10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on August 5, 2020
UNITED STATES SECURITIES AND EXCHANGE COMMISSION |
||||||||||
Washington, D.C. 20549 |
||||||||||
FORM 10-Q
For the quarterly period ended June 30, 2020
or
Commission File Number: 001-37963
(Exact name of registrant as specified in its charter) |
||||||||||||
(State or other jurisdiction of |
(I.R.S. Employer |
|||||||||||
incorporation or organization) |
Identification Number) |
(441 ) 279-8400
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices) | |||||||||||
Securities registered pursuant to Section 12(b) of the Act: | |||||||||||
Title of each class |
Trading Symbol |
Name of each exchange on which registered |
|||||||||
Depositary Shares, each representing a 1/1,000th interest in a
|
|||||||||||
Depositary Shares, each representing a 1/1,000th interest in a
|
|||||||||||
Depositary Shares, each representing a 1/1,000th interest in a
|
|||||||||||
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 ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☑ |
Accelerated filer ☐ |
Non-accelerated filer ☐ |
Smaller reporting company |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
As of July 31, 2020, 194,250,720 of our Class A common shares were outstanding.
TABLE OF CONTENTS
PART I—FINANCIAL INFORMATION
PART II—OTHER INFORMATION
As used in this Quarterly Report on Form 10-Q (report), unless the context otherwise indicates, any reference to “Athene,” “our Company,” “the Company,” “us,” “we” and “our” refer to Athene Holding Ltd. together with its consolidated subsidiaries and any reference to “AHL” refers to Athene Holding Ltd. only.
Forward-Looking Statements
Certain statements in this report are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act). You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “seek,” “assume,” “believe,” “may,” “will,” “should,” “could,” “would,” “likely” and other words and terms of similar meaning, including the negative of these or similar words and terms, in connection with any discussion of the timing or nature of future operating or financial performance or other events. However, not all forward-looking statements contain these identifying words. Forward-looking statements appear in a number of places throughout and give our current expectations and projections relating to our business, financial condition, results of operations, plans, strategies, objectives, future performance and other matters.
We caution you that forward-looking statements are not guarantees of future performance and that our actual consolidated financial condition, results of operations, liquidity, cash flows and performance may differ materially from that made in or suggested by the forward-looking statements contained in this report. A number of important factors could cause actual results or conditions to differ materially from those contained or implied by the forward-looking statements, including the risks discussed in Part II–Item 1A. Risk Factors included in this report and Part I–Item 1A. Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2019 (2019 Annual Report). Factors that could cause actual results or conditions to differ from those reflected in the forward-looking statements contained in this report include:
• |
the accuracy of management’s assumptions and estimates; |
• |
variability in the amount of statutory capital that our insurance and reinsurance subsidiaries have or are required to hold; |
• |
interest rate and/or foreign currency fluctuations; |
• |
our potential need for additional capital in the future and the potential unavailability of such capital to us on favorable terms or at all; |
• |
major public health issues, and specifically the pandemic caused by the effects of the spread of the Coronavirus Disease of 2019 (COVID-19); |
• |
changes in relationships with important parties in our product distribution network; |
• |
the activities of our competitors and our ability to grow our retail business in a highly competitive environment; |
• |
the impact of general economic conditions on our ability to sell our products and on the fair value of our investments; |
• |
our ability to successfully acquire new companies or businesses and/or integrate such acquisitions into our existing framework; |
• |
downgrades, potential downgrades or other negative actions by rating agencies; |
• |
our dependence on key executives and inability to attract qualified personnel, or the potential loss of Bermudian personnel as a result of Bermuda employment restrictions; |
• |
market and credit risks that could diminish the value of our investments; |
• |
changes to the creditworthiness of our reinsurance and derivative counterparties; |
• |
the discontinuation of London Inter-bank Offered Rate (LIBOR); |
• |
changes in consumer perception regarding the desirability of annuities as retirement savings products; |
• |
potential litigation (including class action litigation), enforcement investigations or regulatory scrutiny against us and our subsidiaries, which we may be required to defend against or respond to; |
• |
the impact of new accounting rules or changes to existing accounting rules on our business; |
• |
interruption or other operational failures in telecommunication and information technology and other operating systems, as well as our ability to maintain the security of those systems; |
• |
the termination by Apollo Global Management, Inc. (AGM) or any of its subsidiaries (collectively, AGM together with its subsidiaries, Apollo) of its investment management agreements with us and limitations on our ability to terminate such arrangements; |
• |
Apollo’s dependence on key executives and inability to attract qualified personnel; |
• |
the accuracy of our estimates regarding the future performance of our investment portfolio; |
• |
increased regulation or scrutiny of alternative investment advisers and certain trading methods; |
• |
potential changes to regulations affecting, among other things, transactions with our affiliates, the ability of our subsidiaries to make dividend payments or distributions to AHL, acquisitions by or of us, minimum capitalization and statutory reserve requirements for insurance companies and fiduciary obligations on parties who distribute our products; |
• |
the failure to obtain or maintain licenses and/or other regulatory approvals as required for the operation of our insurance subsidiaries; |
• |
increases in our tax liability resulting from the Base Erosion and Anti-Abuse Tax (BEAT); |
• |
improper interpretation or application of Public Law no. 115-97, the Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 (Tax Act) or subsequent changes to, clarifications of or guidance under the Tax Act that is counter to our interpretation and has retroactive effect; |
• |
AHL or any of its non-United States (U.S.) subsidiaries becoming subject to U.S. federal income taxation; |
• |
adverse changes in U.S. tax law; |
• |
our being subject to U.S. withholding tax under the Foreign Account Tax Compliance Act (FATCA); |
• |
changes in our ability to pay dividends or make distributions; |
• |
our failure to recognize the benefits expected to be derived from the share exchange transaction with Apollo; |
3
• |
the failure to achieve the economic benefits expected to be derived from the Athene Co-Invest Reinsurance Affiliate 1A Ltd. (together with its subsidiaries, ACRA) capital raise or future ACRA capital raises; |
• |
the failure of third-party ACRA investors to fund their capital commitment obligations; and |
• |
other risks and factors listed in Part II–Item 1A. Risk Factors included in this report, Part I—Item 1A. Risk Factors included in our 2019 Annual Report and those discussed elsewhere in this report and in our 2019 Annual Report.
|
We caution you that the important factors referenced above may not be exhaustive. In light of these risks, you should not place undue reliance upon any forward-looking statements contained in this report. Unless an earlier date is specified, the forward-looking statements included in this report are made only as of the date that this report was filed with the U.S. Securities and Exchange Commission (SEC). We undertake no obligation, except as may be required by law, to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise. Comparisons of results for current and any prior periods are not intended to express any future trends, or indications of future performance, unless expressed as such, and should only be viewed as historical data.
