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American Equity Investment Life Holding (NYSE:AEL)

Q4 2012 Earnings Call

February 21, 2013 10:00 am ET

Executives

Julie L. LaFollette - Director of Investor Relations

John Michael Matovina - Chief Executive Officer, President, Vice Chairman, Member of Executive Committee, Member of Disclosure Committee and Member of Investment Committee

Ted M. Johnson - Chief Financial Officer, Principal Accounting Officer, Treasurer and Member of Disclosure Committee

Ronald J. Grensteiner - Vice President and President of American Equity Investment Life Insurance Company

Analysts

Randy Binner - FBR Capital Markets & Co., Research Division

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Paul Sarran - Evercore Partners Inc., Research Division

Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Jeffrey Smith - Eagle Boston Investment Management, Inc.

Richard Lee Todaro - Kennedy Capital Management, Inc.

Edward Shields - Sandler O'Neill + Partners, L.P., Research Division

Operator

Welcome to American Equity Investment Life Holding Company's Fourth Quarter 2012 Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Director of Investor Relations.

Julie L. LaFollette

Good morning, and welcome to American Equity Investment Life Holding Company's conference call to discuss fourth quarter 2012 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com. Presenting on today's call are John Matovina, Chief Executive Officer; Ted Johnson, Chief Financial Officer; and Ron Grensteiner, President of the Life Company. Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be available on our website shortly after today's call. It is now my pleasure to introduce John Matovina.

John Michael Matovina

Thank you, Julie, and good morning, everyone, and welcome to the call this morning. As we reported yesterday evening, fourth quarter 2012 operating earnings were $30.9 million or $0.47 per diluted share. And that brought the full year earnings to $110 million or $1.69 per share. Also as we acknowledged, the fourth quarter does include about $0.02 a share from an income tax benefit for lower effective tax rate. So excluding that item, we would have had $0.45 per share in the fourth quarter.

Relative to the third quarter, operating income, which -- the comparison there, we're going to exclude that impact of unlocking. So our third quarter earnings excluding unlocking were $27 million, so we're up 14%. Some of that is due to higher spread income, although on a percentage basis, clearly the spread is down a few basis points. It also reflects some lower DAC amortization and some of the tax benefit I just spoke to. Results continue to be held back by the low interest rate environment and the high cash balances in short-term investments that have resulted from calls of government agency securities that we've talked about on previous calls. Also as we've acknowledged, those agency securities have been a cornerstone of the company's investment portfolio dating back to our formation, and through the years, they've provided very acceptable yields that met our spread requirements without risk-based capital charges.

We've gone through several cycles of calls on those securities, and each time, we reinvested a portion of the call redemption proceeds into new callable securities with lower yields than the call securities. And that reinvestment back in the agencies help keep the cash balances low but obviously perpetuated the call risk. And 2012 should mark the turning point in that cycle on the elevated levels of low yielding investments as we had more than $4.3 billion in securities called last year, but we only purchased $660 million of new callable securities.

We ended the year with $2.2 billion in what we'll call excess cash and short-term investments. And as you'll hear in Ted's remarks, those short-term investments include $728 million of callable agency securities that were purchased as substitutes for cash. So if those are called as expected in 2012, we'll need to reinvest those into longer-term securities with higher yields as well. If those don't get called as expected, their yields would increase to a 3.75% to 4% rate on the expiration date -- or expiration of the call date, excuse me. The call exposure for long-term investments in the first quarter of 2013 is only $50 million. So we're anticipating a meaningful reduction in our excess cash and other short-term cash investment or other short-term investment balances in the first quarter. The remainder of the call exposure for long-term investments in 2013 consists of $678 million of securities callable in April. So given the large call exposure in the second quarter, we may see some increase in the excess cash and other short-term investment balance in the second quarter. But then, once that timeframe is behind us, we should return to seeing some meaningful reductions in the -- those balances and getting us back to a fully invested type position by year end.

Our sales pace did pick up a little bit in the fourth quarter, kind of a continuation of the product pricing environment that kind of scripted our way in the third quarter. We also benefited from a new money rate reduction that we implemented in early December. And as usual, Ron's remarks will include commentary about the competitive environment in more details on the sales results. And finally, just to acknowledge that, as we did in the press release, our A.M. Best rating of the A- (Excellent) was affirmed in late January by A.M. Best, and also the stable outlook on the rating was affirmed as well. So with that, I will turn the call over to Ted for some additional comments on the financial results.

Ted M. Johnson

Thank you, John. Investment spread for the fourth quarter was 2.59%, and total invested assets at December 31 were $27.5 billion or $25.1 billion on a amortized cost basis.

Invested assets will grow by an additional $1 billion as we invest the temporary cash balance held at the end of the year.

The spread results of 2.59% was 3 basis points less than the previous quarter spread of 2.62%. The average cash and other short-term investment balance during the fourth quarter was $2.7 billion compared to $2 billion during the third quarter. The yield on these instruments in the fourth quarter was 32 basis points, compared to 27 basis points in the third quarter.

