d) to any other party to this Agreement, (e) in connection with the exercise of any remedies hereunder or any suit, action or proceeding relating to this Agreement or the other Credit Documents or the enforcement of rights hereunder, (f) subject to an agreement containing provisions substantially the same as those of this Section, to (i) any assignee of or Participant in, or any prospective assignee of or Participant in, any of its rights or obligations under this Agreement or (ii) any actual or prospective counterparty (or its advisors) to any swap or derivative transaction relating to the Borrower and its obligations, (g) with the consent of the Borrower or (h) to the extent such Information (i) becomes publicly available other than as a result of a breach of this Section or (ii) becomes available to the Administrative Agent or any Lender on a non-confidential basis from a source other than the Borrower. For the purposes of this Section, “Information” means all
74
information received from the Borrower relating to the Borrower or its business, other than any such information that is available to the Administrative Agent or any Lender on a non-confidential basis prior to disclosure by the Borrower; provided that, in the case of information received from the Borrower after the date hereof, such information is clearly identified at the time of delivery as confidential. Any Person required to maintain the confidentiality of Information as provided in this Section shall be considered to have complied with its obligation to do so if such Person has exercised the same degree of care to maintain the confidentiality of such Information as such Person would accord to its own confidential information.
EACH LENDER ACKNOWLEDGES THAT INFORMATION AS DEFINED IN SECTION 9.12(a) FURNISHED TO IT PURSUANT TO THIS AGREEMENT MAY INCLUDE MATERIAL NON-PUBLIC INFORMATION CONCERNING THE BORROWER AND ITS RELATED PARTIES OR THEIR RESPECTIVE SECURITIES, AND CONFIRMS THAT IT HAS DEVELOPED COMPLIANCE PROCEDURES REGARDING THE USE OF MATERIAL NON-PUBLIC INFORMATION AND THAT IT WILL HANDLE SUCH MATERIAL NON-PUBLIC INFORMATION IN ACCORDANCE WITH THOSE PROCEDURES AND APPLICABLE LAW, INCLUDING FEDERAL AND STATE SECURITIES LAWS.
ALL INFORMATION, INCLUDING REQUESTS FOR WAIVERS AND AMENDMENTS, FURNISHED BY THE BORROWER OR THE ADMINISTRATIVE AGENT PURSUANT TO, OR IN THE COURSE OF ADMINISTERING, THIS AGREEMENT WILL BE SYNDICATE-LEVEL INFORMATION, WHICH MAY CONTAIN MATERIAL NON-PUBLIC INFORMATION ABOUT THE BORROWER AND ITS SUBSIDIARIES AND AFFILIATES AND THEIR RELATED PARTIES OR THEIR RESPECTIVE SECURITIES. ACCORDINGLY, EACH LENDER REPRESENTS TO THE BORROWER AND THE ADMINISTRATIVE AGENT THAT IT HAS IDENTIFIED IN ITS ADMINISTRATIVE QUESTIONNAIRE A CREDIT CONTACT WHO MAY RECEIVE INFORMATION THAT MAY CONTAIN MATERIAL NON-PUBLIC INFORMATION IN ACCORDANCE WITH ITS COMPLIANCE PROCEDURES AND APPLICABLE LAW.
SECTION 9.13. Interest Rate Limitation. Notwithstanding anything herein to the contrary, if at any time the interest rate applicable to any Loan, together with all fees, charges and other amounts which are treated as interest on such Loan under applicable law (collectively the “Charges”), shall exceed the maximum lawful rate (the “Maximum Rate”) which may be contracted for, charged, taken, received or reserved by the Lender holding such Loan in accordance with applicable law, the rate of interest payable in respect of such Loan hereunder, together with all Charges payable in respect thereof, shall be limited to the Maximum Rate and, to the extent lawful, the interest and Charges that would have been payable in respect of such Loan but were not payable as a result of the operation of this Section shall be cumulated and the interest and Charges payable to such Lender in respect of other Loans or periods shall be increased (but not above the Maximum Rate therefor) until such cumulated amount, together with interest thereon at the Federal Funds Effective Rate to the date of repayment, shall have been received by such Lender.
SECTION 9.14. USA PATRIOT Act. Each Lender that is subject to the requirements of the USA Patriot Act (Title III of Pub. L. 107-56 (signed into law October 26, 2001)) (the “Act”) hereby notifies the Borrower that pursuant to the requirements of the Act, it is required to obtain, verify and record information that identifies the Borrower, which information includes the name and address of the Borrower and other information that will allow such Lender to identify the Borrower in accordance with the Act.