GLOSSARY OF SELECTED TERMS
Unless otherwise indicated in this report, the following terms have the meanings set forth below:
Entities
Term or Acronym |
Definition |
|
A-A Mortgage |
A-A Mortgage Opportunities, L.P. |
|
AAA Investor |
AAA Guarantor – Athene, L.P. |
|
AAIA |
Athene Annuity and Life Company |
|
AARe |
Athene Annuity Re Ltd., a Bermuda reinsurance subsidiary |
|
ACRA |
Athene Co-Invest Reinsurance Affiliate 1A Ltd., together with its subsidiaries |
|
ADIP |
Apollo/Athene Dedicated Investment Program |
|
AGM |
Apollo Global Management, Inc. |
|
AHL |
Athene Holding Ltd. |
|
ALRe |
Athene Life Re Ltd., a Bermuda reinsurance subsidiary |
|
ALReI |
Athene Life Re International Ltd., a Bermuda reinsurance subsidiary |
|
AmeriHome |
AmeriHome Mortgage Company, LLC |
|
AOG |
Apollo Operating Group |
|
Apollo |
Apollo Global Management, Inc., together with its subsidiaries |
|
Apollo Group |
(1) Apollo, (2) the AAA Investor, (3) any investment fund or other collective investment vehicle whose general partner or managing member is owned, directly or indirectly, by Apollo or one or more of Apollo’s subsidiaries, (4) BRH Holdings GP, Ltd. and its shareholders, (5) any executive officer or employee of AGM or its subsidiaries (6) any shareholder that has granted to AGM or any of its affiliates a valid proxy with respect to all of such shareholder’s Class A common shares pursuant to our bye-laws and (7) any affiliate of any of the foregoing (except that AHL or its subsidiaries are not members of the Apollo Group) |
|
Athene USA |
Athene USA Corporation |
|
Athora |
Athora Holding Ltd. |
|
BMA |
Bermuda Monetary Authority |
|
CoInvest VI |
AAA Investments (Co-Invest VI), L.P. |
|
CoInvest VII |
AAA Investments (Co-Invest VII), L.P. |
|
ISG |
Apollo Insurance Solutions Group LP, formerly known as Athene Asset Management LLC |
|
Jackson |
Jackson National Life Insurance Company |
|
LIMRA |
Life Insurance and Market Research Association |
|
MidCap |
MidCap FinCo Designated Activity Company |
|
NAIC |
National Association of Insurance Commissioners |
|
NYSDFS |
New York State Department of Financial Services |
|
RLI |
ReliaStar Life Insurance Company |
|
Treasury |
United States Department of the Treasury |
|
VIAC |
Venerable Insurance and Annuity Company, formerly Voya Insurance and Annuity Company |
|
Venerable |
Venerable Holdings, Inc., together with its subsidiaries |
4
Certain Terms & Acronyms
Term or Acronym |
Definition |
|
ABS |
Asset-backed securities |
|
ACL |
Authorized control level RBC as defined by the model created by the National Association of Insurance Commissioners |
|
ALM |
Asset liability management |
|
ALRe RBC |
The risk-based capital ratio using Bermuda capital and applying NAIC risk-based capital factors to the statutory financial statements of AHL’s non-U.S. reinsurance subsidiaries on an aggregate basis. Adjustments are made to (i) exclude U.S. subsidiaries which are included within our U.S. RBC Ratio, (ii) exclude our interests in the AOG units and other non-insurance subsidiary holding companies from our capital base and (iii) limit RBC concentration charges such that when they are applied to determine target capital, the charges do not exceed 100% of the asset’s carrying value. |
|
Alternative investments |
Alternative investments, including investment funds, CLO equity positions and certain other debt instruments considered to be equity-like |
|
Base of earnings |
Earnings generated from our results of operations and the underlying profitability drivers of our business |
|
Bermuda capital |
The capital of Athene’s non-U.S. reinsurance subsidiaries calculated under U.S. statutory accounting principles, including that for policyholder reserve liabilities which are subjected to U.S. cash flow testing requirements, but (i) excluding certain items that do not exist under our applicable Bermuda requirements, such as interest maintenance reserves and (ii) including certain Bermuda statutory accounting differences, such as marking to market of inception date investment gains or losses relating to reinsurance transactions. Bermuda capital may from time to time materially differ from the calculation of statutory capital under U.S. statutory accounting principles primarily due to the foregoing differences. |
|
Block reinsurance |
A transaction in which the ceding company cedes all or a portion of a block of previously issued annuity contracts through a reinsurance agreement |
|
BSCR |
Bermuda Solvency Capital Requirement |
|
CAL |
Company action level risk-based capital as defined by the model created by the National Association of Insurance Commissioners |
|
CLO |
Collateralized loan obligation |
|
CMBS |
Commercial mortgage-backed securities |
|
CML |
Commercial mortgage loans |
|
Cost of crediting |
The interest credited to the policyholders on our fixed annuities, including, with respect to our fixed indexed annuities, option costs, as well as institutional costs related to institutional products, presented on an annualized basis for interim periods |
|
Cost of funds |
Cost of funds includes liability costs related to cost of crediting on both deferred annuities and institutional products, as well as other liability costs. Cost of funds is computed as the total liability costs divided by the average net invested assets for the relevant period. Presented on an annualized basis for interim periods. |
|
DAC |
Deferred acquisition costs |
|
Deferred annuities |
Fixed indexed annuities, annual reset annuities, multi-year guaranteed annuities and registered index-linked annuities |
|
DSI |
Deferred sales inducement |
|
Excess capital |
Capital in excess of the level management believes is needed to support our current operating strategy |
|
FIA |
Fixed indexed annuity, which is an insurance contract that earns interest at a crediting rate based on a specified index on a tax-deferred basis |
|
Fixed annuities |
FIAs together with fixed rate annuities |
|
Fixed rate annuity |
An insurance contract that offers tax-deferred growth and the opportunity to produce a guaranteed stream of retirement income for the lifetime of its policyholder |
|
Flow reinsurance |
A transaction in which the ceding company cedes a portion of newly issued policies to the reinsurer |
|
GAAP |
Accounting principles generally accepted in the United States of America |
|
GLWB |
Guaranteed lifetime withdrawal benefit |
|
GMDB |
Guaranteed minimum death benefit |
|
Gross invested assets |
The sum of (a) total investments on the consolidated balance sheet with available-for-sale securities at amortized cost, excluding derivatives, (b) cash and cash equivalents and restricted cash, (c) investments in related parties, (d) accrued investment income, (e) consolidated variable interest entities’ assets, liabilities and noncontrolling interest and (f) policy loans ceded (which offset the direct policy loans in total investments). Gross invested assets includes investments supporting assumed funds withheld and modco agreements and excludes assets associated with funds withheld liabilities related to business exited through reinsurance agreements and derivative collateral (offsetting the related cash positions). Gross invested assets includes the entire investment balance attributable to ACRA as ACRA is 100% consolidated |
5
Term or Acronym |
Definition |
|
IMA |
Investment management agreement |
|
IMO |
Independent marketing organization |
|
Investment margin on deferred annuities |
Investment margin applies to deferred annuities and is the excess of our net investment earned rate over the cost of crediting to our policyholders, presented on an annualized basis for interim periods |
|
Liability outflows |
The aggregate of withdrawals on our deferred annuities, maturities of our funding agreements, payments on payout annuities, and pension risk benefit payments |
|
MMS |
Minimum margin of solvency |
|
Modco |
Modified coinsurance |
|
MVA |
Market value adjustment |
|
MYGA |
Multi-year guaranteed annuity |
|
Net invested assets |
The sum of (a) total investments on the consolidated balance sheet with available-for-sale securities at amortized cost, excluding derivatives, (b) cash and cash equivalents and restricted cash, (c) investments in related parties, (d) accrued investment income, (e) consolidated variable interest entities’ assets, liabilities and noncontrolling interest and (f) policy loans ceded (which offset the direct policy loans in total investments). Net invested assets includes investments supporting assumed funds withheld and modco agreements and excludes assets associated with funds withheld liabilities related to business exited through reinsurance agreements and derivative collateral (offsetting the related cash positions). Net invested assets includes our economic ownership of ACRA investments but does not include the investments associated with the noncontrolling interest |