The increase in yield reflects additional purchases of short-term investments as substitutes for the cash instruments. I'll comment further on the short-term investments shortly. Partially offsetting the cost of liquidity was 11 basis points from prepayment income on commercial real estate, on mortgages and consent fees on bonds. In addition, we also had 3 basis points of benefit from over hedging in the fourth quarter.

The cost of money declined 2.44% in the fourth quarter from 2.55% in the third quarter. This decline reflects management's actions to maintain spreads by adjusting rates to our policyholders. We will make further reduction in policyholder rates as necessary to restore investment spreads to 3% target. We currently have approximately 63 basis points of room to reduce fixed rates and rates on index annuity policies before minimum guarantees would cause spread compression. You can see that it is also disclosed in the financial supplement on Page 12 and Page 13.

During the fourth quarter, we purchased $2 billion of new fixed income securities at an average yield of 3.59%. And we funded $145 million of new commercial mortgage loans at an average yield of 4.51%. $1.4 billion of the security purchases were investment grade corporate bonds with an average yield of 3.66%. We also purchased $241 million of commercial mortgage-backed securities with an average yield of 3.89% and $250 million of government agency bonds with an average yield of 3%.

During the fourth quarter, we also purchased $1.03 billion of short-term investments to obtain higher yields than what was available from cash instruments. These purchases included $524 million of government agency pass-through residential mortgage-backed securities yielding 1.27% and $509 million of government agency bonds yielding 0.75% the next call date. If not called, the yield on the government agency bonds would increase to 3.75% after the call date passes. Calls, sales, maturities and paydowns of fixed income securities for the fourth quarter were $950 million with an average yield of 4.62%. Our government agency bond call exposure for 2013 includes $50 million of securities with book yields and coupon rates of 4% that were called in January and $678 million of securities with book yields and coupon rates of 4% or higher that are expected to be called in April.

In addition, our short-term investments include $728 million of government agency bonds, of which $219 million of these securities with weighted average book yield of 1.08% are expected to be called in March and April. And $509 million of these securities with a book yield of 0.75%, which were previously discussed as being purchased in the fourth quarter, are expected to be called in July.

The securities with book yields of 0.75% to 1.08% were purchased at a premium to par, and if not called as presently expected, their book yields would increase to 3.75% or 4% immediately after the call date passes. Operating costs and expenses at $18.7 million were essentially flat for the quarter compared to $18.6 million in the third quarter, excluding the litigation reserve established during the third quarter.

The increase from fourth quarter 2011 is primarily related to the prospective adoption of the revised accounting guidance for deferred policy acquisition cost, which resulted in $2 million of additional expense recognized in the fourth quarter of 2012. This amount relates to home-office expenses that were previously deferred and amortized over the life of the underlying policies. The estimated annual effective tax rate applied to operating income for the first 9 months of 2012 was 35.3%. The actual final effective tax rate for the year was 34.3% and reflected a larger benefit from tax preference investment income than previously estimated and the reduced level of pretax income for 2012.

This lower effective tax rate reduced income tax expense on fourth quarter pretax operating income by $465,000. In addition, because the lower rate was applied retroactively to all 2012 operating income, income tax expense in the fourth quarter was reduced by $1.3 million or $0.02 per share for the portion of the year prior to the fourth quarter. If pretax operating income rebounds in 2013 as presently anticipated, we would likely have a higher effective tax rate in 2013.

Book value per share excluding accumulated other comprehensive income of $16.49 is up $0.42 from September 30 book value of $16.07. Our RBC at year end is estimated at $3.32. This is compared to $3.36 at the end of the third quarter and $3.46 at the end of 2011.

With that, I'll turn the call over to Ron to talk about sales and production.

Ronald J. Grensteiner

Thank you, Ted, good morning, everyone. Sales for the fourth quarter were $1.07 billion, up from $982 million in the third quarter. We did get a surge of applications in December due to an interest rate adjustment for new policies that we announced in late November.

The fourth quarter was our strongest quarter of the year, and our second half was better than the first half. If you will recall, we made some changes to rates and benefits in late 2011 but our competitors did not follow our lead until mid-2012. When they started to make their changes and their rates and benefits were comparable to ours, we began to recapture some of that market share.

For the year, we were a touch high of $4 billion in paid business, our third biggest year in company history. We'll chalk up 2012 as a satisfying year given the difficult interest rate environment. To our pending goals, our pending account is trending up. In December, we peaked at 3,845 applications on the fifth, and then we bottomed down in January at 2,477. And as of today, we were right at 2,900.

We are optimistic for 2013. If we look at LIMRA statistics for example, for 2012, variable annuity sales were down 7% year-over-year and fixed annuities overall were down 11% year-over-year.