[signature pages follow]
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY, as Borrower
By: /s/ John Matovina
Name: John Matovina
Title: Vice Chairman, Chief Financial Officer
JPMORGAN CHASE BANK, NATIONAL ASSOCIATION, individually and as Administrative Agent
By: /s/ Thomas A. Kiepura
Name: Thomas A. Kiepura
Title: Vice President
SUNTRUST BANK, individually and as Syndication Agent
By: /s/ K. Scott Bazemore
Name: K. Scott Bazemore
Title: Vice President
DEUTSCHE BANK SECURITIES INC., as Documentation Agent
By: /s/ John S. McGill
Name: John S. McGill
Title: Director
By: /s/ Kathleen Bowers
Name: Kathleen Bowers
Title: Director
DEUTSCHE BANK AG NEW YORK BRANCH, as a Lender
By: /s/ John S. McGill
Name: John S. McGill
Title: Director
By: /s/ Kathleen Bowers
Name: Kathleen Bowers
Title: Director
BANKERS TRUST COMPANY, as a Lender
By: /s/ Jon M. Doll
Name: Jon M. Doll
Title: Vice President & Senior Lending Officer
CITIBANK, N.A., as a Lender
By: /s/ Blake Grenich
Name: Blake Grenich
Title: Vice President
ASSOCIATED BANK, NATIONAL ASSOCIATION, as a Lender
By: /s/ Peter J Bulandr
Name: Peter J Bulandr
Title: Senior Vice President
WEST BANK, as a Lender
By: /s/ Kevin J. Smith
Name: Kevin J. Smith
Title: Senior Vice President
Schedule 2.01
Commitments
JPMorgan Chase Bank, National Association | $30,000,000 |
SunTrust Bank | $30,000,000 |
Deutsche Bank AG New York Branch | $25,000,000 |
Bankers Trust Company | $25,000,000 |
Citibank, N.A. | $20,000,000 |
Associated Bank, National Association | $15,000,000 |
West Bank | $15,000,000 |
TOTAL | $160,000,000 |
SCHEDULE 3.07 PART A
Subsidiaries
SCHEDULE 3.07 - INFORMATION CONCERNING ACTIVITIES OF INSURER MEMBERS OF A HOLDING COMPANY GROUP
PART 1 - ORGANIZATIONAL CHART
Material Subsidiaries: American Equity Investment Life Insurance Company (all other subsidiaries are not material)
I) American Equity Investment Life Holding Company
IA FEIN #42-1447959
West Des Moines, IA 50266
December 15, 1995/Jurisdiction Iowa
A) American Equity Investment Life Insurance Company
NAIC NO. #92738, IA FEIN #42-1153896, GROUP NO. #2658
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
December 19, 1980/Jurisdiction Iowa
1) American Equity Investment Life Insurance Company of New York
NAIC NO. #11135, FEIN #22-3762465, GROUP NO. #2658
Lake Success, NY 11042
100% American Equity Investment Life Insurance Company
March 1, 2001/Jurisdiction New York
2) Eagle Life Insurance Company
NAIC No. #13183, FEIN #26-3218907, GROUP No. #2658
West Des Moines, IA 50266
100% American Equity Investment Life Insurance Company
August 28, 2008/Jurisdiction Iowa
3) AERL, L.C.
FEIN #27-0413288
West Des Moines, IA 50266
100% American Equity Investment Life Insurance Company
June 10, 2009/Jurisdiction Iowa
B) American Equity Investment Service Company
IA FEIN #42-1459400
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
September 2, 2005/Jurisdiction Iowa
C) American Equity Properties, LC
IA FEIN #42-1461598
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
September 17, 1996/Jurisdiction Iowa
D) American Equity Capital, Inc.
IA FEIN #42-1470628
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
February 16, 1998/Jurisdiction Iowa
E) American Equity Advisors, Inc.
FEIN #27-0168742
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
April 6, 2009/Jurisdiction Iowa
F01) American Equity Capital Trust I
FEIN #51-6513908
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
July 9, 1999/Jurisdiction Delaware
F02) American Equity Capital Trust II
FEIN #42-6593040
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
October 26, 1999/Jurisdiction Delaware
F03) American Equity Capital Trust III
FEIN #42-6624950
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
April 29, 2004/Jurisdiction Delaware
F04) American Equity Capital Trust IV
FEIN #51-6553461
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
December 16, 2003/Jurisdiction Delaware
F05) American Equity Capital Trust V
FEIN #20-3761213
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
March 11, 2004/Jurisdiction Delaware
F06) American Equity Capital Trust VI
FEIN #20-3761298
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
March 11, 2004/Jurisdiction Delaware
F07) American Equity Capital Trust VII
FEIN #20-1624559
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
September 14, 2004/Jurisdiction Delaware
F08) American Equity Capital Trust VIII
FEIN #20-6415950
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
December 22, 2004/Jurisdiction Delaware
F09) American Equity Capital Trust IX
FEIN #43-6924157
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
June 15, 2005/Jurisdiction Delaware
F10) American Equity Capital Trust X
FEIN #26-6026667
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
August 4, 2005/Jurisdiction Delaware
F11) American Equity Capital Trust XI
FEIN #20-3936420
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
December 15, 2005/Jurisdiction Delaware
F12) American Equity Capital Trust XII
FEIN #35-6766778
West Des Moines, IA 50266
100% American Equity Investment Life Holding Company
February 15, 2006/Jurisdiction Delaware
SCHEDULE 3.07 PART B
Investments
SCHEDULE 3.12 PART A
Material Debt Agreements
Schedule 3.12 Part A | |||||||||
Material Debt Agreements | |||||||||
Balances as of December 31, 2010 | |||||||||
Description | Principal Outstanding | GAAP Carrying Amount | Interest Rate | Indenture | Due Date | ||||
Convertible 2010 Senior Notes | $ | 200,000,000 | $ | 164,664,629 | 3.500% | Indenture, dated as of September 20, 2010 | September 15, 2015 | ||
Convertible 2004 Senior Notes | 74,494,000 | 72,637,000 | 5.250% | Indenture, dated as of December 6, 2004 | December 15, 2024 | ||||
Convertible 2009 Senior Notes | 115,839,000 | 93,533,131 | 5.250% | Indenture, dated as of December 22, 2009 | December 15, 2029 | ||||
American Equity Capital Trust I | 22,953,350 | 22,953,350 | 8.000% | Indenture, dated as of September 7, 1999 | September 30, 2029 | ||||
American Equity Capital Trust II | 100,000,000 | 75,931,569 | 5.000% | Indenture, dated as of October 29, 1999 | June 1, 2047 | ||||
American Equity Capital Trust III | 27,840,000 | 27,840,000 | Floating | Indenture, dated as of April 29, 2004 | April 29, 2034 | ||||
