American Equity Investment Life Holding's (AEL) CEO John Matovina on Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: American Equity (AEL)

American Equity Investment Life Holding Company (NYSE:AEL)

Q2 2014 Results Earnings Conference Call

July 31, 2014 12:00 PM ET

Executives

Lisa McQuerrey - Vice President

John Matovina - Chief Executive Officer

Ted Johnson - Chief Financial Officer

Ron Grensteiner - President of Life Company

Analysts

Randy Binner - FBR Capital Markets

Mark Hughes - SunTrust

Steven Schwartz - Raymond James

Operator

Welcome to the American Equity Investment Life Holding Company’s Second Quarter 2014 Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Lisa McQuerrey, Vice President. Please go ahead.

Lisa McQuerrey

Thank you Carolyn. Good morning and welcome to American Equity Investment Life Holding Company’s conference call to discuss second quarter 2014 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. And it is now my pleasure to introduce John Matovina.

John Matovina

Thank you, Lisa and thanks to each of you for joining us on the call this morning. We understand, there maybe a few of you who are suffering from earnings call fatigue already, in that, there were several life companies ahead of us today doing calls. So thank you for joining us.

In the first half of 2014, our performance has plateaued somewhat. However our foundation for future growth remains quite strong and the prospects for future growth remain excellent. We are selling retirement savings and retirement income products to an ever growing market and the aging baby boomers need the security that our principle protected, fixed index annuity products provide. Similarly other than defined benefit pension plans which are a dying breed annuities are the only financial product that can provide retirees with a guaranteed pay check provides.

So, looking at a few of the highlights of the second quarter results, our attractive product attributes and excellent customer service, resulted in more than $1 billion of sales for the quarter. Our operating income of $38.5 million or $0.48 per diluted share enabled us to produce a very acceptable return on average equity of just under 12% on a trailing 12 month basis. And we continue to improve our capital structure and reduce our debt leverage by deploying more of the proceeds from the $400 million senior note offering from last summer to retire our convertible debt. We retired $51 million of principal amount in the second quarter and have now retired $238 million principal amount of the two convertible debt instruments.

Although our performance has been satisfactory, we’re not happy with flattish results and are determined to increase our sales and improve our financial performance, while $1 billion sales for the quarter is good we’ve been around that level for several quarters now and need to get our quarterly sales levels higher, but not at the expense of acceptable profits.

As we have previously stated the market is quite competitive these days with a lot of attention directed toward potential product returns rather than guarantees in protection of principal. Early next month we will be introducing three initiatives that should enhance our competitiveness in the fixed-index annuity market. Ron’s remarks will include further details on those initiatives as well as usual commentary about sales results in the competitive environment. Our investment spread for the quarter was 2.7% that was flat with a year ago and slightly less than the first quarter. The decrease was largely due to a fore guard investment income on higher levels of cash and short-term investments. And we've previously achieved a fully invested position in the third quarter of last year but did caution that there was still a modest amount of call risk in our investment portfolio. And unfortunately that call risk did materialize in April 2014.

And given the lower available investment yields in the quarter and our long-term view for rising rates, we did not reinvest the cash from those call bonds promptly. However, the pace of new investment purchases has picked up and we expect our cash and short-term investments to be at normal operating levels by the end of this quarter.

So let me now turn the call over to Ted for more detailed comments on the second quarter financial results.

Ted Johnson

Thank you, John. Our second quarter operating income of $38.5 million was 8% higher than the adjusted second quarter 2013 operating income. Second quarter 2013 operating income included a $5.5 million charge for guarantee fund assessments related to the insolvency of Executive Life of New York.

The diluted share count for the second quarter was 13% higher than the second quarter of 2013 and the increase equates to approximately $0.06 per share. The increase in diluted shares results from shares issued since the second quarter of 2013 for retirement of convertible notes and exercise of stock options.

In addition there was greater dilution from convertible notes, warrants and stock options outstanding due to the company's common stock being at a much higher price in the second quarter of 2014 compared to the second quarter of 2013.