Fixed index annuities were the only annuity segment that had growth in 2012 at 5%. We've also seen some positive articles in the press about annuities and even mentions in Washington, D.C. as a source of retirement guaranteed income.

Also, this is the time of the year when senior management makes personal office business to our top 10 to 15 marketing companies and we also attend a fair number of marketing company-sponsored aging [ph] events. And all of these businesses have really confirmed for us that there's a real sense of optimism in 2013 that we'll have a better year for sales or it will be a better sales year than it was in 2012.

The current stock market is certainly getting some money off of the sidelines, but we suspect those that are seeking real safety and guarantees will be reluctant to get in the market given the wide volatile market swings over the last 13 years.

Even in today's low interest rate, fixed index annuity rates are at least double compared with what you can get in 1-year CD. And if you add on a 5% or 10% premium bonus, that customer gets a very nice head start versus sitting in a 1-year CD waiting for rates to go up. And of course, fixed index annuities have a lot more potential when interest is linked to the S&P 500. And for example, the credited interest rate -- the average credited interest rate in the fourth quarter was 5.26%, and the highest in the fourth quarter was 19.33%.

So some pretty nice interest rates that are locked in, guaranteed and tackled backwards. To kind of give you some additional perspective on that, 23% of the policies in the fourth quarter received between 6% and 7% and another 22% received somewhere between 5% and 6%. And if we look for the average -- or if we look at the average for all of 2012, the average credited rate was 3.20%.

The competition this year, so far, has been quiet. There have been a couple of new product introductions, but there isn't anything out there that has the sales force really talking about.

At American Equity, we are planning some of our own product enhancements for -- to be introduced around the end of the first quarter. These aren't anything controversial or new to the market, but they're new to us. Things that we withheld introducing in 2012 because we didn't think the time was right. But we think the time is right now, and we're going to get these introduced, and hopefully, give us the ability to recapture some of the business that might be going elsewhere.

We're having another Million Dollar Producer Forum in March. It will be only for our Gold Eagle producers in 2012. We expect about 350 producers plus multiple marketing companies. In the past, we've invited all producers who could prove they wrote at least $1 million in sales regardless of the company. Last year, we decided to focus exclusively on our Gold Eagle members, and it was very well received. This really gives us 2 opportunities per year to see and visit with our top producers, in this event, and of course, our convention in the fall. As a refresher, our Gold Eagle producers are producers who write at least $1 million of premium in a calendar year. We're going to also continue to hold our producer forums in Des Moines as well. This is where we bring our producers in to learn more about our value proposition, meet our people and receive the red carpet treatment. This is an excellent way to build new relationships and cement old ones.

Amazingly, I think American Equity is one of the few companies that still gathers top producers at various locations or at our home office. And we are still the only company where we have company representatives having one-on-one visits in producers' offices. Last year, our marketing team, led by Kirby Wood, visited 2,297 agencies -- agents in their offices, one-on-one. So all of these things that I'm talking about here are certainly relationship-building activities that are core to our company's culture.

We finished the year last year with 945 Gold Eagle members. Of this 945 producers, 59% of them -- they were responsible, excuse me, for 59% of our total production. And of the 945 members, 650 or 58% were retained from the previous year. We're pleased with this percentage considering we had a lower production year in 2012 than 2011. And it's also a sign that our loyal producers recognize American Equity as a complete package and that it's not always about rates. We have a much higher retention rate for our bigger producers. For example, we retained 55% of our Gold Eagle members who wrote between $1 million and $2 million the previous year. But we retained 82-plus-percent for those that wrote $2 million or more. So it's a big jump when we can get those producers to the $2 million level. We retained 86% of the producers that wrote $5 million or more the previous year.

Finally, we're going to continue to hold our policyholder appreciation events. We've hosted 11,000 policyholders and 727 Gold Eagle producers since June of 2010. This is an event where we invite policyholders within a geographic area to attend American Equity-hosted programs and luncheons. We talk about the company history, our business philosophies, we talk about financials and the ABCs, 123s of fixed annuities. But our #1 mission is to say thank you for the business and thank you for entrusting us with their retirement money. And after each program, we have multiple guests that approach us and say things like, "Thank you for watching out for our money, and thank you for the excellent service." And we know of no other insurance company or financial institution for that matter that holds such a program.

In December, we were at The Villages near Orlando, and we were full with 300 guests and we had 150 on the waiting list. So we decided to go back, we were there earlier this month. We were full again and had another waiting list of 175. So I guess we're going to have to go back to The Villages sometime this year again. So to say these programs are well received will be an understatement. So with that, I'm going to -- that concludes my report, I'm going to turn it back to John.

John Michael Matovina

Thank you, Ron. So to kind of summarize, refresh or recap the outlook for 2013, our business -- the year's off to a good start in terms of business-wise. And I think Ron shared or expressed his optimism that -- about a decent year or good year for sales. We are going to remain committed, though, to disciplining our product pricing as we have through the history of the company and would not look to pursue market share at the expense of acceptable profits.