American Equity Capital Trust IV | 12,372,000 | 12,372,000 | Floating | Indenture, dated as of December 16, 2003 | January 8, 2034 | ||||
American Equity Capital Trust VII | 10,830,000 | 10,830,000 | Floating | Indenture, dated as of September 14, 2004 | September 14, 2034 | ||||
American Equity Capital Trust VIII | 20,620,000 | 20,620,000 | Floating | Indenture, dated as of December 22, 2004 | December 22, 2034 | ||||
American Equity Capital Trust IX | 15,470,000 | 15,470,000 | Floating | Indenture, dated as of June 15, 2005 | June 15, 2035 | ||||
American Equity Capital Trust X | 20,620,000 | 20,620,000 | Floating | Indenture, dated as of August 4, 2005 | September 15, 2035 | ||||
American Equity Capital Trust XI | 20,620,000 | 20,620,000 | 8.595% | Indenture, dated as of December 15, 2005 | December 15, 2035 | ||||
American Equity Capital Trust XII | 41,238,000 | 41,238,000 | Floating | Amended and Restated Indenture, dated as of February 15, 2006 | April 7, 2036 | ||||
Amended and Restated Indenture, dated as of July 7, 2006 | |||||||||
$ | 682,896,350 | $ | 599,329,679 | ||||||
SCHEDULE 3.12 PART B
Material Liens
NONE
SCHEDULE 3.14 PART A
Existing Equity
Rights
Schedule 3.14 (PART A) | |||
Existing Equity Rights | |||
Balances as of December 31, 2010 | |||
Shares | |||
Stock options - employees and directors | 2,303,000 | ||
Stock options - agents | 1,811,050 | ||
Deferred compensation agreements - officers and directors | 479,972 | ||
Deferred compensation agreements - National Marketing Organizations | 81,745 | ||
American Equity Capital Trust I - 736,328 Convertible Trust Preferred Securities | 2,727,084 | ||
2015 Convertible Senior Notes - Conversion Price $12.50 | — | (1) | |
2024 Convertible Senior Notes - Conversion Price $14.03 | — | (2) | |
2029 Convertible Senior Notes - Conversion Price $9.69 | 2,904,570 | (3) | |
2010 Warrants - $16.00 per share | — | (4) | |
(1) = There are 200,000 2015 Convertible Senior Notes outstanding with a principal amount of $1,000 each. Although we have the option to net share settle these notes upon conversion, we expect to settle these notes in cash. | |||
(2) = There are 74,494 2024 Convertible Senior Notes outstanding with a principal amount of $1,000 each. The principal amount will be repaid in cash and any amount that our stock price exceeds the conversion price will be settled in shares of our common stock. At December 31, 2010, our stock price is at $12.55 so there are no shares issuable upon extinguishment of these notes. | |||
(3) = There are 115,839 2029 Convertible Senior Notes outstanding with a principal amount of $1,000 each. The principal amount will be repaid in cash and any amount that our stock price exceeds the conversion price will be settled in shares of our common stock. | |||
(4) = We sold warrants in 2010 for the purchase of up to approximately 16 million shares of our common stock at a price of $16.00 per share. The warrants expire on various dates from 12/2015 through 3/2016 and are intended to be settled in net shares. | |||
SCHEDULE 3.14 PART B
Existing Repurchase
Obligations
NONE
SCHEDULE 6.01
Existing Debt
(See Schedule 3.12 Part A)
SCHEDULE 6.02
Existing Liens
NONE
SCHEDULE 6.06
Surplus Relief Reinsurance
Schedule 6.06 Surplus Relief Reinsurance
12/31/2010
Treaty | Reinsurer | Description |
2008 Hannover Reinsurance Treaty | Hannover Life Reassurance Company | Coinsurance and yearly renewable term reinsurance agreement |
2005 Hannover Reinsurance Treaty | Hannover Life Reassurance Company | Yearly renewable term reinsurance agreement covering 47% of waived surrender charges related to penalty free partial withdrawals and death on certain business |
SCHEDULE 6.10
Restrictive Agreements
NONE
EXHIBIT A
ASSIGNMENT AND ASSUMPTION
This Assignment and Assumption (the “Assignment and Assumption”) is dated as of the Effective Date set forth below and is entered into by and between [Insert name of Assignor] (the “Assignor”) and [Insert name of Assignee] (the “Assignee”). Capitalized terms used but not defined herein shall have the meanings given to them in the Credit Agreement identified below (as amended, the “Credit Agreement”), receipt of a copy of which is hereby acknowledged by the Assignee. The Standard Terms and Conditions set forth in Annex 1 attached hereto are hereby agreed to and incorporated herein by reference and made a part of this Assignment and Assumption as if set forth herein in full.
For an agreed consideration, the Assignor hereby irrevocably sells and assigns to the Assignee, and the Assignee hereby irrevocably purchases and assumes from the Assignor, subject to and in accordance with the Standard Terms and Conditions and the Credit Agreement, as of the Effective Date inserted by the Administrative Agent as contemplated below (i) all of the Assignor's rights and obligations in its capacity as a Lender under the Credit Agreement and any other documents or instruments delivered pursuant thereto to the extent related to the amount and percentage interest identified below of all of such outstanding rights and obligations of the Assignor under the respective facilities identified below (including any guarantees included in such facilities) and (ii) to the extent permitted to be assigned under applicable law, all claims, suits, causes of action and any other right of the Assignor (in its capacity as a Lender) against any Person, whether known or unknown, arising under or in connection with the Credit Agreement, any other documents or instruments delivered pursuant thereto or the loan transactions governed thereby or in any way based on or related to any of the foregoing, including contract claims, tort claims, malpractice claims, statutory claims and all other claims at law or in equity related to the rights and obligations sold and assigned pursuant to clause (i) above (the rights and obligations sold and assigned pursuant to clauses (i) and (ii) above being referred to herein collectively as the “Assigned Interest”). Such sale and assignment is without recourse to the Assignor and, except as expressly provided in this Assignment and Assumption, without representation or warranty by the Assignor.