|
Net investment earned rate |
Income from our net invested assets divided by the average net invested assets for the relevant period, presented on an annualized basis for interim periods |
|
Net investment spread |
Net investment spread measures our investment performance less the total cost of our liabilities, presented on an annualized basis for interim periods |
|
Net reserve liabilities |
The sum of (a) interest sensitive contract liabilities, (b) future policy benefits, (c) dividends payable to policyholders, and (d) other policy claims and benefits, offset by reinsurance recoverable, excluding policy loans ceded. Net reserve liabilities also includes the reserves related to assumed modco agreements in order to appropriately match the costs incurred in the consolidated statements of income with the liabilities. Net reserve liabilities is net of the ceded liabilities to third-party reinsurers as the costs of the liabilities are passed to such reinsurers and therefore we have no net economic exposure to such liabilities, assuming our reinsurance counterparties perform under our agreements. Net reserve liabilities is net of the reserve liabilities attributable to the ACRA noncontrolling interest |
|
Other liability costs |
Other liability costs include DAC, DSI and VOBA amortization, change in rider reserves, the cost of liabilities on products other than deferred annuities and institutional products, excise taxes, as well as offsets for premiums, product charges and other revenues |
|
OTTI |
Other-than-temporary impairment |
|
Payout annuities |
Annuities with a current cash payment component, which consist primarily of single premium immediate annuities, supplemental contracts and structured settlements |
|
Policy loan |
A loan to a policyholder under the terms of, and which is secured by, a policyholder’s policy |
|
PRT |
Pension risk transfer |
|
RBC |
Risk-based capital |
|
Rider reserves |
Guaranteed lifetime withdrawal benefits and guaranteed minimum death benefits reserves |
|
RMBS |
Residential mortgage-backed securities |
|
RML |
Residential mortgage loan |
|
Sales |
All money paid into an individual annuity, including money paid into new contracts with initial purchase occurring in the specified period and existing contracts with initial purchase occurring prior to the specified period (excluding internal transfers) |
|
SPIA |
Single premium immediate annuity |
|
Surplus assets |
Assets in excess of policyholder obligations, determined in accordance with the applicable domiciliary jurisdiction’s statutory accounting principles |
|
TAC |
Total adjusted capital as defined by the model created by the NAIC |
|
U.S. RBC Ratio |
The CAL RBC ratio for AADE, our parent U.S. insurance company |
|
VIE |
Variable interest entity |
|
VOBA |
Value of business acquired |
6
Item 1. Financial Statements
Index to Condensed Consolidated Financial Statements (unaudited)
7
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Assets |
|||||||
Investments |
|||||||
Available-for-sale securities, at fair value (amortized cost: 2020 – $71,215 and 2019 – $67,479; allowance for credit losses: 2020 – $173) |
$ |
$ |
|||||
Trading securities, at fair value (consolidated variable interest entities: 2020 – $0 and 2019 – $16)
|
|||||||
Equity securities, at fair value |
|||||||
Mortgage loans (allowance for credit losses: 2020 – $352 and 2019 – $11; portion at fair value: 2020 – $25 and 2019 – $27; consolidated variable interest entities: 2020 – $1,856 and 2019 – $0) |
|||||||
Investment funds (portion at fair value: 2020 – $146 and 2019 – $154; consolidated variable interest entities: 2020 – $0 and 2019 – $19) |
|||||||
Policy loans |
|||||||
Funds withheld at interest (portion at fair value: 2020 – $763 and 2019 – $801) |
|||||||
Derivative assets |
|||||||
Short-term investments (portion at fair value: 2020 – $364 and 2019 – $406) |
|||||||
Other investments (allowance for credit losses: 2020 – $6; portion at fair value: 2020 – $109 and 2019 – $93)
|
|||||||
Total investments |
|||||||
Cash and cash equivalents (consolidated variable interest entities: 2020 – $0 and 2019 – $3)
|
|||||||
Restricted cash |
|||||||
Investments in related parties |
|||||||
Available-for-sale securities, at fair value (amortized cost: 2020 – $4,173 and 2019 – $3,783; allowance for credit losses: 2020 – $2) |
|||||||
Trading securities, at fair value |
|||||||
Equity securities, at fair value (consolidated variable interest entities: 2020 – $0 and 2019 – $6) |
|||||||
Mortgage loans (allowance for credit losses: 2020 – $27 and 2019 – $0) |
|||||||
Investment funds (portion at fair value: 2020 – $1,885 and 2019 – $819; consolidated variable interest entities: 2020 – $0 and 2019 – $664) |
|||||||
Funds withheld at interest (portion at fair value: 2020 – $560 and 2019 – $594) |
|||||||
Other investments (allowance for credit losses: 2020 – $14) |
|||||||
Accrued investment income (related party: 2020 – $53 and 2019 – $27) |
|||||||
Reinsurance recoverable (portion at fair value: 2020 – $2,099 and 2019 – $1,821) |
|||||||
Deferred acquisition costs, deferred sales inducements and value of business acquired |
|||||||
Other assets (consolidated variable interest entities: 2020 – $6 and 2019 – $20)
|
|||||||
Total assets |
$ |
$ |
(Continued)
See accompanying notes to the unaudited condensed consolidated financial statements
8
(In millions, except per share data) |
June 30, 2020 |
December 31, 2019 |
|||||
Liabilities and Equity |
|||||||
Liabilities |
|||||||
Interest sensitive contract liabilities (related party: 2020 – $14,609 and 2019 – $15,285; portion at fair value: 2020 – $12,463 and 2019 – $11,992) |
$ |
$ |
|||||
Future policy benefits (related party: 2020 – $1,446 and 2019 – $1,302; portion at fair value: 2020 – $2,334 and 2019 – $2,301) |
|||||||
Other policy claims and benefits (related party: 2020 – $0 and 2019 – $13)
|
|||||||
Dividends payable to policyholders |
|||||||
Short-term debt |
|||||||
Long-term debt |
|||||||
Derivative liabilities |
|||||||
Payables for collateral on derivatives and securities to repurchase |
|||||||
Funds withheld liability (portion at fair value: 2020 – $46 and 2019 – $31) |
|||||||
Other liabilities (related party: 2020 – $70 and 2019 – $79; consolidated variable interest entities: 2020 – $28 and 2019 – $0)
|
|||||||
Total liabilities |
|||||||
Commitments and Contingencies (Note 12) |
|||||||
Equity |
|||||||
Preferred stock |
|||||||
Series A – par value $1 per share; $863 aggregate liquidation preference; authorized, issued and outstanding: 2020 and 2019 – 0.0 shares |
|||||||
Series B – par value $1 per share; $345 aggregate liquidation preference; authorized, issued and outstanding: 2020 and 2019 – 0.0 shares |
|||||||
Series C – par value $1 per share; $600 aggregate liquidation preference; authorized, issued and outstanding: 2020 and 2019 – 0.0 shares |
|||||||
Common stock |
|||||||
Class A – par value $0.001 per share; authorized: 2020 and 2019 – 425.0 shares; issued and outstanding: 2020 – 194.3 and 2019 – 143.2 shares |
|||||||
Class B – par value $0.001 per share; convertible to Class A; authorized: 2020 – 0.0 and 2019 – 325.0 shares; issued and outstanding: 2020 – 0.0 and 2019 – 25.4 shares |
|||||||
Class M-1 – par value $0.001 per share; convertible to Class A; authorized: 2020 – 0.0 and 2019 – 7.1 shares; issued and outstanding: 2020 – 0.0 and 2019 – 3.3 shares |
|||||||
Class M-2 – par value $0.001 per share; convertible to Class A; authorized: 2020 – 0.0 and 2019 – 5.0 shares; issued and outstanding: 2020 – 0.0 and 2019 – 0.8 shares |
|||||||
Class M-3 – par value $0.001 per share; convertible to Class A; authorized: 2020 – 0.0 and 2019 – 7.5 shares; issued and outstanding: 2020 – 0.0 and 2019 – 1.0 shares |
|||||||
Class M-4 – par value $0.001 per share; convertible to Class A; authorized: 2020 – 0.0 and 2019 – 7.5 shares; issued and outstanding: 2020 – 0.0 and 2019 – 4.0 shares |
|||||||
Additional paid-in capital |
|||||||
Retained earnings |
|||||||
Accumulated other comprehensive income (related party: 2020 – $(106) and 2019 – $17)
|
|||||||
Total Athene Holding Ltd. shareholders’ equity |
|||||||
Noncontrolling interests |
|||||||
Total equity |
|||||||
Total liabilities and equity |
$ |
$ |
(Concluded)
See accompanying notes to the unaudited condensed consolidated financial statements
9
ATHENE HOLDING LTD.