Obviously, a big challenge ahead this year, as we've kind of talked about on this call, is spread management and getting that spread back up to the 3% target level. We're going to continue to deploy the cash as quickly as we can. However, if the current environment continues to exist, it's going to be the second half of the year before we get that -- we can reach a fully invested position. As I said earlier, the first quarter should see some improvement. And in fact, we look to -- probably invested, say, $800 million or so thus far in the first quarter. So we've whittled down a big piece of that cash balance so far.

But as we said, there's some pressure coming in Q2 from some additional calls, almost $700 million of calls there. So in terms of rates, there is still a little bit of renewal rate adjustment going on for policies that were not captured in the rate adjustment that started in late 2011. But we will be looking at additional rate adjustments as necessary to work hand-in-hand with the deployment of cash as the investment yield fills in. And we're still confident that we can get back to that 3% level. To give you a little color on that, the investment yield in the portfolio at the end of the year was about 5.2%. We see that going to 5%, 10% or so through taking out the cash and the short-term investments with below long-term yields and reinvesting those at rates, say, between 3.25% and 3.5%. And then there would be some additional pressure on that investment yield from the cash flows of other payments on investments during the year, reinvestment of interest, that might cause us to go down another 5 to 10 basis points. So we're looking at investment yield at the end of the year someplace in the low 5% range. And that's exclusive of what's going to happen with new money, although we think we've got the new money appropriately priced to yield the desired spread.

On the cost of money, our renewal cost for the first several weeks of January have been coming in at 2.22, 2.23, 2.24, so that signifies about a 2.80 to 2.85 spread, which means we probably got to get 15 to 20 basis points out of renewal rates to get back to the 3% target. So there you have some details on the path of how we're going to get there. And with that, we'll open the call up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Randy Binner from FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

I wanted to -- I think this is probably best for Ron, but it seemed like the commentary from a sales perspective is that, I think, Ron said it's kind of quiet so far this year. And I'm surprised, if you look at 2012, I'd say that the kind of the private equity backed companies out there came out of the gate really fast last -- in early 2012. Then they kind of hit their budgets for the year and they went away. And I fully would have expected them to be back this year. So I'd be really interested to kind of get more color on that. And maybe I'm misinterpreting what you said, but is that true that the PE company, specially now that Aviva is kind of one of those, are they really not hitting it as hard as they did early last year?

Ronald J. Grensteiner

I guess, Randy -- this is Ron. My commentary is more along the lines in there haven't been any interest rate increases or haven't been any decreases. There really haven't been any new product announcements. I wouldn't say that anybody's less aggressive, but nothing has really changed much so far this year or since December. Like I mentioned there has been a couple of product announcements but they're not products that are going to steal market share away from us, I don't believe. They have their own unique features. So I expect the private equity companies are going to be aggressive. From Aviva standpoint, I think it's too early to tell what's going to happen with them. They're going through their situation. But when I say it's been quiet, there hasn't been any news so to speak.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. Just 2 clarifications there. One, I mean, so it's not -- I mean, just to clarify this. I think last year, the private equity companies, it was a guarantee -- it wasn't necessarily like the basic, the normal product features, but it was the income guarantees where they are more aggressive, the riders especially. And so just to clarify, that's not -- it's not as aggressive as it was at the early part of last year with that said?

Ronald J. Grensteiner

Randy, I would agree with that. The roll-up rate, as we call them, what you're referring to came down by everybody last year, including the companies that had the highest rates. They're still higher than everybody else, but they came down as well.

Randy Binner - FBR Capital Markets & Co., Research Division

And is Aviva in the market? Are they able to stay in the market with the change there, or they're kind of taking a break?

Ronald J. Grensteiner

I don't know that -- we can't -- we don't know. I guess, from my perspective, they haven't made any announcements to their feel that they're going to do this, that or the other thing. They just continue. They're continuing with their strategy whatever that might be.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. Okay, that's helpful. And then I just had a couple little questions on some of the details from the call. One, I guess, Ted, you said there was an extra $2 million of expenses for the home-office that were not DAC-able, and I think you said in the fourth quarter. Did I get that right, that, that was all in the fourth quarter? And where did that show up in the income statement, was it in the other expense line?

Ted M. Johnson

It's in the other -- it's in operating expense line.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. So that means that -- so that line actually did quite well in the quarter if it was heavy by $2 million more of expenses that weren't there before. Was there anything unusually low? I mean, I'm looking at the total number, that's like $18.7 million.

Ted M. Johnson

There wasn't anything unusually low in the quarter for operating expenses.