1. Assignor:
2. Assignee:
[and is an Affiliate/Approved Fund of [identify Lender] Select as applicable.]
3. Borrower: American Equity Investment life Holding Company
4. Administrative Agent: JPMorgan Chase Bank, National Association, as the administrative agent under the Credit Agreement
5. Credit Agreement: The Credit Agreement dated as of January 28, 2011 among American Equity Investment life Holding Company, as Borrower, the Lenders parties thereto, and JPMorgan Chase Bank, National Association, as Administrative Agent.
6. Assigned Interest:
Aggregate Amount of Commitment/Loans for all Lenders | Amount of Commitment/Loans Assigned | Percentage Assigned of Commitment/Loans [Set forth, to at least 9 decimals, as a percentage of the Commitment/Loans of all Lenders thereunder.] |
$ | $ | % |
$ | $ | % |
$ | $ | % |
Effective Date: _____________ ___, 20___ [TO BE INSERTED BY ADMINISTRATIVE AGENT AND WHICH SHALL BE THE EFFECTIVE DATE OF RECORDATION OF TRANSFER IN THE REGISTER THEREFOR.]
The Assignee agrees to deliver to the Administrative Agent a completed Administrative Questionnaire in which the Assignee designates one or more credit contacts to whom all syndicate-level information (which may contain material non-public information about the Borrower and its related parties or its respective securities) will be made available and who may receive such information in accordance with the Assignee's compliance procedures and applicable laws, including Federal and state securities laws.
The terms set forth in this Assignment and Assumption are hereby agreed to:
ASSIGNOR
[NAME OF ASSIGNOR]
By:
Title:
ASSIGNEE
[NAME OF ASSIGNEE]
By:
Title:
[Consented to and] [To be added only if the consent of the Administrative Agent is required by the terms of the Credit Agreement.] Accepted:
JPMorgan Chase Bank, National Association, as
Administrative Agent
By
Title:
[Consented to:] [To be added only if the consent of the Borrower is required by the terms of the Credit Agreement.]
American Equity Investment Life Holding Company
By
Title:
ANNEX 1
STANDARD TERMS AND CONDITIONS FOR
ASSIGNMENT AND ASSUMPTION
1. Representations and Warranties.
1.1 Assignor. The Assignor (a) represents and warrants that (i) it is the legal and beneficial owner of the Assigned Interest, (ii) the Assigned Interest is free and clear of any lien, encumbrance or other adverse claim and (iii) it has full power and authority, and has taken all action necessary, to execute and deliver this Assignment and Assumption and to consummate the transactions contemplated hereby; and (b) assumes no responsibility with respect to (i) any statements, warranties or representations made in or in connection with the Credit Agreement or any other Credit Document, (ii) the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Documents or any collateral thereunder, (iii) the financial condition of the Borrower, any of its Subsidiaries or Affiliates or any other Person obligated in respect of any Credit Document or (iv) the performance or observance by the Borrower, any of its Subsidiaries or Affiliates or any other Person of any of their respective obligations under any Credit Document.
1.2. Assignee. The Assignee (a) represents and warrants that (i) it has full power and authority, and has taken all action necessary, to execute and deliver this Assignment and Assumption and to consummate the transactions contemplated hereby and to become a Lender under the Credit Agreement, (ii) it satisfies the requirements, if any, specified in the Credit Agreement that are required to be satisfied by it in order to acquire the Assigned Interest and become a Lender, (iii) from and after the Effective Date, it shall be bound by the provisions of the Credit Agreement as a Lender thereunder and, to the extent of the Assigned Interest, shall have the obligations of a Lender thereunder, (iv) it has received a copy of the Credit Agreement, together with copies of the most recent financial statements delivered pursuant to Section 5.01 thereof, as applicable, and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Assumption and to purchase the Assigned Interest on the basis of which it has made such analysis and decision independently and without reliance on the Administrative Agent or any other Lender, and (v) if it is a Non-U.S. Lender, attached to the Assignment and Assumption is any documentation required to be delivered by it pursuant to the terms of the Credit Agreement, duly completed and executed by the Assignee; and (b) agrees that (i) it will, independently and without reliance on the Administrative Agent, the Assignor or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Documents, and (ii) it will perform in accordance with their terms all of the obligations which by the terms of the Credit Documents are required to be performed by it as a Lender.
2. Payments. From and after the Effective Date, the Administrative Agent shall make all payments in respect of the Assigned Interest (including payments of principal, interest, fees and other amounts) to the Assignor for amounts which have accrued to but excluding the Effective Date and to the Assignee for amounts which have accrued from and after the Effective Date.
3. General Provisions. This Assignment and Assumption shall be binding upon, and inure to the benefit of, the parties hereto and their respective successors and assigns. This Assignment and Assumption may be executed in any number of counterparts, which together shall constitute one instrument. Delivery of an executed counterpart of a signature page of this Assignment and Assumption by telecopy shall be effective as delivery of a manually executed counterpart of this Assignment and Assumption. This Assignment and Assumption shall be governed by, and construed in accordance with, the law of the State of New York.