Investment spread for the second quarter was 270 basis points and total invested assets at the end of the quarter were $33.1 billion. Our spread result of 270 basis points was seven basis points lower than the previous quarter spread of 277 basis points. Spread performance was impacted by average yield on investments, which declined 12 basis points to 4.83% from 4.95% in the first quarter of 2014.

Much of this decline was due to the higher levels of low yielding cash and short-term investments during the quarter, which primarily resulted from 500 million in calls of U.S. Government Agency Securities in April of 2014. The average yield on invested assets also continued to be impacted by the investment of new premiums and portfolio cash flows at rates below the portfolio rate.

The average yield on fixed income securities purchases and commercial mortgage loans funded during the second quarter was 4.15% compared to 4.39% in the first quarter of 2014. The aggregate cost of money for annuity liabilities was 2.13% in the second quarter compared to 2.18% in the first quarter.

The company continued to reduce its cost of money through lower crediting rates and the five basis-point reduction in the aggregate cost of money also benefited from improved hedging results. We were 3 basis points over hedged in the second quarter and less than 1 basis point under hedged in the first quarter. The second quarter hedging outcome is more consistent with our historical experience of managing the hedging process toward an over hedged outcome.

We have been implementing renewal rate adjustments to small groups of policies for some time now. And policies issued in the second quarter of 2011 were adjusted this quarter for the first time since their issue date.

In addition, as reported in our first quarter call, during the second quarter, we initiated additional renewal rate reductions for policies issued prior to July 20, 2010. These rate reductions will occur on policy anniversary date over a 15-month period that began on April 14th with the majority of the rate reductions complete by May 15, 2015. Our most recent new money rate adjustments were in the third quarter of 2013 when we increased rates in response to rising investment yields at that time. However investment yields no longer support those rates while we have been reluctant to reduce new money rate so far this year for competitive reasons we are aware of our spread and our return on average equity objectives. Reductions in new money rates are likely should the current interest rate conditions continue.

Interest expense for notes payable was 9.1 million compared to 10.3 million in the first quarter and 6.8 million in the second quarter of 2013. The decline from the first quarter is due to the retirement of convertible notes in the second and first quarters interest expense for notes payable will decline further in the third quarter of 2014 as the full effect of the convertible notes retired in the second quarter is realized and if additional convertible notes are retired in the third quarter.

The increase in interest expense compared to the second quarter of 2013 is due to the issuance of 400 million of senior notes in July 2013 offset impart by the reduction in interest expense for the retirement of our convertible note. Interest expense on our subordinated debentures of 3 million in the second quarter is not materially different from earlier periods. We have 169.6 million of floating rate subordinated debentures which support 164.5 million of floating rate trust preferred securities held by third parties. We have swapped 85.5 million of floating rate trust referred securities to fixed rates and have capped a floating on the other 79 million for a term of seven years beginning March 2014 for the swap and July 2014 for the caps. These derivatives are effectively raising the interest cost on the underlying trust preferred securities.

Pretax operating income in the second quarter was reduced by $600,000 for the interest rate swap. The caps are expected to reduce pretax operating income by a $142,000 each quarter unless the three months LIBOR exceeds the 250 cap, in which case we would benefit from the caps. And our effective interest cost for the underlying trust preferred securities would be capped at 6.22%.

The amount for each of these derivatives are reported in change in fair value of derivatives.

Excluding amounts related to class action litigation settlements, other operating cost and expenses were $20.9 million in the second quarter compared to $21.3 million in the first quarter of 2014 and $28.1 million in the second quarter of 2013. The second quarter of 2013 amount includes $8.5 million for guarantee fund assessments related to insolvency of Executive Life of New York. Adjusting for this item, operating expenses for the second quarter of 2014 were $1.3 million higher than the second quarter of 2013. This increase is related to increases in compensation expenses and risk charges on a reinsurance agreement.

As John commented earlier, we further reduced our debt leverage and potential additional dilutions from further increases in stock prices this quarter through the retirement of $51 million principle amount of the two issues of our convertible notes. The total consideration paid included $65.1 million of cash and $1.5 million shares of our common stock. We estimate that these convertible debt retirements reduce book value per share by $0.49 per share and net income by $0.07 per share during the second quarter. Our S&P adjusted debt-to-capital ratio declined from 25.8% at year-end to 2013 to 22.8% at the end of this quarter. We want to see that much near or below 20% by the end of this year.