Condensed Consolidated Statements of Income (Loss) (Unaudited)
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions, except per share data) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Revenues |
|||||||||||||||
Premiums (related party of $94 and $56 for the three months ended and $163 and $122 for the six months ended June 30, 2020 and 2019, respectively)
|
$ |
$ |
$ |
$ |
|||||||||||
Product charges (related party of $12 and $14 for the three months ended and $28 and $28 for the six months ended June 30, 2020 and 2019, respectively)
|
|||||||||||||||
Net investment income (related party investment income of $490 and $154 for the three months ended and $276 and $353 for the six months ended June 30, 2020 and 2019, respectively; consolidated variable interest entities of $16 and $21 for the three months ended and $16 and $37 for the six months ended June 30, 2020 and 2019, respectively; and related party investment expense of $123 and $94 for the three months ended and $251 and $186 for the six months ended June 30, 2020 and 2019, respectively) |
|||||||||||||||
Investment related gains (losses) (related party of $761 and $431 for the three months ended and $130 and $752 for the six months ended June 30, 2020 and 2019, respectively; and consolidated variable interest entities of $(7) and $3 for the three months ended and $(6) and $8 for the six months ended June 30, 2020 and 2019, respectively) |
( |
) |
|||||||||||||
Other revenues |
|||||||||||||||
Total revenues |
|||||||||||||||
Benefits and expenses |
|||||||||||||||
Interest sensitive contract benefits (related party of $197 and $114 for the three months ended and $100 and $297 for the six months ended June 30, 2020 and 2019, respectively)
|
|||||||||||||||
Amortization of deferred sales inducements |
( |
) |
( |
) |
|||||||||||
Future policy and other policy benefits (related party of $142 and $91 for the three months ended and $192 and $197 for the six months ended June 30, 2020 and 2019, respectively) |
|||||||||||||||
Amortization of deferred acquisition costs and value of business acquired |
( |
) |
|||||||||||||
Dividends to policyholders |
|||||||||||||||
Policy and other operating expenses (related party of $11 and $12 for the three months ended and $27 and $20 for the six months ended June 30, 2020 and 2019, respectively) |
|||||||||||||||
Total benefits and expenses |
|||||||||||||||
Income (loss) before income taxes
|
( |
) |
|||||||||||||
Income tax expense (benefit) |
( |
) |
|||||||||||||
Net income (loss)
|
( |
) |
|||||||||||||
Less: Net income (loss) attributable to noncontrolling interests
|
( |
) |
|||||||||||||
Net income (loss) attributable to Athene Holding Ltd. shareholders
|
( |
) |
|||||||||||||
Less: Preferred stock dividends |
|||||||||||||||
Net income (loss) available to Athene Holding Ltd. common shareholders |
$ |
$ |
$ |
( |
) |
$ |
|||||||||
Earnings per share |
|||||||||||||||
Basic – Class A |
$ |
$ |
$ |
( |
) |
$ |
|||||||||
Basic – Classes B, M-1, M-2, M-3 and M-4 |
N/A |
( |
) |
||||||||||||
Diluted – Class A |
( |
) |
|||||||||||||
Diluted – Class B |
N/A |
( |
) |
||||||||||||
Diluted – Class M-1 |
N/A |
( |
) |
||||||||||||
Diluted – Class M-2 |
N/A |
( |
) |
||||||||||||
Diluted – Class M-3 |
N/A |
( |
) |
||||||||||||
Diluted – Class M-4 |
N/A |
( |
) |
||||||||||||
N/A – Not applicable. See Notes 9 – Earnings Per Share and 10 – Equity for further information. |
See accompanying notes to the unaudited condensed consolidated financial statements
10
ATHENE HOLDING LTD.
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Net income (loss)
|
$ |
$ |
$ |
( |
) |
$ |
|||||||||
Other comprehensive income (loss), before tax |
|||||||||||||||
Unrealized investment gains (losses) on available-for-sale securities, net of offsets |
( |
) |
|||||||||||||
Unrealized gains (losses) on hedging instruments |
( |
) |
|||||||||||||
Foreign currency translation and other adjustments |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Other comprehensive income (loss), before tax |
( |
) |
|||||||||||||
Income tax expense related to other comprehensive income (loss) |
|||||||||||||||
Other comprehensive income (loss) |
( |
) |
|||||||||||||
Comprehensive income (loss) |
( |
) |
|||||||||||||
Less: Comprehensive income (loss) attributable to noncontrolling interests |
( |
) |
|||||||||||||
Comprehensive income (loss) attributable to Athene Holding Ltd. shareholders |
$ |
$ |
$ |
( |
) |
$ |
See accompanying notes to the unaudited condensed consolidated financial statements
11
Three months ended |
|||||||||||||||||||||||||||||||
(In millions) |
Preferred stock |
Common stock |
Additional paid-in capital |
Retained earnings |
Accumulated other comprehensive income (loss) |
Total Athene Holding Ltd. shareholders’ equity |
Noncontrolling interests |
Total shareholders’ equity |
|||||||||||||||||||||||
Balance at March 31, 2019
|
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Net income |
— |
— |
— |
— |
|||||||||||||||||||||||||||
Other comprehensive income |
— |
— |
— |
— |
|||||||||||||||||||||||||||
Issuance of preferred shares, net of expenses |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Issuance of common shares, net of expenses |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Stock-based compensation |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Retirement or repurchase of shares |
— |
— |
( |
) |
( |
) |
— |
( |
) |
— |
( |
) |
|||||||||||||||||||
Balance at June 30, 2019 |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Balance at March 31, 2020
|
$ |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||||
Net income |
— |
— |
— |
— |
|||||||||||||||||||||||||||
Other comprehensive income |
— |
— |
— |
— |
|||||||||||||||||||||||||||
Issuance of preferred shares, net of expenses |
— |
— |
— |
— |
583 |
— |
|||||||||||||||||||||||||
Stock-based compensation |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Preferred stock dividends |
— |
— |
— |
( |
) |
— |
( |
) |
— |
( |
) |
||||||||||||||||||||
Balance at June 30, 2020 |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
Six months ended |
|||||||||||||||||||||||||||||||
(In millions) |
Preferred stock |
Common stock |
Additional paid-in capital |
Retained earnings |
Accumulated other comprehensive income (loss) |
Total Athene Holding Ltd. shareholders’ equity |
Noncontrolling interests |
Total shareholders’ equity |
|||||||||||||||||||||||
Balance at December 31, 2018 |
$ |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||||
Net income |
— |
— |
— |
— |
|||||||||||||||||||||||||||
Other comprehensive income |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Issuance of preferred shares, net of expenses |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Issuance of common shares, net of expenses |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Stock-based compensation |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Retirement or repurchase of shares |
— |
— |
( |
) |
( |
) |
— |
( |
) |
— |
( |
) |
|||||||||||||||||||
Balance at June 30, 2019 |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Balance at December 31, 2019 |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Adoption of accounting standard |
— |
— |
— |
( |
) |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||
Net loss |
— |
— |
— |
( |
) |