John Michael Matovina

Randy, this is John. I think the $2 million is kind of a relevant comparison of fourth quarter '12 to fourth quarter '11, but we've been dealing with $2 million a quarter or some number close to that in each of the quarters of 2012 from the adoption of the DAC 09-G standard, which reduced the amount of cost that could be capitalized. So this is kind of the final quarter to comment on that because when we get to 2013, those quarters are comparable to 2012 on an -- from an accounting standard basis.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. That's helpful. Maybe I'll try and ask this question, in a way. I mean, so your -- that line item ran over $20 million in the first quarter of '12, it's been under in the last 3 quarters of 2012. I mean, is that something we can -- is that sustainable? Does the other expense can stay $20 million or lower?

Ted M. Johnson

So Q4 of 2011, it was $17.5 million.

I think it's going to run around that $20 million amount.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. That's helpful. Because I mean at least we had it running higher. On the margin, it's always been a big drag of EPS, so if you all can keep that to $20 million, that's definitely -- that's going to be favorable for you.

John Michael Matovina

Yes, as I'm looking at the number too, I can't remember back the first quarter what cost an elevated number to be 22, but obviously, we've been running 18.9 and 18 -- I can't -- the sheet I'm looking at for third quarter has got the litigation amount in it. But we've been under $19 million each of the last 3 quarters. I don't remember what might have been in the first quarter that caused it to be elevated, but the last 3 quarters of under $19 million are likely indicative of where things are going to be at.

Randy Binner - FBR Capital Markets & Co., Research Division

Yes, I know. And I'll jump back in the queue. But I guess that is a reflection that the legal cost drag which we got pretty used to over other years seems to be kind of much less apparent now than it was maybe historically.

John Michael Matovina

Right. That is true.

Randy Binner - FBR Capital Markets & Co., Research Division

And you don't have -- there's no major class action outstanding, right? I mean, there's no update on any of that?

John Michael Matovina

We're still incurring fees to create a settlement agreement on what we call the McCormack case, which is the one we talked about in Q3 for the establishment of the reserve and the settlement of that. But those aren't anywhere near the level of fees that we had in that predecessor case when we actually went to trial on that case. So there's still some, although it shouldn't be a lot of money, to bring the McCormack case to a conclusion.

And our policy on accounting for those fees is that the settlement estimate that we booked in Q3 does not include the expected cost for our lawyers to complete that, it included the expected amounts that would be paid to the plaintiff's attorneys in the context of the settlement agreement.

Operator

And your next question comes from the line of Steven Schwartz from Raymond James & Associates.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Ron, you were going in and out at the beginning of your talk. Could you possibly go over the at-numbers again?

Ronald J. Grensteiner

The pending count?

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Yes.

Ronald J. Grensteiner

Sure, I am sorry about that. We're having some technical difficulties in the office. What I was mentioning is that we had that announcement that we were lowering rates. We made the announcement the end of November, and it became effective in December. And so that always causes a surge in our applications as they try to beat the deadline. So in December, our pending count peaked at 3,845 on the fifth of December, and it bottomed out this past January at 2,477 and has since been trending up, and we're just a little bit shy at 2,900 today.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. Okay. Just a couple of other things, John. The -- you mentioned, I think it was you, maybe it was Ted. You mentioned that the cost of renewal, cost of renewal money, was looking at 2.2%, 2.24%?

John Michael Matovina

Right.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

How much more is there to go of this, assuming that you don't change renewal rates again?

John Michael Matovina

You mean how much further reduction from rate adjustment's already done?

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Well, I guess I'm saying is there $500 million more that over the next few quarters will be adjusted down to this rate from some other rate?

John Michael Matovina

I don't know -- the adjustments that are still kicking in would be new business issued in 2010. And actually, what we'll have ongoing, I think, over the course of this year is all the policies issued in 2010 will get a modest rate adjustment as they hit their anniversaries. So I mean that is $4 billion in total. But when you -- the effect on the overall rate, I think, is not going to -- their rates are not coming down to 2.20%. I think we've figured that, that would drop cost by another -- cost from the total portfolio by another 2 or 3 basis points when we take that one up.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. All right. That's where I was going to go. Hannover, you're doing nothing with them this year?

John Michael Matovina

We do not have any new arrangements with Hanover this year, so there's some existing arrangements, which once you create a surplus, it just starts running off over the time period. Those continue to run off. There is one ongoing arrangement with Hannover though that covers the excess penalty free withdrawals, I'll call them. Statutory reserves require you to assume that every policyholder takes maximum use of the 10% penalty free withdrawal each year and the treaty with Hannover relative to that kind of caps our reserve cost in the 4% to 5% utilization versus an actual experience of 3% to 3.5%. So as new business is added, it does come on under the Hannover treaty and provides some reserve reduction benefit to us to keep from having higher reserves on the new business. And then likewise, the benefit from that treaty diminishes as business is surrendered that withdrawals.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. But nothing new that's going to jack the other expense line?

John Michael Matovina

Right.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. And then what's the cost of new money?

John Michael Matovina

1.25-ish.

Operator

And your next question comes from the line of Paul Sarran from Evercore.