EXHIBIT B
FORM OF BORROWING NOTICE
______________, 20__
The undersigned, American Equity Investment Life Holding Company (the "Borrower"), refers to the Credit Agreement, dated as of January 28, 2011 (the "Credit Agreement"), among the Borrower, the Lenders party thereto and JPMorgan Chase Bank, National Association, as Administrative Agent. Capitalized terms used herein have the meanings assigned to them in the Credit Agreement. The Borrower hereby irrevocably requests a Borrowing, pursuant to Section 2.03 of the Credit Agreement, as follows:
(i) The aggregate amount of the requested Borrowing is $___________.
(ii) The Business Day on which the Borrower requests the Borrowing to be made is ____________, 20__.
(iii) The requested Borrowing is an [Eurodollar] [ABR] Borrowing.
(iv) If a Eurodollar Borrowing, the Interest Period for the requested Borrowing is ____ [one, two, three or six] months.
(v) The requested Borrowing shall be funded to Borrower's account no. _____________________.
Very truly yours,
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
By:
Name: _____________________________
Title:
EXHIBIT C
REVOLVING NOTE
$___,000,000 January 28, 2011
American Equity Investment Life Holding Company, a Delaware corporation (the “Borrower”), promises to pay to ___________________ (the “Lender”) the aggregate unpaid principal amount of the Revolving Loans made by the Lender to the Borrower pursuant to Article II of the Agreement (as hereinafter defined), in immediately available funds at the main office of JPMorgan Chase Bank, National Association in New York, New York, as Administrative Agent, together with interest on the unpaid principal amount hereof at the rates and on the dates set forth in the Agreement. The Borrower shall pay the principal of and accrued and unpaid interest on the Revolving Loans in full on the Maturity Date.
The Lender shall, and is hereby authorized to, record on the schedule attached hereto, or to otherwise record in accordance with its usual practice, the date and amount of each Revolving Loan and the date and amount of each principal payment hereunder.
This Revolving Note is one of the Notes issued pursuant to, and is entitled to the benefits of, the Credit Agreement dated as of January 28, 2011 (which, as it may be amended, restated or modified and in effect from time to time, is herein called the “Agreement”), among the Borrower, the lenders party thereto, including the Lender, and JPMorgan Chase Bank, National Association, as Administrative Agent, to which Agreement reference is hereby made for a statement of the terms and conditions governing this Revolving Note, including the terms and conditions under which this Revolving Note may be prepaid or its maturity date accelerated. Capitalized terms used herein and not otherwise defined herein are used with the meanings attributed to them in the Agreement.
This Revolving Note is to be governed by and construed and enforced in accordance with the laws of the State of New York.
[SIGNATURE PAGE FOLLOWS]
IN WITNESS WHEREOF, the undersigned has executed this Revolving Note by its duly authorized officer.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY | |
By: | |
Print Name: | |
Title: | |
EXHIBIT D
FORM OF U.S. TAX CERTIFICATE
(For Non-U.S. Participants That Are Partnerships For U.S. Federal Income Tax Purposes)
Reference is hereby made to the Credit Agreement dated as of January 28, 2011 (as amended,
supplemented or otherwise modified from time to time, the "Credit Agreement"), among American Equity Investment Life Holding Company, each lender from time to time party thereto and JPMorgan Chase Bank, National Association, as Administrative Agent.
Pursuant to the provisions of Section 2.14 of the Credit Agreement, the undersigned
hereby certifies that (i) it is the sole record owner of the participation in respect of which it is
providing this certificate, (ii) its partners/members are the sole beneficial owners of such
participation, (iii) with respect such participation, neither the undersigned nor any of its
partners/members is a bank extending credit pursuant to a loan agreement entered into in the
ordinary course of its trade or business within the meaning of Section 881(c)(3)(A) of the Code, (iv)
none of its partners/members is a ten percent shareholder of the Borrower within the meaning of
Section 871(h)(3)(B) of the Code, (v) none of its partners/members is a controlled foreign
corporation related to the Borrower as described in Section 881(c)(3)(C) of the Code, and (vi) the
interest payments in question are not effectively connected with the undersigned's or its
partners/members' conduct of a U.S. trade or business.
The undersigned has furnished its participating Lender with IRS Form W-8IMY
accompanied by an IRS Form W-8BEN from each of its partners/members claiming the portfolio
interest exemption. By executing this certificate, the undersigned agrees that (1) if the information
provided on this certificate changes, the undersigned shall promptly so inform such Lender and (2)
the undersigned shall have at all times furnished such Lender with a properly completed and
currently effective certificate in either the calendar year in which each payment is to be made to the
undersigned, or in either of the two calendar years preceding such payments.
Unless otherwise defined herein, terms defined in the Credit Agreement and used
herein shall have the meanings given to them in the Credit Agreement.
[NAME OF PARTICIPANT]
By:______________________________________
Name:
Title:
Date: ________ __, 20[ ]
EXHIBIT E
FORM OF COMPLIANCE CERTIFICATE
______________, 20__
Please refer to the Credit Agreement, dated as of January 28, 2011 (the "Credit Agreement"), among American Equity Investment Life Holding Company (the "Borrower"), the Lenders party thereto and JPMorgan Chase Bank, National Association, as Administrative Agent. Capitalized terms used herein have the meanings assigned to them in the Credit Agreement. The undersigned hereby certifies, in his or her capacity as a Financial Officer of the Borrower, as follows:
(i) Enclosed herewith is a copy of the [annual audited/quarterly] financial statements of the Borrower as at ________________ (the "Computation Date"), which statements fairly present in all material respects the financial condition and results of operations of the Borrower and its Consolidated Subsidiaries as of the Computation Date on a consolidated basis in accordance with GAAP consistently applied [, subject to the absence of footnotes].