As I commented in the last several quarterly conference calls unlike diluted earnings per share, there is not an established accounting protocol for determining diluted book value per share. And the book value per share numbers we report do not include any potential dilution from convertible securities and stock options.

With our stock price trading significantly higher than the conversion price and the conversion price significantly below reported book value per share, potential further reduction in book value per share from conversions or retirements of our convertible notes could be meaningful.

At June 30th, the aggregate principal amount of convertible notes outstanding was $78 million and we had $96.5 million of net proceeds remaining from the $400 million senior notes offering, which we intend to use for the retirement of these obligations. The form and timing of any such activity will be dependent upon market conditions and other factors, and there can be no assurance that any such transactions can be completed prior to the December 2014 call date for the 5.25 convertible notes or the September 2015 maturity date for the 3.5% convertible notes.

Our RBC at the end of the second quarter was estimated at 356 up from 344 at the end of 2013. We remain comfortably above the 300% rating threshold from AM Best and we have adequate regulatory capital to support much larger sales volumes than we are currently experiencing.

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

Ron Grensteiner

Thank you, Ted. Good morning, everyone. Before I speak about sales and marketing I would like to make a few comments about the value proposition of our products once again policy holders with an anniversary in the second quarter had some really nice index credits with the rising stock market, but had no risk to their principal or previously credited interests. The average index credit in the second quarter was 5.63% and the largest was nearly 17%. For the first half of this year 44% of the annual index credits were 6% or more and 89% of the index credits were at least 3%. One of Dave Noble’s principals of excellence when we formed the company was to provide above average value to our policy holders and keeping this as a core principal that certainly helped American Equity enjoy the great success we have had over the years.

We're now on the sales and marketing. Our sales for the second quarter were 1.42 billion up from 921 million in the first quarter. We are down however from 1.1 billion in the second quarter of '13 and we're down 5% for the first half of this year compared to the first half of last year.

As John, mentioned while we got back to the $1 billion mark in the second quarter we are not completely satisfied with our progress. With that said we're not going to chase sales at the expense of acceptable profits nor are we willing to introduce products or initiatives that cannot withstand the test of time. So it's okay to be contrarian if we're doing what's bet for the company and our policyholders. We're in a highly competitive industry that is prone to marketing gimmicks that attempt to embellish the benefits of fixed indexed annuities. And our products don’t need embellishing and the index credits that I spoke of earlier are testament to that. We credited an average of 563 in the second quarter in case you missed it.

Our policy holders are depending on us; first and foremost to guarantee principal, guarantee interest and guarantee income. We have lots of market share to companies who offer volatility control index strategies that are being marketed as uncapped, we don't think the strategy is a bad strategy, it certainly has, it's place in our industry, we just think the marketing as uncapped is setting up unrealistic consumer expectations in the future.

Furthermore they are being marketed with illustrations and back testing was only exacerbates the problem and put a kind of emphasis on upside potential rather than the guarantees of our products. We have been exploring this strategy however for several months, but we did not want to introduce one unless it met certain criteria and the most important criteria being that it was not a proprietary index, it was trackable and it was transparent.

We also want to separate ourselves from the crowd and we want to innovative index and how that strategy is marketed. By now you probably know, one of our August initiatives that was in our press release is the introduction of a volatility controlled index, it’s call the S&P 500 dividends aristocrats, daily risk controlled 5% index, that's helpful. We're actually going to call it the volatility controlled index.

It is an annual point-to-point, annual reset strategy with a 100% participation rate minus fee, the fee is 2.25 or 2.50 depending on the product to which it is attached a unique feature of this strategy is that the index does include dividends and there are a minimum of 40 S&P 500 companies that make-up the index and they all have at least 25 years of track record of paying increasing dividends.

As far as the marketing goes, we will not market this as an uncapped strategy nor will we use back tested hypothetical illustrations. What we will say is it’s a good strategy for today’s low rate environment and it should provide more predictable interest credits but highs won’t be as high and the lows won’t be as low.