— |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||
Other comprehensive income (loss) |
— |
— |
— |
— |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Issuance of preferred shares, net of expenses |
— |
— |
— |
— |
583 |
— |
|||||||||||||||||||||||||
Issuance of common shares, net of expenses |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Stock-based compensation |
— |
— |
— |
— |
— |
||||||||||||||||||||||||||
Retirement or repurchase of shares |
— |
— |
( |
) |
( |
) |
— |
( |
) |
— |
( |
) |
|||||||||||||||||||
Preferred stock dividends |
— |
— |
— |
( |
) |
— |
( |
) |
— |
( |
) |
||||||||||||||||||||
Contributions from noncontrolling interests |
— |
— |
— |
— |
— |
— |
|||||||||||||||||||||||||
Distributions to noncontrolling interests |
— |
— |
— |
— |
— |
— |
( |
) |
( |
) |
|||||||||||||||||||||
Balance at June 30, 2020 |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
See accompanying notes to the unaudited condensed consolidated financial statements
12
Six months ended June 30, |
|||||||
(In millions) |
2020 |
2019 |
|||||
Cash flows from operating activities |
|||||||
Net income (loss) |
$ |
( |
) |
$ |
|||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
|||||||
Amortization of deferred acquisition costs and value of business acquired |
( |
) |
|||||
Amortization of deferred sales inducements |
( |
) |
|||||
Accretion of net investment premiums, discounts and other |
( |
) |
( |
) |
|||
Net investment income (related party: 2020 – $(12) and 2019 – $(52); consolidated variable interest entities: 2020 – $(5), 2019 – $0) |
( |
) |
( |
) |
|||
Net recognized (gains) losses on investments and derivatives (related party: 2020 – $75 and 2019 – $(15); consolidated variable interest entities: 2020 – $7 and 2019 – $(8)) |
( |
) |
|||||
Policy acquisition costs deferred |
( |
) |
( |
) |
|||
Changes in operating assets and liabilities: |
|||||||
Accrued investment income (related party: 2020 – $(26) and 2019 – $3) |
( |
) |
( |
) |
|||
Interest sensitive contract liabilities (related party: 2020 – $102 and 2019 – $264) |
|||||||
Future policy benefits, other policy claims and benefits, dividends payable to policyholders and reinsurance recoverable (related party: 2020 – $140 and 2019 – $162) |
|||||||
Funds withheld assets and liabilities (related party: 2020 – $(325) and 2019 – $(953)) |
( |
) |
|||||
Other assets and liabilities |
( |
) |
|||||
Net cash provided by operating activities |
|||||||
Cash flows from investing activities |
|||||||
Sales, maturities and repayments of: |
|||||||
Available-for-sale securities (related party: 2020 – $209 and 2019 – $73) |
|||||||
Trading securities (related party: 2020 – $31 and 2019 – $60; consolidated variable interest entities: 2020 – $10 and 2019 – $33) |
|||||||
Equity securities (related party: 2020 – $3 and 2019 – $51; consolidated variable interest entities: 2020 – $0 and 2019 – $51) |
|||||||
Mortgage loans (related party: 2020 – $0 and 2019 – $4) |
|||||||
Investment funds (related party: 2020 – $241 and 2019 – $116; consolidated variable interest entities: 2020 – $20 and 2019 – $5) |
|||||||
Derivative instruments and other invested assets |
|||||||
Short-term investments (related party: 2020 – $28 and 2019 – $0) |
|||||||
Purchases of: |
|||||||
Available-for-sale securities (related party: 2020 – $(611) and 2019 – $(436)) |
( |
) |
( |
) |
|||
Trading securities (related party: 2020 – $(150) and 2019 – $(6)) |
( |
) |
( |
) |
|||
Equity securities (related party: 2020 – $(3) and 2019 – $(213)) |
( |
) |
( |
) |
|||
Mortgage loans |
( |
) |
( |
) |
|||
Investment funds (related party: 2020 – $(807) and 2019 – $(402); consolidated variable interest entities: 2020 – $0 and 2019 – $(21)) |
( |
) |
( |
) |
|||
Derivative instruments and other invested assets |
( |
) |
( |
) |
|||
Short-term investments (related party: 2020 – $(28) and 2019 – $0) |
( |
) |
( |
) |
|||
Deconsolidation of previously consolidated variable interest entities |
( |
) |
|||||
Other investing activities, net |
|||||||
Net cash used in investing activities |
( |
) |
( |
) |
|||
(Continued) |
|||||||
See accompanying notes to the unaudited condensed consolidated financial statements |
13
Six months ended June 30, |
|||||||
(In millions) |
2020 |
2019 |
|||||
Cash flows from financing activities |
|||||||
Issuance of common stock |
$ |
$ |
|||||
Repayment of short-term debt |
( |
) |
|||||
Proceeds from long-term debt |
|||||||
Deposits on investment-type policies and contracts (related party: 2020 – $39 and 2019 – $117) |
|||||||
Withdrawals on investment-type policies and contracts (related party: 2020 – $(210) and 2019 – $(225)) |
( |
) |
( |
) |
|||
Payments for coinsurance agreements on investment-type contracts, net |
( |
) |
( |
) |
|||
Capital contributions from noncontrolling interests |
|||||||
Capital distributions to noncontrolling interests |
( |
) |
|||||
Net change in cash collateral posted for derivative transactions and securities to repurchase |
|||||||
Issuance of preferred stock, net of expenses |
|||||||
Preferred stock dividends |
( |
) |
|||||
Repurchase of common stock |
( |
) |
( |
) |
|||
Other financing activities, net |
( |
) |
|||||
Net cash provided by financing activities |
|||||||
Effect of exchange rate changes on cash and cash equivalents |
( |
) |
|||||
Net increase in cash and cash equivalents |
|||||||
Cash and cash equivalents at beginning of year1
|
|||||||
Cash and cash equivalents at end of period1
|
$ |
$ |
|||||
Supplementary information |
|||||||
Non-cash transactions |
|||||||
Deposits on investment-type policies and contracts through reinsurance agreements (related party: 2020 – $156 and 2019 – $108) |
$ |
$ |
|||||
Withdrawals on investment-type policies and contracts through reinsurance agreements (related party: 2020 – $730 and 2019 – $910) |
|||||||
Investments received from settlements on reinsurance agreements |
|||||||
Investments received from pension risk transfer premiums |
|||||||
Related party investments received in exchange for the issuance of Class A common shares |
— |
||||||
1 Includes cash and cash equivalents and restricted cash.
|
(Concluded)
See accompanying notes to the unaudited condensed consolidated financial statements
14
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Business, Basis of Presentation and Significant Accounting Policies
Athene Holding Ltd. (AHL), a Bermuda exempted company, together with its subsidiaries (collectively, Athene, we, our, us, or the Company), is a leading retirement services company that issues, reinsures and acquires retirement savings products in all United States (U.S.) states and the District of Columbia, and the United Kingdom (UK).
We conduct business primarily through the following consolidated subsidiaries:
• |
Our non-U.S. reinsurance subsidiaries, to which AHL’s other insurance subsidiaries and third-party ceding companies directly and indirectly reinsure a portion of their liabilities, including Athene Life Re Ltd. (ALRe), a Bermuda exempted company, and Athene Life Re International Ltd. (ALReI); and |
• |
Athene USA Corporation, an Iowa corporation (together with its subsidiaries, Athene USA). |
In addition, we consolidate certain variable interest entities (VIEs) for which we determined we are the primary beneficiary. See Note 4 – Variable Interest Entities for further information on VIEs.