(ii) No Default has occurred [or if a Default has occurred, specify the details of the Default and any action taken or proposed to be taken with respect thereto].
(iii) No change in GAAP or in the application thereof has become effective since the date of, or had an effect on, the Borrower's most recent audited financial statements [or if a change has occurred or become effective, specify the change and its effect on the attached financial statements].
(iv) The computations set forth on the schedule attached hereto correspond to the ratios and/or financial restrictions contained in Sections 6.11, 6.12, 6.13 and 6.14 of the Credit Agreement and such computations are true and correct as at the Computation Date.
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
By:
Name: _____________________________
Title: _______________________________
Schedule to Compliance Certificate
Dated as of _________________ The descriptions of the calculations set forth in this certificate are sometimes abbreviated for simplicity, but are qualified in their entirety by reference to the full text of the calculations provided in the Credit Agreement.
A.Section 6.11 - Maximum Ratio of Debt to Capital | |
1.Adjusted Consolidated Debt | $________ |
Adjusted Total Capitalization: | |
2.Total Capitalization | $________ |
3.Accumulated Other Comprehensive Loss | $________ |
4.Accumulated Other Comprehensive Income | $________ |
5.(2) plus (3), or minus (4) | $________ |
6.Ratio of (1) to (5) | ____ to 1 |
7.Maximum allowed | 0.35 to 1.00 |
8.In Compliance: | Yes/No |
B.Section 6.12 - Minimum Risk-Based Capital Ratio | |
1.Total Adjusted Capital | $________ |
2.Authorized Control Level Risk-Based Capital | $________ |
3.Item (2) multiplied by two (2) | $________ |
4.Ratio of (1) to (3) | _____% |
5.Minimum allowed | 275% |
6.In Compliance: | Yes/No |
C.Section 6.13 - Minimum Coverage Ratio | |
Borrower-Only Cash” | |
1.Amounts Available for Dividends | $________ |
2.Trailing Borrower-Only EBITDA | $_______ |
3.Cash and Cash Equivalents (with the value thereof determined on a mark-to market basis) | $_______ |
4.Sum of (1), (2) and (3) | $_______ |
Fixed Charges: | |
5.Interest Expense of the Borrower only | $_______ |
6.amortization of Debt discount | $_______ |
7.amortization of Debt issuance costs | $_______ |
8.(5) minus (6) and (7) | $_______ |
9.Restricted Payments made or incurred by the Borrower only | $_______ |
10.cash portion of any expense incurred by the Borrower only attributable to interest rate Hedging Agreements related to any Borrower Debt | $_______ |
11.principal payments owing in respect of Debt of the Borrower only, including the value of any Convertible Debt that may be put to the Borrower | $_______ |
12.Sum of (8), (9), (10) and (11) | $________ |
13.Ratio of (4) to (12) | ____ to 1 |
14.Minimum allowed | 1.00 to 1.00 |
15.In Compliance: | Yes/No |
D.Section 6.14 - Minimum Statutory Surplus | |
Statutory Surplus of American Equity Life as of date of determination | $________ |
Minimum Required: | |
Eighty percent (80%) of the Statutory Surplus of American Equity Life as of December 31, 2010 | $________ |
Fifty percent (50%) of the statutory net income (positive) of American Equity Life for each Fiscal Quarter ending after the Effective Date | $________ |
Fifty percent (50%) of all capital contributed to American Equity Life following the Fiscal Quarter-end immediately preceding the Effective Date | $________ |
Sum of (1), (2) and (3) | $________ |
5. In Compliance: | Yes/No |
Exhibit 10.35
AMENDMENT V
TO THE REINSURANCE AGREEMENT
BETWEEN
AMERICAN EQUITY INVESTMENT LIFE INSURANCE COMPANY
(Referred to in this Amendment as the Company)
AND
HANNOVER LIFE REASSURANCE COMPANY OF AMERICA
(Referred to in this Amendment as the Reinsurer)
This Amendment V is to be attached to and made a part of the Automatic YRT Reinsurance Agreement which became effective October 1, 2005. All provisions of the Reinsurance Agreement not in conflict with the provisions of this Amendment V shall remain unchanged.
As of the effective date of this Amendment V, the following shall replace Exhibit B-1 -- Plans Covered in its entirety.
EXHIBIT B-1
PLANS COVERED
This Agreement provides for reinsurance of the Company's Single Premium Deferred Annuities (SPDAs) and Flexible Premium Deferred Annuities (FPDAs), with the plan codes listed below.
All such plans issued and in-force as of the Effective Date of the Agreement and all such plans issued on or after the Effective Date are reinsured under the Agreement.
With respect to plans reinsured with EquiTrust Life Insurance Company or Athene Life Re Ltd. as of the Effective Date of this Agreement, the Agreement provides reinsurance on the portion of such plans not reinsured with EquiTrust Life Insurance Company or Athene Life Re Ltd.