We still believe the monthly point to point strategy has the most indexed credit potential in a climbing stock market and of course the good old S&P 500 annual point to point strategy is certainly the most popular and the easiest to understand.

Our second August initiative is a new lifetime income benefit rider. We have already a very competitive rider but again we want to differentiate ourselves from the crowd and solidify our status as the go to company for income. This new lifetime income benefit rider will have gender based payouts versus unisex payout rates. This isn’t new in the mortality business. Annuities and payout phase use gender based payouts and life insurance premiums are gender based too. We are simply taking a special and very popular benefit and making it better.

In the end, our male payout rates will be higher for all ages and our female payout rates will be slightly higher for four out of ten ages and slightly lower for six out of ten. We are the first company in the fixed index annuity market space to introduce gender based lifetime income benefit rates.

Finally, our third August initiative is a new commission schedule. Currently our producers receive 75% of their total commissions at policy issue; they receive another 12.5% in the 13th month and the final 12.5% in the 25th month. We introduced this commission structure back in 2009 when our competitors were reducing commissions across the board. We did not reduce commissions; we simply stretched the total payments over 24 months. While it wasn't popular when it was introduced, it has become hugely popular today. Our producers are comforted to know that they will be receiving benefits two years down the road for work they are doing today.

Our total commissions are greater than most of our competitors over a two year period, but commissions paid in the first year are approximately a 100 basis points less than our competitors. We believe this is a hindrance to recruiting new agents to American Equity.

So the new schedule reduces total commissions by a 100 basis points, but pays all the commissions at policy issue versus spreading it over 24 months. This will put our commissions pay that issue at par with the bulk of our competitors.

We don't think many of our current producers will switch to this option, but we do believe it will help us recruit new agents to American Equity.

We recently had a group of 40 Gold Eagle producers in our office and we pulled them on this very question, what would you prefer in getting more total commissions over 24 months or getting less total commissions but more in the first year? And a 100% of the participants selected our current schedule of paying more over 24 months.

Our marketing team has been out visiting producers and marketing companies, the last two weeks about these three upcoming initiatives. And so far we've had a very positive response, and we're excited for a more robust second half of the year.

Our pending count peaked at 3,400 in April and has not been above 3,000 since late June. The average daily pending count for July has been just under 2,800 and we hope these three initiatives will help us report better third quarter numbers.

Turning to Eagle Life, we continue to be very busy with our marketing strategy. The second quarter production was flat however at $17.4 million compared to the first quarter of this year. However, we are up the first half of this year from $10.7 million in the first half of last year that’s a 225% increase. We’ve had some really good momentum this year. We have had some competitors introduced some super competitive multiyear of guaranteed rate annuities which has kind of water that down a bit. They are coming now with some rates that are 75 basis points more in rate on a five year rate guarantee. And that five year rate guarantee product is of course really interest rate sensitive and it serves as the primary entry point into many of the banks and broker dealers, primarily the bank channel.

Once a working relationship is established that’s when we start to get the FIA products introduced in both of these channels. We would have liked to been further along with Eagle Life but we have learned the approval process takes a lot longer in the bank and BB channel and it is more rate sensitive than in the independent channel. Now today, we have three banks and 20 broker dealers that have signed selling agreements, 14 of those 23 were signed up in 2014. We remain encouraged and continue to feel that Eagle Life is an opportunity for growth within the American Equity family company.

Finally I am just very proud of our home office team. They continue to provide the best customer service in the business, another principle of Dave Noble to form the company and I really believe that the excellent customer service is what helping our sales today and separating us from the pack on a service level. And that would be the case going into the future.

And that concludes my report and I am going to report the call back to John.

John Matovina

Thank you Ron and Ted. So kind of wrap up while our second quarter results were not exceptional they do keep us on track to achieve our goals. And we're well positioned to continue to capitalize on the growing demand for our retirement savings and retirement income products.