Consolidation and Basis of Presentation —We have prepared the accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the United States Securities and Exchange Commission’s rules and regulations for Form 10-Q and Article 10 of Regulation S-X. The accompanying condensed consolidated financial statements are unaudited and reflect all adjustments, consisting only of normal recurring items, considered necessary for fair statement of the results for the interim periods presented. All intercompany accounts and transactions have been eliminated. Interim operating results are not necessarily indicative of the results expected for the entire year, particularly in light of the material risks and uncertainties surrounding the spread of the Coronavirus Disease of 2019 (COVID-19), which has resulted in significant volatility in the financial markets.
For entities that are consolidated, but not 100% owned, we allocate a portion of the income or loss and corresponding equity to the owners other than us. We include the aggregate of the income or loss and corresponding equity that is not owned by us in noncontrolling interests in the consolidated financial statements.
Summary of Significant Accounting Policies
The following accounting policies have been updated for the adoption of Accounting Standards Update (ASU) 2016-13 and related ASUs, and apply for reporting periods beginning January 1, 2020.
Investments
Purchased Credit Deteriorated (PCD) Investments – We purchase certain structured securities, primarily residential mortgage backed securities (RMBS), and re-performing mortgage loans having experienced a more-than-insignificant deterioration in credit quality since their origination which upon our assessment have been determined to meet the definition of PCD investments. Additionally, structured securities classified as beneficial interests follow the initial measurement guidance for PCD investments if there is a significant difference between contractual cash flows adjusted for expected prepayments and expected cash flows at the date of recognition. The initial allowance for credit losses for PCD investments is recorded through a gross-up adjustment to the initial amortized cost. For mortgage loans, the initial allowance is determined using the methodology described in the Credit Losses – Assets Held at Amortized Cost and Off-Balance Sheet Credit Exposures section. For structured securities classified as beneficial interests, the initial allowance is calculated as the present value of the difference between contractual cash flows adjusted for expected prepayments and expected cash flows at the date of recognition. The non-credit purchase discount or premium is amortized into investment income using the effective interest method. The credit discount, represented by the allowance for expected credit losses, is remeasured each period following the policies for measuring credit losses described in the Credit Losses – Assets Held at Amortized Cost and Off-Balance Sheet Credit Exposures and Credit Losses – Available-for-Sale Securities sections below.
15
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Credit Losses – Assets Held at Amortized Cost and Off-Balance Sheet Credit Exposures – We establish an allowance for expected credit losses at the time of purchase for assets held at amortized cost, which primarily includes our residential and commercial mortgage loan portfolios, but also includes certain other loans and reinsurance assets. The allowance for expected credit losses represents the portion of the asset's amortized cost basis that we do not expect to collect due to credit losses over the asset's contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions or macroeconomic forecasts. We use a quantitative probability of default and loss given default methodology to develop our estimate of expected credit loss. We develop the estimate on a collective basis factoring in the risk characteristics of the assets in the portfolio. If an asset does not share similar risk characteristics with other assets, the asset is individually assessed.
Allowance estimates are highly dependent on expectations of future economic conditions and macroeconomic forecasts, which involve significant judgment and subjectivity. We use quantitative modeling to develop the allowance for expected credit losses. Key inputs into the model include data pertaining to the characteristics of the assets, historical losses and current market conditions. Additionally, the model incorporates management’s expectations around future economic conditions and macroeconomic forecasts over a reasonable and supportable forecast period, after which the model reverts to historical averages. These inputs, the reasonable and supportable forecast period, and reversion to historical average technique are subject to a formal governance and review process by management. Additionally, management considers qualitative adjustments to the model output to the extent that any relevant information regarding the collectability of the asset is available and not already considered in the quantitative model. If we determine that a financial asset has become collateral dependent, which we determine to be when foreclosure is probable, the allowance is measured as the difference between amortized cost and the fair value of the collateral, less any expected costs to sell.
The initial allowance for invested assets held at amortized cost other than for PCD investments, and subsequent changes in the allowance including PCD investments, are recorded through a charge to credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss). Credit loss expense for reinsurance assets held at amortized cost is recorded through policy and other operating expenses on the condensed consolidated statements of income (loss).
We limit accrued interest income on loans to 90 days of interest. Once a loan becomes 90 days past due, the loan is put on non-accrual status and any accrued interest is written off. Once a loan is on non-accrual status, we first apply any payments received to the principal of the loan, and once the principal is repaid, we include amounts received in net investment income. We have elected to present accrued interest receivable separately in accrued investment income on the condensed consolidated balance sheets. We have also elected the practical expedient to exclude the accrued interest receivable from the amortized cost balance used to calculate the allowance given our policy to write off such balances in a timely manner. Any write-off of accrued interest is recorded through a reversal of net investment income on the condensed consolidated statements of income (loss).
Upon determining that all or a portion of the amortized cost of an asset is uncollectible, which is generally when all efforts for collection are exhausted, the amortized cost is written off against the existing allowance. Any write off in excess of the existing allowance is recorded through credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss).
We also have certain off-balance sheet credit exposures for which we establish a liability for expected future credit losses. These exposures primarily relate to commitments to fund commercial or residential mortgage loans that are not unconditionally cancelable. The methodology for estimating the liability for these credit exposures is consistent with that described above, with the additional consideration pertaining to the probability of funding. At the time the commitment expires or is funded, the liability is reversed and an allowance for expected credit losses is established, as applicable. The liability for off-balance sheet credit exposures is included in other liabilities on the condensed consolidated balance sheets. The establishment of the initial liability and all subsequent changes are recorded through credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss).
Credit Losses – Available-for-Sale Securities – We evaluate available-for-sale (AFS) securities with a fair value that has declined below amortized cost to determine how the decline in fair value should be recognized. If we determine, based on the facts and circumstances related to the specific security, that we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, any existing allowance for credit losses is reversed and the amortized cost of the security is written down to fair value. If neither of these conditions exist, we evaluate whether the decline in fair value has resulted from a credit loss or other factors.
For non-structured AFS securities, we qualitatively consider relevant facts and circumstances in evaluating whether a decline below fair value is credit-related. Relevant facts and circumstances include but are not limited to: (1) the extent to which the fair value is less than amortized cost; (2) changes in agency credit ratings, (3) adverse conditions related to the security’s industry or geographical area, (4) failure to make scheduled payments, and (5) other known changes in the financial condition of the issuer or quality of any underlying collateral or credit enhancements. For structured AFS securities meeting the definition of beneficial interests, the qualitative assessment is bypassed, and any securities having experienced a decline in fair value below amortized cost move directly to a quantitative analysis.
16
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
If upon completion of this analysis it is determined that a potential credit loss exists, an allowance for expected credit losses is established equal to the amount by which the present value of expected cash flows is less than amortized cost, limited by the amount by which fair value is less than amortized cost. A non-structured security’s cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using security-specific facts and circumstances including timing, security interests and loss severity. A structured security’s cash flow estimates are based on security-specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayments and structural support, including subordination and guarantees. The expected cash flows are discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete a structured security. For securities with a contractual interest rate that varies based on changes in an independent factor, such as an index or rate, the effective interest rate is calculated based on the factor as it changes over the life of the security. Inherently under the discounted cash flow model, both the timing and amount of cash flows affect the measurement of the allowance for expected credit losses.
The allowance for expected credit losses is remeasured each period for the passage of time, any change in expected cash flows, and changes in the fair value of the security. All impairments, whether intent or requirement to sell or credit-related, are recorded through a charge to credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss). All changes in the allowance for expected credit losses are recorded through credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss).