Paul Sarran - Evercore Partners Inc., Research Division

Maybe for Ron. After the pricing change you made in December, where do you sit relative to pricing of the other large competitors?

Ronald J. Grensteiner

We're right in the hunt. When we look at caps, annual point-to-point caps for example, are about 2.75, fixed strategies are between 1 and 1.25. The roll-up rates for the lifetime income benefit rider are all very competitive, so I would say...

John Michael Matovina

With exceptions.

Ronald J. Grensteiner

With the outlook -- the one outlier. But I'd say, overall, everybody is fairly close.

Paul Sarran - Evercore Partners Inc., Research Division

Okay. Once you do manage back to a 300 basis point spread, what does that mean for ROE? Do you have that calculation?

Ronald J. Grensteiner

No, I don't.

Paul Sarran - Evercore Partners Inc., Research Division

Are we talking 12%, 13%, 14%? I think you've gotten a size there in the past.

John Michael Matovina

May I guess? If I were to throw out a ballpark, from deep in the back of my head, I'd say probably 13%.

We're not trying to be overly aggressive in estimating it.

Paul Sarran - Evercore Partners Inc., Research Division

Understood. A question on capital. If you have another year of around $4 billion of gross sales, where would your RBC go, all else equal over the course of the year? Is there any kind of sensitivity you can give on that front?

John Michael Matovina

Not right at the moment, Paul. My sense is it doesn't change a lot, but the project that we undertake each year to kind of get some good firm numbers on that is in its normal status right now and is typically completed in mid to late March to give us a precise number. But sales at the same level probably don't change the RBC that much. Probably relative to what's happening this year, what might be putting a little more pressure on the RBC is the fact that we still do have investments at the agencies that we do own and don't have any risk-based capital charge on them. So the portfolio activities have resulted in, say, more Class 2 bonds being bought, which are the BBB categories. So that puts a little bit pressure on RBC, but it shouldn't do a whole lot to that given the foundation of the $24 billion of the portfolio that's already there.

Paul Sarran - Evercore Partners Inc., Research Division

Okay. And then one last one. Given the majority of your lawsuits have been settled or are near settlement, 151A has gone away, you just hired a new General Counsel. What are going to be his kind of first major focus or responsibilities at this point?

John Michael Matovina

There's lots of things that are legal in nature that come with running an insurance business besides dealing with lawsuits and things like that. So...

Ted M. Johnson

He also is in charge of our compliance area and also all of our other in-house attorneys that deal with any day-to-day legal issues or things that we have internally. So...

John Michael Matovina

Yes, we have SEC filing obligations...

Ted M. Johnson

There were a lot of activities here, when we had certain contracts or things that needed to be written, et cetera, we were reaching out to outside counsel to do that. Now, a majority of that is all being done in-house.

Operator

And your next question comes from the line of Mark Hughes with SunTrust.

Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

The 63 basis points of room before you run into the guarantees, is there any way to translate that into time, if we keep new money yield, where they're at today, I know you've got some flexibility to adjust crediting rates obviously. What -- how much running room did that get you?

John Michael Matovina

Well, I mean, we really don't have -- we have very little negative pressure on that number right now, Mark. Kind of back to my comment to Steven's question, we've got the 2010 business that's going through some rate adjustment, but that, I think, the 2 basis points -- 2 to 3 basis points expected cost of money reduction probably knocks the 63 down some. But of course, as new business gets added, it's being added at rates that are above the minimums on those policies. So it will help to keep the rate at that level or move it up some. Now of course, any renewal rate adjustment or substance would start to eat away at that in a more meaningful way. And as I commented earlier, there's one of those likely on the horizon, but it's probably in the 15 to 20 basis point measurement, so -- and then beyond that, it's a question of do rates stay at these levels if they go up at any point in time that likely takes pressure off that.

Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

So one might say if rates were to stay at this level, for the foreseeable future, you should be in good shape?

John Michael Matovina

That would be my take, yes.

Mark D. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then the pending count, 2,900, I think, currently. What was that at this time last year? And are those numbers comparable?

Ronald J. Grensteiner

Yes, Mark. Actually at this time last year, we were right at 3,000. So we're just 100 away. And our average for the whole year last year, if we take all the months, add them up, divided by 12, was 2,900 for the whole year of 2012.

John Michael Matovina

So we're average.

Operator

And your next question comes from the line of Jeff Smith with Eagle Investment Management.

Jeffrey Smith - Eagle Boston Investment Management, Inc.

I'm sorry, all my questions have been answered.

Operator

And your next question comes from the line of Richard Todaro with Kennedy Capital.

Richard Lee Todaro - Kennedy Capital Management, Inc.

A couple of maybe dumb questions, but the -- is there any risk of tax changes that can affect the life insurance business that you're hearing about? Or is that kind of behind us now?

John Michael Matovina

I'm not hearing about any. Ron, have you?

Ronald J. Grensteiner

They always talk about it, everything is on the list at this time of year, but I haven't heard anything, any serious talk about it.