As always we remain dedicated to growing our assets under management and specifically there we want to maintain that $1 billion plus sales level each quarter and grow it. We want to see some measurable sales progress out of Eagle Life. While the sales environment our products remain competitive, we are optimistic that the initiatives we will introduce early next month will translate into stronger sales in the second half of the year. But first we want to continue to generate double-digit operating returns on equity and we'll as we talked about for many quarters be very mindful of where spread results are at and continue to manage crediting rates both renewal and new to get our spreads back up to that 3% target that we've achieved in the past

So with that I'll turn the call back to the operator to open up the call for questions.

Question-and-Answer-Session

Operator

(Operator Instructions). First question cold come from the line of Randy Binner from FBR Capital Markets. Please go head.

Randy Binner - FBR Capital Markets

Hi, thank you. I have a few I guess Ron I got that July pending at 2,800 but what were the other pending counts that you rattled out. I think for the past couple of months?

John Matovina

For the last we picked in April around 30 see what was it. It has been around the 2,800, we peaked in April at 3,400 and it's kind of been hovering around 3,000 and then it's not uncommon for pending to kind of slide during vacation time as well, but it's been around 2,800.

Randy Binner - FBR Capital Markets

And then is it, so it's low in July and August, and then it kind of ramps back up into the back part of the year usually, is that right?

John Matovina

When kids start getting back to school and everybody kind of returns to a normal schedule things start to ramp up again. But so it's not completely unusual to have lower pending, it sis lower than it was last July, last July it was over 3,000.

Randy Binner - FBR Capital Markets

Yes. So, okay. So, yes. So this is, you're going to be kind of flat at that this year, so that reads to the new initiatives. And I guess on the commission structure, just a couple of clarifications or question. One is that the individual has the auction to use the newer old structure for the commissions, correct?

John Matovina

Correct. They actually have three different choices. They can get the, what we call the 611 or now they can get the 700 or they can get 4.5 with a 75 basis points strait.

Randy Binner - FBR Capital Markets

Okay, got you. And I think that, I'm trying to dust off my RBC model here which hasn't been getting as much work. But back when you extended out the commission structure I believe there was an RBC benefit that came from that. So is there, do you have any way of estimating what the RBC impact would be if, hypothetically, everyone switched to the new upfront commission structure? Is that the right way to think of it?

John Matovina

Exactly the right…

Randy Binner - FBR Capital Markets

Yes.

John Matovina

That’s exactly the right way to think Randy and the impact on RBC is estimated is about 5 basis points and the reason is not bigger is because while we are paying more in the first year and that 5 basis points was assuming 100% opted for 700 but the reason is not a bigger impact is because even though we are paying more in the first year we are paying less overall.

Randy Binner - FBR Capital Markets

Got you. And you landed at what 356 is that right on the RBC this quarter?

John Matovina

Right.

Randy Binner - FBR Capital Markets

Okay. This means a lot of RBC ratios this morning. And then just a modeling question on other expense and operating costs in the income statement that item, so this is the item that all in was in the quarter it’s about $15 million and it’s about $19 million in the first quarter of 2014. Usually we would run kind of pretty comfortably north of $20 million a quarter for all those items together. So just wondering I mean these are unusually helpful numbers in that regard. Is there IT initiatives or executive compensation, any items that would kind of catch up in the back half in that category and put us back in kind of the north of $20 million range?

John Matovina

Randy where you get the first quarter operating expense what are you looking at?

Randy Binner - FBR Capital Markets

Well, it's about $19 million all in. I might be calculating it a little different than you reported, so I guess I'll ask it more broadly. Other operating costs and expenses, those have been lower the front half. Would those kind of peak back up to more normal levels in the back half? And litigation is a big item in there too.

John Matovina

I think the run rate you see right now is probably pretty normalized here for this quarter because there is really nothing unusual in there and obviously in prior quarters back when we had litigation expense that was obviously effecting that on the litigation front that's all quite now. And so we're not really incurring very much litigation costs anymore.

So, I mean operating expenses now are $20.9 million. That's a pretty normalized amount now.

Randy Binner - FBR Capital Markets

Okay, and there's nothing timing-wise in the back half, like I said with IT initiatives or any other initiatives where that might pop back up that you are aware of?

Ted Johnson

No.

Randy Binner - FBR Capital Markets

Great. That's all I have. Thank you very much.