We have elected to present accrued interest receivable separately in accrued investment income on the condensed consolidated balance sheets. We have also elected the practical expedient to exclude the accrued interest receivable from the amortized cost balance used to calculate the allowance for expected credit losses, as we have a policy to write off such balances in a timely manner, when they become 90 days past due. Any write-off of accrued interest is recorded through a reversal of net investment income on the condensed consolidated statements of income (loss).
Upon determining that all or a portion of the amortized cost of an asset is uncollectible, which is generally when all efforts for collection are exhausted, the amortized cost is written off against the existing allowance. Any write off in excess of the existing allowance is recorded through credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss).
Adopted Accounting Pronouncements
Financial Instruments – Credit Losses (ASU 2019-05, ASU 2019-04, ASU 2018-19 and ASU 2016-13)
This update limits the number of credit impairment models used for different assets and results in accelerated credit loss recognition on assets held at amortized cost, which primarily includes our commercial and residential mortgage loans, but also includes certain other loans and reinsurance assets. The identification of PCD financial assets includes all assets that have experienced a more-than-insignificant deterioration in credit since origination. Additionally, changes in the expected cash flows of purchased credit-deteriorated financial assets are recognized immediately in the income statement. AFS securities are not in scope of the new credit loss model, but were subject to targeted improvements including the establishment of a valuation allowance for credit losses versus the previous direct write down approach. We adopted this update effective January 1, 2020 with a cumulative-effect adjustment that decreased retained earnings by $117 million net of tax and offsetting impacts to DAC, DSI, VOBA and the SOP 03-1 reserve. The adjustment to retained earnings primarily relates to the establishment of an allowance on our commercial mortgage loan portfolio, which represented 1.59 % of the amortized cost of the portfolio, but also includes immaterial impacts relating to other assets in scope, including residential mortgage loans, funds withheld at interest, and reinsurance recoverable.
Additionally, the update requires investments previously considered purchased credit impaired (PCI), which includes certain of our residential mortgage loans and RMBS to become subject to a modified PCD framework at the transition date. Any required allowance at transition for these assets is to be recorded through a gross-up of the amortized cost, rather than a charge to retained earnings. Additionally, under the AFS impairment model, the recording of an allowance is prohibited in instances where fair value exceeds amortized cost as such securities are not considered impaired under the AFS impairment model. Therefore, no allowance was recorded at transition for PCI RMBS that were in an unrealized gain position. The transition increase of amortized cost and corresponding valuation allowance for residential mortgage loans and RMBS was $36 million and $17 million, respectively.
Collaborative Arrangements (ASU 2018-18)
The amendments in this update provide guidance on whether certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606, providing comparability in the presentation of revenue for certain transactions. We adopted this update effective January 1, 2020. This update did not have a material effect on our consolidated financial statements.
Consolidation (ASU 2018-17)
The amendments in this update expand certain discussions in the VIE guidance, including considerations necessary for determining when a decision-making fee is a variable interest. We adopted this update effective January 1, 2020. The adoption of this update did not have a material effect on our consolidated financial statements.
Cloud Computing Arrangements (ASU 2018-15)
The amendments in this update align the requirements for capitalizing implementation costs incurred in a cloud computing service arrangement with the requirements for capitalizing implementation costs incurred for internal-use software. We adopted this update on a prospective basis effective January 1, 2020. This update did not have a material effect on our consolidated financial statements.
17
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Fair Value Measurement – Disclosure Requirements (ASU 2018-13)
The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. On October 1, 2018, we early adopted the removal and modification of certain disclosures as permitted. The additional disclosures in the update were adopted effective January 1, 2020. The adoption of this update did not have a material effect on our consolidated financial statements.
Intangibles – Simplifying the Test for Goodwill Impairment (ASU 2017-04)
The amendments in this update simplify the subsequent measurement of goodwill by eliminating the comparison of the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill to determine the goodwill impairment loss. With the adoption of this guidance, a goodwill impairment is the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of the goodwill allocated to that reporting unit. Entities continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. We do not have material goodwill and adopted this update on a prospective basis effective January 1, 2020. The adoption of this update did not have a material effect on our consolidated financial statements.
Recently Issued Accounting Pronouncements
Insurance – Targeted Improvements to the Accounting for Long-Duration Contracts (ASU 2019-09, ASU 2018-12)
These updates amend four key areas pertaining to the accounting and disclosures for long-duration insurance and investment contracts.
• |
The update requires cash flow assumptions used to measure the liability for future policy benefits to be updated at least annually and no longer allows a provision for adverse deviation. The remeasurement of the liability associated with the update of assumptions is required to be recognized in net income. Loss recognition testing is eliminated for traditional and limited-payment contracts. The update also requires the discount rate used in measuring the liability to be an upper-medium grade fixed-income instrument yield, which is to be updated at each reporting date. The change in liability due to changes in the discount rate is to be recognized in other comprehensive income. |
• |
The update simplifies the amortization of deferred acquisition costs and other balances amortized in proportion to premiums, gross profits, or gross margins, requiring such balances to be amortized on a constant level basis over the expected term of the contracts. Deferred costs are required to be written off for unexpected contract terminations but are not subject to impairment testing. |
• |
The update requires certain contract features meeting the definition of market risk benefits to be measured at fair value. Among the features included in this definition are the guaranteed lifetime withdrawal benefits (GLWB) and guaranteed minimum death benefit (GMDB) riders attached to our annuity products. The change in fair value of the market risk benefits is to be recognized in net income, excluding the portion attributable to changes in instrument-specific credit risk which is recognized in other comprehensive income. |
• |
The update also introduces disclosure requirements around the liability for future policy benefits, policyholder account balances, market risk benefits, separate account liabilities, and deferred acquisition costs. This includes disaggregated rollforwards of these balances and information about significant inputs, judgments, assumptions and methods used in their measurement. |
While we are currently required to adopt these updates on January 1, 2022, the Financial Accounting Standards Board has proposed a deferral to the adoption date, which, if codified, would require adoption on January 1, 2023. Certain provisions of the update are required to be adopted on a fully retrospective basis, while others may be adopted on a modified retrospective basis. Early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements.
Income Taxes – Simplifying the Accounting for Income Taxes (ASU 2019-12)
The amendments in this update simplify the accounting for income taxes by eliminating certain exceptions to the tax accounting guidance related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities related to foreign investment ownership changes. It also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill and allocating consolidated income taxes to separate financial statements of entities not subject to income tax. We will be required to adopt this update January 1, 2021 and apply certain aspects of the update retrospectively while other aspects will be applied on a modified retrospective basis. Early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements.
2. Investments
AFS Securities—Our AFS investment portfolio includes bonds, collateralized loan obligations (CLO), asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), RMBS and redeemable preferred stock. Our AFS investment portfolio includes related party investments that are primarily comprised of investments over which Apollo can exercise significant influence. These investments are presented as investments in related parties on the condensed consolidated balance sheets, and are separately disclosed below.