With respect to the IDX-RG-09, IDXRG-09IN, INDEX-2-09, FX-RG-09, FXRG-2-09, IDX-2-09IN, I-2-09LB10, I209LB10FL, I-209LBIN, I209TXLB10, IDX-2-09TX, and I-RG09LB10 plans:
1. | The term "surrender charge" as used throughout this Agreement shall mean the combined effect of the contractually defined surrender charge and the bonus vesting schedule. The resulting surrender charge percentages are level within each contract year. |
2. | Contracts with bonus percentages over 12% will not be reinsured under this Agreement unless the Company obtains prior written approval from the Reinsurer. |
AUTOMATIC YRT
HA-AEIL-05
November 18, 2010 AMENDMENT V
Plan Codes | ||||
ACCUMULATOR | FPDA-3 | I-2001TX | INDEX-10 | INDEX-6TX |
BN PROCEED | FPDA3 2.25 | I-2001TX-5 | INDEX-1-05 | INDEX-8 |
BRAVO | FPDA-3 7.3 | I-2002 | INDEX-12 | INDEXP3 |
BRAVO 2003 | FPDA-3 REV | I-2002 REV | INDEX-13 | INDEXP3FL |
CUMULATOR | FPDA-3FL | I-2-09LB10 | INDEX-15 | INDEXP3-PA |
F-3FLREV | FPDA-3IN | I-209LB10FL | INDEX-16 | INDEXP3TX |
F-3INREV | FPDA-3TX | I-209LBIN | INDEX-17 | INDEX-T03 |
F-3REVTX | FPDA-4 | I209TXLB10 | INDEX-18 | INDX-2 |
FPD11NOMVA | FPDA-4PA | I-25 (REV) | INDEX-19 | INDX-I |
FPD22.25IN | FPDA-4SNF | I-27 (REV) | INDEX-2 | INDX-IIN |
FPD32.25IN | FPDA-5 | I-27REV IN | INDEX-2-06 | INDX-IPA |
FPD72.25IN | FPDA5 2.25 | I-27REV KY | INDEX-2-09 | INDX-ITX |
FPD82.25IN | FPDA5225IN | I-29 (REV) | INDEX-22 | I-RG09LB10 |
FPDA-1 | FPDA-5FL | IDX-105ELB | INDEX-23 | IX107ELFL |
FPDA-1(3%) | FPDA-5PLUS | IDX-1-05IN | INDEX-24 | IX107LBFL |
FPDA-10 | FPDA-6 | IDX-1-05KY | INDEX-25 | S-7TXREV |
FPDA-10IL | FPDA-6FL | IDX-1-05SC | INDEX-25WA | SNF ACC55 |
FPDA-2TX | FPDA-6TX | IDX-1-07ELB | INDEX-26 | SNF ACCUM |
FPDA-10IN | FPDA-7 | IDX-1-07FL | INDEX-27 | SPDA-1 |
FPDA-10PA | FPDA7 2.25 | IDX-1-07LB | INDEX-27IN | SPDA-1(3%) |
FPDA-10SNF | FPDA-8 | IDX-2-09IN | INDEX-28 | SPDA-1PA |
FPDA-10TX | FPDA8 2.25 | IDX-2-09TX | INDEX-28IN | SPDA-1PLUS |
FPDA-10VA | FPDA-PD2 | IDX-26 7.5 | INDEX-28KY | SPDA-1SNF |
FPDA-10WA | GFIR | IDX-28ELB | INDEX-29 | SPDA-1UT |
FPDA-11 | GFIR2-3 | IDX-28LB | INDEX-30 | SPDA-2 |
FPDA-11SNF | GFIR-5 | IDX-30LB | INDEX-3-05 | SPDA-2(3%) |
FPDA-11TX | I-1-05LB10 | IDX-405ELB | INDEX-30IN | SPDA-2PA |
FPDA-12 | I-1-07LB10 | IDX-4-05LB | INDEX-30KY | SPDA-2SNF |
FPDA-1PA | I107LB10FL | IDX-4-05TX | INDEX-4 | SPDA-5 |
FPDA-1SNF | I-19 (REV) | IDX-6-05-1 | INDEX-4-05 | STRETCH |
FPDA-2 | I-19 REV7 | IDX-RG-09 | INDEX-5 | SUPER-7 |
FPDA2 2.25 | I-2000 | IDXRG-09IN | INDEX-5-05 | SUPER-7REV |
FPDA2-2001 | I-2000TX | INDEX | INDEX-6 | SUPER-7TX |
FPDA-2PLUS | I-2000TX-5 | INDEX 1-07 | INDEX-6-05 | SUPR7 2.25 |
INDEX-6SNF | I-2001 | INDEX-1 | FX-RG-09 | SUPR7225IN |
FXRG-2-09 | ||||
AUTOMATIC YRT
HA-AEIL-05
November 18, 2010 AMENDMENT V
EXECUTION
In witness of the above, this Amendment V is signed in duplicate at the dates and places indicated with an effective date of October 1, 2010.