Operator

Thanks for that question. (Operator Instructions). Next question we have comes from the line of Mark Hughes from SunTrust. Please go ahead.

Mark Hughes - SunTrust

Thank you, good afternoon. The new product rollouts, the new initiatives, is it your experience Ron that those will have a pretty immediate impact or do they build slowly?

Ron Grensteiner

I think we'll see an immediate impact at least in activity. I anticipate our pending count and our inflows applications should increase during the month of August. A lot of times, when you got transfers, and 10 35 exchanges involved, actually the number hitting the production report tend to lag a bit. But my hope is that we'll see an immediate impact, once we get this introduced and get the word out.

Mark Hughes - SunTrust

And then any particular updates on security benefit or Allianz, kind of what they are up to in the market?

Ron Grensteiner

Well, the last we've heard both of those companies have made some adjustments Allianz has increased the fee on their Barclays dynamic bond index and although they have -- and they have reduced the bonus that they pay on their income account value for income purposes. Security benefit has done some of the same. They reduced some of the bonuses on their income account values and so they’ve made some adjustments, but those are -- I guess other companies we noticed F&G has reduced rates a little bit but that’s the primary ones.

Mark Hughes - SunTrust

Right. Do you think that's material from a competitive standpoint?

Ron Grensteiner

Anytime they do something we don’t help, but I don’t know that I would consider them material, they are not huge changes, but they are changes.

Mark Hughes - SunTrust

Right, okay. And then Ted, Ted, what should we think about in terms of spread for the third quarter? Anything that hasn't come up that may impact the spread? I mean are we looking flat, up, down based on what you know now, how should we think about 3Q?

Ted Johnson

Well with 3Q we’ll see -- we should see, continue to see some benefit from the rate reductions that we have done. The rate reductions on the larger block of policies which we reported last quarter we’re adjusting on $15 million of liabilities, we’re adjusting those down by 20 basis points, those started in April. We should start to see the effect of those rate adjustments and then prior rate adjustments that we’ve done should continue to so flow through. So we expect to see a continued reduction in the cost of money on the top-line on the yield, obviously what will help in the next quarter is putting the excess cash and liquidity that we have to work which is our goal to have that all put to work before the end of next quarter.

Mark Hughes - SunTrust

And the impact of that if you do get a put to work, how many basis points should that be?

Ted Johnson

That's going to be somewhat dependent on the yields that are going to be available for us to purchase, but it’s a little higher to estimate about what that impact would be. The weighted average -- I would say the weighted average amount of excess liquidity that we held in the quarter was a little over 600 million with the weighted average.

Mark Hughes - SunTrust

Right. Do you think those things will be offset, the spread will be relatively flat?

Ted Johnson

I don't know that I know that it will be relatively flat.

Mark Hughes - SunTrust

Do you think it will be up?

John Matovina

Mark, I don’t think we want to make a prediction there. I mean I think getting the cash put back to work is positive and that and certainly rate reductions were positive. So, but the timing of the purchases is kind of a wildcard and that’s -- while we talk about things that influence it, we just don't make those types of projections or predictions.

Mark Hughes - SunTrust

Understood, thank you.

Operator

Thank you for that question. The next question we have comes from the line of Steven Schwartz from Raymond James. Please go head.

Steven Schwartz - Raymond James

Hey good morning everybody. That made me laugh. That was classic. Where we’d you go Marl. A couple of things, wanted to ask one of Mark's question the different way. The excess liquidity or at least the 500 from the agency that was called in April, Ted, what was the effect on yield from that going from wherever it was to basically investing in cash? Do you know that?

Ted Johnson

I don't know that. I mean we'll say that if you were going to look at the amount of cash that we held during the quarter, the weighted average and if you assumed that we invested it at the rate, the average rate which was 415 for the quarter; that would calculate to approximately 7 basis points.

Steven Schwartz - Raymond James

Okay. All right. That will work.

Ted Johnson

I mean that's typically the calculation, but that's assuming that we would be able to invest that at the 415 that was available to us in the quarter.

Steven Schwartz - Raymond James

Sure. Okay. That's good. And then one more follow-up, and then some other things. So, you had the 15 billion which is 20 EPS, could you remind us what the other block was?