Richard Lee Todaro - Kennedy Capital Management, Inc.

Okay. As far as your -- just understanding your 3% spread and the crediting rates, I'm just not familiar with this, but I assume there's a certain time factor when you can adjust them and certain stipulations of when and how you can adjust it. And so how fast -- I guess this was asked earlier, but at this rate, if interest rates stayed at this level, where could you take crediting rates this year and then next year? How do I think about that?

John Michael Matovina

Well, the -- if we make adjustments to new business, those happen fairly promptly for all business obviously issued after the effective date. When we adjust renewal rates, and I kind of talked about trying to maybe get 15 to 20 basis points, that actually takes a full year to almost 2 years to fully realize the benefit of that because: one, the rate adjustment only takes place on the policy anniversary. If you're in an index calculation, we obviously have to wait until your year is up before we can adjust the cap for participation rate. So once the rate adjustments start, it takes a full year to cycle through all the policies. And then it's going to take another year to fully realize the -- to realize the full benefit in the cost of money because a policy you adjusted in the 12-month of the cycle, you don't see the benefits of that rate reduction on that policy until the 12th month through the 23rd month. And that's kind of why we're still seeing -- we're still getting some small benefit this year from the rate adjustments that we did in 2011 -- or started in 2011 because not all of the policies have been through a full year on the lower rate.

Richard Lee Todaro - Kennedy Capital Management, Inc.

Let me ask this another way. Let's say rates start to go up and some of the crediting rates aren't very attractive and people down the road want to get out of it and it makes sense to pay the surrender charge or whatever it is, is there -- if you were above your 3% spread, could you adjust up crediting rates to keep customers?

John Michael Matovina

Oh, yes.

Richard Lee Todaro - Kennedy Capital Management, Inc.

Okay. How do you think your spread compares to competitors in the industry?

John Michael Matovina

I wish I knew. The one dilemma of being the kind of the only public company in the universe is none of those other companies publish their data.

Richard Lee Todaro - Kennedy Capital Management, Inc.

But they were all just solds, so wouldn't you think there's block through the book out there that everybody knew, and said, "Oh my God, their rate's X?"

John Michael Matovina

The acquirers may know but...

Richard Lee Todaro - Kennedy Capital Management, Inc.

Okay. Here is once again my dumb question. So it looks like you guys, like most life companies, have significant gains in the portfolio, and I don't know when is that significant relative to your equity, maybe $10 a share and you're making $2 in earnings a year or something. Is there any thoughts to maybe take some of those gains and maybe not focus as much on the crediting rate and do some sort of risk-adjusted analysis to take the profits and pay out the spread and figure it out later? Or is that just completely ridiculous on my point?

John Michael Matovina

I don't want to say it's ridiculous. There likely is merits to recognizing on an individual basis to sale the security at a gain, but a wholesale change in the portfolio to do that mean it would just exasperate the problem we've been talking about in terms of all the cash we have to invest. This would just mean more securities to be reinvested. The other thing is, while it would build up the GAAP book value for the company, obviously future earnings and ROEs would be much less because you can't realize those gains and then go in and slash the crediting rates to reflect the fact that now you got a lower investment yield. That would, I think, create a lot of ill will with policyholders and agents and damage the long-term franchise of the company. And then the other thing on the statutory side is those gains were all what the regulatory looks at as, say, interest rate-related versus credit-related. So you would have to defer those gains and amortize them into your regulatory income over the life of the security that you sold. So you're really not receiving any benefit in your regulatory capital from recognizing those gains, immediate benefit like you'd see in your GAAP equity.

Richard Lee Todaro - Kennedy Capital Management, Inc.

So then, I guess, this would be my last question. In a -- you guys, I'm sure, are watching the Fed minutes like the rest of us. If we start to get to a point where they start to raise rates, which will be interesting, individuals are selling bonds and the Feds are selling bonds, who knows what can happen, right? If we start to get in to some sort of gradually rising interest rate environment next year, would you be better off sitting on that cash instead of worrying about your spread this year? Or how do you think about that? And then also, it seems like a gradual rising interest rate environment may start to help sales as the crediting rates look better to customers and the rest of that. So just gradual rising interest rate environment, general thoughts, I guess.

John Michael Matovina

I think you got it pegged right that gradual rising rate environment would be favorable to us from -- on the fronts you've kind of commented on. Sales likely as well, sales and then investment of money. But we're not in the business of trying to time interest rates so the prospect of continuing to sit on the cash with the expectation that we might be able to get higher yields a year from now is kind of not in our thinking. While -- rates are too unpredictable. I mean, people have been talking about rates going up for how many years now, and they kept going down. So yes, we certainly think that there's going to be a time when they go up, and it would be nice to see the Fed out of the way. But I think the prospect of sitting on the cash to wait for higher rates is not something that we're going to consider.

Richard Lee Todaro - Kennedy Capital Management, Inc.