HANNOVER LIFE REASSURANCE COMPANY OF AMERICA | AMERICAN EQUITY INVESTMENT LIFE INSURANCE COMPANY |
ORLANDO, FLORIDA | WEST DES MOINES, IOWA |
DATE: NOVEMBER 18, 2010 | DATE: NOVEMBER 18, 2010 |
BY: /S/ JEFF BURT | BY: /S/ JUDITH A. NAANEP |
TITLE: EVP | TITLE: VP, CORPORATE ACTUARY |
BY: /S/ STEVE NAJJAR | BY: /S/ ELIZABETH CLARK |
TITLE: EVP | TITLE: AVP |
Exhibit 12.1
Ratio of Earnings to Fixed Charges
Year Ended December 31, | |||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
Consolidated income before income taxes and minority interests | $ | 65,266 | $ | 86,164 | $ | 77,053 | $ | 38,144 | $ | 116,029 | |||||||||
Interest sensitive and index product benefits and amortization of deferred sales inducements | 793,091 | 387,882 | 235,836 | 571,917 | 429,062 | ||||||||||||||
Interest expense on notes payable | 22,125 | 14,853 | 19,773 | 20,916 | 21,278 | ||||||||||||||
Interest expense on subordinated debentures | 14,906 | 15,819 | 19,445 | 22,520 | 21,354 | ||||||||||||||
Interest expense on amounts due under repurchase agreements and other interest expense | — | 534 | 8,207 | 15,926 | 32,931 | ||||||||||||||
Interest portion of rental expense | 648 | 570 | 459 | 468 | 431 | ||||||||||||||
Consolidated earnings | $ | 896,036 | $ | 505,822 | $ | 360,773 | $ | 669,891 | $ | 621,085 | |||||||||
Interest sensitive and index product benefits and amortization of deferred sales inducements | $ | 793,091 | $ | 387,882 | $ | 235,836 | $ | 571,917 | $ | 429,062 | |||||||||
Interest expense on notes payable | 22,125 | 14,853 | 19,773 | 20,916 | 21,278 | ||||||||||||||
Interest expense on subordinated debentures | 14,906 | 15,819 | 19,445 | 22,520 | 21,354 | ||||||||||||||
Interest expense on amounts due under repurchase agreements and other interest expense | — | 534 | 8,207 | 15,926 | 32,931 | ||||||||||||||
Interest portion of rental expense | 648 | 570 | 459 | 468 | 431 | ||||||||||||||
Combined fixed charges | $ | 830,770 | $ | 419,658 | $ | 283,720 | $ | 631,747 | $ | 505,056 | |||||||||
Ratio of consolidated earnings to fixed charges | 1.1 | 1.2 | 1.3 | 1.1 | 1.2 | ||||||||||||||
Ratio of consolidated earnings to fixed charges, both excluding interest sensitive and index product benefits and amortization of deferred sales inducements | 2.7 | 3.7 | 2.6 | 1.6 | 2.5 | ||||||||||||||
Exhibit 21.2
AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
Subsidiaries of American Equity Investment Life Holding Company
State of Incorporation | |
Insurance Subsidiaries: | |
American Equity Investment Life Insurance Company | Iowa |
American Equity Investment Life Insurance Company of New York | New York |
Eagle Life Insurance Company | Iowa |
Noninsurance Subsidiaries: | |
American Equity Investment Service Company | Iowa |
American Equity Properties, L.C. | Iowa |
American Equity Capital, Inc. | Iowa |
American Equity Capital Trust I | Iowa |
American Equity Capital Trust II | Iowa |
American Equity Capital Trust III | Iowa |
American Equity Capital Trust IV | Iowa |
American Equity Capital Trust V | Iowa |
American Equity Capital Trust VI | Iowa |
American Equity Capital Trust VII | Iowa |
American Equity Capital Trust VIII | Iowa |
American Equity Capital Trust IX | Iowa |
American Equity Capital Trust X | Iowa |
American Equity Capital Trust XI | Iowa |
American Equity Capital Trust XII | Iowa |
AERL, L.C. | Iowa |
American Equity Advisors, Inc. | Iowa |
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
American Equity Investment Life Holding Company
We consent to the incorporation by reference in the registration statements (No. 333-171161, No. 333-157846, No. 333-149854, No. 333-148681, and No. 333-123862) on Form S-3 and the registration statements (No. 333-167755 and No. 333-127001) on Form S-8 of American Equity Investment Life Holding Company and subsidiaries (the Company) of our report dated March 9, 2011, with respect to the consolidated balance sheets of the Company as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2010, and all related financial statement schedules, and the effectiveness of internal control over financial reporting as of December 31, 2010, which report appears in the December 31, 2010 annual report on Form 10-K of American Equity Investment Life Holding Company.
Our report dated March 9, 2011, contains an explanatory paragraph that states that, effective January 1, 2009, the Company has changed its method of accounting for other-than-temporary impairments of debt securities due to the adoption of Financial Accounting Standards Board Accounting Standards Codification 320, and the Company has changed its method of accounting for convertible debt instruments due to the retrospective adoption of ASC 470.
/s/ KPMG LLP
Des Moines, Iowa
March 9, 2011
Exhibit 31.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Wendy C. Waugaman, certify that:
1. | I have reviewed this annual report on Form 10-K of American Equity Investment Life Holding Company; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
(a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
(b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
(c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
(d) | Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and |
5. | The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
(a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
(b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
Date: | March 9, 2011 | By: | /s/ WENDY C. WAUGAMAN | |
Wendy C. Waugaman, Chief Executive Officer and President (Principal Executive Officer) |
Exhibit 31.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John M. Matovina, certify that:
1. | I have reviewed this annual report on Form 10-K of American Equity Investment Life Holding Company; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
(a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
(b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
(c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
(d) | Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and |
5. | The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
(a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
(b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
Date: | March 9, 2011 | By: | /s/ JOHN M. MATOVINA | |
John M. Matovina, Vice Chairman, Chief Financial Officer and Treasurer (Principal Financial Officer) |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of American Equity Investment Life Holding Company (the "Company") on Form 10-K for the fiscal year ended December 31, 2010 as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, Wendy C. Waugaman, Chief Executive Officer and President of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
1. | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; |
and
2. | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
Date: | March 9, 2011 | By: | /s/ WENDY C. WAUGAMAN | |
Wendy C. Waugaman, Chief Executive Officer and President (Principal Executive Officer) |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of American Equity Investment Life Holding Company (the "Company") on Form 10-K for the fiscal year ended December 31, 2010 as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, John M. Matovina, Vice Chairman, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
1. | The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; |
and
2. | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
Date: | March 9, 2011 | By: | /s/ JOHN M. MATOVINA | |
John M. Matovina, Vice Chairman, Chief Financial Officer and Treasurer (Principal Financial Officer) |