Ted Johnson

The 2011, do you remember John.

John Matovina

That's not only we have ever given a quantification on that, I mean is only be a few basis points on a whole portfolio, because it's a single year of business.

Ted Johnson

I think what we commented on is that we expected I think last quarter we comment two to three basis points in reduction of cost of money from that rate adjustments that we expected to see this quarter and into next quarter.

Steven Schwartz - Raymond James

Just from the smaller one?

Ted Johnson

From the smaller one.

Steven Schwartz - Raymond James

Okay. All right. And then some of my own here. Ron, I'm not going to ask you to say what the name of that index was again, but do you know the symbol?

Ron Grensteiner

Yes, I do. It is SPXD5UN.

Steven Schwartz - Raymond James

So that's SPX, David, five, U, Nancy?

Ron Grensteiner

Correct.

Steven Schwartz - Raymond James

Okay. And so that sounded to me like that was some type of S&P500 index, subset of the S&P 500 that paid dividends of some amount, would that be accurate?

John Matovina

Correct, it’s 40 companies that have a 25 year track record of paying dividends.

Ted Johnson

And increasing dividends.

John Matovina

And increasing dividends.

Steven Schwartz - Raymond James

Okay. All right. And then you say it's volatility control. Is there some type of overlay you are moving into fixed income if something happens or it's just that this is going to be pretty stable because of the nature of these stocks, what's the volatility?

Ted Johnson

Well the volatility trigger it’s 5% we want to keep it within the 5% range and the two mechanisms are of course is the aristocrat index itself and then the other part is basically cash I think we say the three month LIBOR.

Steven Schwartz - Raymond James

So it's this index or cash. And if one, so if the index moves down 5% you move to cash? I guess I'm not quite getting it.

Ted Johnson

Well the index it’s not the index as it’s reported already has calculated what the cash versus the aristocrat component is.

John Matovina

You move in and out of cash based upon the volatility of the index and I don’t know whether it’s three month back volatility I am not sure of that technical aspect of it but the obviously all S&P500 has a volatility associated with it I think – is the 30 day volatility measure and then you got one year volatility in all that so it’s a volatility gets outside of a parameter then they shift you to cash.

Ted Johnson

And its rebalanced on a daily basis.

Steven Schwartz - Raymond James

Okay. I got you.

Ted Johnson

So the concept would be that during periods of high volatility which typically equate to declines in the performance of the index, you're in cash and then lower volatility which tends to equate with positive performance, you're in the equity side.

Steven Schwartz - Raymond James

Okay, alright. And then one more, if I may. On the new, I was thinking about this, on the new commission does that change, I'm thinking now from accounting and modeling. Is that obviously, it will be small to start with if the major producers don't switch. But does that, overtime change things like DAC amortization or what's capitalized and things like that?

John Matovina

Absolutely. We only capitalize what we pay. So, absent any other changes, if spread didn't change or anything like that. The people taking the 7% upfront commission would be more profitable to us than the people taken the spread commissions. And the way that profitability would emerge would be through lower DAC amortization, because we capitalize less.

Steven Schwartz - Raymond James

Okay. Is the new commission on a present value basis, is the new commission schedule more expensive, I mean, you lowered the total rate but you're not paying over three years.

John Matovina

I don't think present value wise, it's more expensive, no. It's got to be less expensive. I mean, because the stretch is only 2 years. So, I don't think.

Steven Schwartz - Raymond James

Okay.

John Matovina

7% at time zero versus 6.11%, with the 1% in the 12 months later in the second one 13, but 24 months later that’s got be higher present value than 7.

Steven Schwartz - Raymond James

Okay. So alright. Okay, I got it. Thanks guys.

Operator

Thank you for the questions. We have no further questions. Ladies and gentlemen, so I’d like to now turn the call back over to Lisa for final remarks.

Lisa McQuerrey

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

Operator

Thank you for your participation in today’s conference. That concludes the presentation. You may now disconnect. Have a great day.

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American Equity (NYSE:AEL): Q2 EPS of $0.48 misses by $0.01. Revenue of $670.73M (+49.9% Y/Y)