So just -- I guess, this is my last question. So just under a scenario where interest rates rise enough that you actually have -- you would have a loss, unrealized loss, in the portfolio and you could start to get maybe redemptions at that point from people wanting money at higher rates. How does the -- if you adjust up your crediting rates -- I don't know, I guess, that's a question offline. I'm just trying to think through how you kind of defend your portfolio if you ended up in that situation so you don't have to take a bunch of losses.

John Michael Matovina

Well, the surrender charge protection is one of the keys there to deterring that type of policyholder behavior. And relative to rates, we still got a lot of business that was issued, go back 3 years and earlier, where the rates those policyholders are getting are still, say, 3% versus a new money rate of 1.25%. So we could have rates go up a couple hundred basis points relative to what we could pay on annuities. And that wouldn't put a lot of pressure on a big chunk of our policyholders, yet it would make the ones that bought policies last year. And of course, this 1.25 rate, we've only had since December. So most of last year, the rates were 1.60 to 1.75.

Richard Lee Todaro - Kennedy Capital Management, Inc.

But they're under big surrender charges, so you're protected, right?

John Michael Matovina

Yes. So -- and the other thing that helps is the -- and this helps all companies in the business, a lot of policies being sold with the lifetime income benefit rider, and at the moment, that rider or the benefits embedded in that rider are not portable. So the longer you're with a particular company, and if you really purchased your annuity as a retirement savings or retirement income vehicle, you've got some embedded value in that rider that if you move to another policy with somebody else, you start all over again. So while you can look at your higher earnings rate as an option, you can't replace your income benefit, you got to start all over again, as I said.

Richard Lee Todaro - Kennedy Capital Management, Inc.

So it seems like you guys are positioned nicely then, at least from a sales standpoint, and the balance sheet should hold up and everything for gradual rise, so that's great.

Operator

And your next question comes from the line of Steven Schwartz from Raymond James & Associates.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Just a couple of follow-ups. We've discussed in the past, didn't discuss this time around, the discount, the reserve discount rate change that's expected. Is that still expected midyear, and any thoughts on that?

John Michael Matovina

Yes, I mean, the reserve rates are always established July 1. So -- and they change from year-to-year for -- or they can change from year-to-year. We are expecting at the moment that it looks like the discount rates for 2013 are going to be slightly less than what they were for 2012. If rates were just to go level from here, that's the reduction we're expecting. Whereas from 2012 -- '11 to '12, debt reduction was 50 to 75 basis points, so a little more modest decrease this year than what we had to deal with last year.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Are you -- last year, part of the issue was that you changed rates to account for that in December. It doesn't sound like you did that this time. It just sounds like you were just adjusting rates, to adjust rates?

John Michael Matovina

We were looking at that, Steven, at product changes and opted not to make any changes because of the expected decline in the discount rate. And part of that thinking revolved around the experience we did have on the competitive side last year where we got out ahead and others waited till later in the year to follow suit and opted not to, at least at this point in time, change rates, or make a change relative -- responsive to the discount rate, which that thing affects the terms of our lifetime income benefit rider more than it does the base policy.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. And John, it sounded like, if I was catching this correctly, you were saying that if you were to take out the cash, the $2.2 billion, in the portfolio, that the remaining piece, $24 billion or whatever, would be at 5.2%, is that accurate?

John Michael Matovina

The 5.2% includes the instruments that our agency bonds purchased at premiums, that are yielding down the 1% level.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. But that was -- it looked to me like in the discussion in your press release, that stuff was included in the cash flow?

John Michael Matovina

Yes, it is.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. Do you know what that number is x that stuff? Back into an average for the quarter, but I'm wondering if you know what it is at the end of the quarter?

John Michael Matovina

If you pull out the stuff that's yielding the 1% or so, and actually this is pulling out the calls to that -- in the first half of the year where the yields in some of the stuff being called are about 4%. So if we pull out all the stuff that's going to be called, the yield looks to be about 5.3%.

Operator

[Operator Instructions] Your next question comes from the line of Ed Shields with Sandler O'Neill.

Edward Shields - Sandler O'Neill + Partners, L.P., Research Division

Ted, I've got a quick numbers question for you. I kind of missed it in the prepared comments. What was the commercial mortgage loan originations in the fourth quarter?

Ted M. Johnson

$145 million at an average yield of 4.51%.

Edward Shields - Sandler O'Neill + Partners, L.P., Research Division

Okay. And the second question I've got is looking forward, what are your expectations for future commercial mortgage loan prepayments, do you have any expectations there or any indicators?

John Michael Matovina

Not -- I don't have any summaries that I could express to you, Ed. I don't think we do.

Operator

And I would now like to turn the call over to Julie LaFollette for closing remarks.

Julie L. LaFollette

Thank you for your interest in American Equity and for participating in today's call. Should you have any follow-up questions, please feel free to contact us.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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