18
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following table represents the amortized cost, allowance for credit losses, gross unrealized gains and losses and fair value of our AFS investments by asset type:
June 30, 2020 |
|||||||||||||||||||
(In millions) |
Amortized Cost |
Allowance for Credit Losses |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
||||||||||||||
AFS securities |
|||||||||||||||||||
U.S. government and agencies |
$ |
$ |
$ |
$ |
$ |
||||||||||||||
U.S. state, municipal and political subdivisions |
( |
) |
|||||||||||||||||
Foreign governments |
( |
) |
|||||||||||||||||
Corporate |
( |
) |
( |
) |
|||||||||||||||
CLO |
( |
) |
( |
) |
|||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||
CMBS |
( |
) |
( |
) |
|||||||||||||||
RMBS |
( |
) |
( |
) |
|||||||||||||||
Total AFS securities |
( |
) |
( |
) |
|||||||||||||||
AFS securities – related party |
|||||||||||||||||||
Corporate |
|||||||||||||||||||
CLO |
( |
) |
( |
) |
|||||||||||||||
ABS |
( |
) |
|||||||||||||||||
Total AFS securities – related party |
( |
) |
( |
) |
|||||||||||||||
Total AFS securities including related party |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
The following table represents the amortized cost, gross unrealized gains and losses, fair value and other than temporary impairments (OTTI) in accumulated other comprehensive income (AOCI) of our AFS investments by asset type:
December 31, 2019 |
|||||||||||||||||||
(In millions) |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
OTTI
in AOCI
|
||||||||||||||
AFS securities |
|||||||||||||||||||
U.S. government and agencies |
$ |
$ |
$ |
$ |
$ |
||||||||||||||
U.S. state, municipal and political subdivisions |
( |
) |
|||||||||||||||||
Foreign governments |
|||||||||||||||||||
Corporate |
( |
) |
|||||||||||||||||
CLO |
( |
) |
|||||||||||||||||
ABS |
( |
) |
|||||||||||||||||
CMBS |
( |
) |
|||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||
Total AFS securities |
( |
) |
|||||||||||||||||
AFS securities – related party |
|||||||||||||||||||
Corporate |
|||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||
ABS |
( |
) |
|||||||||||||||||
Total AFS securities – related party |
( |
) |
|||||||||||||||||
Total AFS securities including related party |
$ |
$ |
$ |
( |
) |
$ |
$ |
19
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The amortized cost and fair value of AFS securities, including related party, are shown by contractual maturity below:
June 30, 2020 |
|||||||
(In millions) |
Amortized Cost |
Fair Value |
|||||
AFS securities |
|||||||
Due in one year or less |
$ |
$ |
|||||
Due after one year through five years |
|||||||
Due after five years through ten years |
|||||||
Due after ten years |
|||||||
CLO, ABS, CMBS and RMBS |
|||||||
Total AFS securities |
|||||||
AFS securities – related party |
|||||||
Due after one year through five years |
|||||||
CLO and ABS |
|||||||
Total AFS securities – related party |
|||||||
Total AFS securities including related party |
$ |
$ |
Actual maturities can differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Unrealized Losses on AFS Securities—The following summarizes the fair value and gross unrealized losses for AFS securities, including related party, for which an allowance for credit losses has not been recorded, aggregated by asset type and length of time the fair value has remained below amortized cost:
June 30, 2020 |
|||||||||||||||||||||||
Less than 12 months |
12 months or more |
Total |
|||||||||||||||||||||
(In millions) |
Fair Value |
Gross
Unrealized
Losses
|
Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
|||||||||||||||||
AFS securities |
|||||||||||||||||||||||
U.S. government and agencies |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
U.S. state, municipal and political subdivisions |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Foreign governments |
( |
) |
( |
) |
|||||||||||||||||||
Corporate |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
ABS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
CMBS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
RMBS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Total AFS securities |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
AFS securities – related party |
|||||||||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||||||
Total AFS securities – related party |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Total AFS securities including related party |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
20
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following summarizes the fair value and gross unrealized losses for AFS securities, including related party, aggregated by asset type and length of time the fair value has remained below amortized cost:
December 31, 2019 |
|||||||||||||||||||||||
Less than 12 months |
12 months or more |
Total |
|||||||||||||||||||||
(In millions) |
Fair Value |
Gross
Unrealized
Losses
|
Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
|||||||||||||||||
AFS securities |
|||||||||||||||||||||||
U.S. government and agencies |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
U.S. state, municipal and political subdivisions |
( |
) |
( |
) |
|||||||||||||||||||
Corporate |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
ABS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
CMBS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
RMBS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Total AFS securities |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
AFS securities – related party |
|||||||||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||||||
Total AFS securities – related party |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Total AFS securities including related party |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
As of June 30, 2020, we held 2,316 AFS securities that were in an unrealized loss position. Of this total, 365 were in an unrealized loss position 12 months or more. As of June 30, 2020, we held 152 related party AFS securities that were in an unrealized loss position. Of this total, 18 were in an unrealized loss position 12 months or more. The unrealized losses on AFS securities can primarily be attributed to changes in market interest rates since acquisition. We did not recognize the unrealized losses in income as we intend to hold these securities and it is not more likely than not we will be required to sell a security before the recovery of its amortized cost.
Allowance for Credit Losses—The following table summarizes the activity in the allowance for credit losses for AFS securities by asset type:
Three months ended June 30, 2020 |
|||||||||||||||||||||||
Additions |
Reductions |
||||||||||||||||||||||
(In millions) |
Beginning balance |
Initial credit losses |
Initial credit losses on PCD securities |
Securities sold during the period |
Additions (reductions) to previously impaired securities |
Ending Balance |
|||||||||||||||||
AFS securities |
|||||||||||||||||||||||
Corporate |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
CLO |
|||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||
CMBS |
|||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||
Total AFS securities |
( |
) |
|||||||||||||||||||||
AFS securities – related party |
|||||||||||||||||||||||
CLO |
|||||||||||||||||||||||
Total AFS securities including related party |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
21
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Six months ended June 30, 2020 |
|||||||||||||||||||||||
Additions |
Reductions |
||||||||||||||||||||||
(In millions) |
Beginning balance |
Initial credit losses |
Initial credit losses on PCD securities |
Securities sold during the period |
Additions (reductions) to previously impaired securities |
Ending Balance |
|||||||||||||||||
AFS securities |
|||||||||||||||||||||||
Corporate |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
CLO |
|||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||
CMBS |
|||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||
Total AFS securities |
( |
) |
|||||||||||||||||||||
AFS securities – related party |
|||||||||||||||||||||||
CLO |
|||||||||||||||||||||||
Total AFS securities including related party |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
Net Investment Income—Net investment income by asset class consists of the following:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
AFS securities |
$ |
$ |
$ |
$ |
|||||||||||
Trading securities |
|||||||||||||||
Equity securities |
|||||||||||||||
Mortgage loans |
|||||||||||||||
Investment funds |
|||||||||||||||
Funds withheld at interest |
|||||||||||||||
Other |
|||||||||||||||
Investment revenue |
|||||||||||||||
Investment expenses |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Net investment income |
$ |
$ |
$ |
$ |
Investment Related Gains (Losses)—Investment related gains (losses) by asset class consists of the following:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
AFS securities |
|||||||||||||||
Gross realized gains on investment activity |
$ |
$ |
$ |
$ |
|||||||||||
Gross realized losses on investment activity |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Net realized investment gains on AFS securities |
|||||||||||||||
Net recognized investment gains (losses) on trading securities |
( |
) |
|||||||||||||
Net recognized investment gains (losses) on equity securities |
( |
) |
|||||||||||||
Derivative gains (losses) |
( |
) |
|||||||||||||
Provision for credit losses |
( |
) |
( |
) |
|||||||||||
Other gains (losses) |
( |
) |
|||||||||||||
Investment related gains (losses) |
$ |
$ |
$ |
( |
) |
$ |
Proceeds from sales of AFS securities were $1,778 million and $1,958 million for the three months ended June 30, 2020 and 2019, respectively, and $3,585 million and $3,211 million for the six months ended June 30, 2020 and 2019, respectively.
22
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following table summarizes the change in unrealized gains (losses) on trading and equity securities we held as of the respective period end:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Trading securities |
$ |
$ |
$ |
$ |
|||||||||||
Trading securities – related party |
( |
) |
( |
) |
( |
) |
|||||||||
Equity securities |
( |
) |
|||||||||||||
Equity securities – related party |
( |
) |
( |
) |
Purchased Financial Assets with Credit Deterioration—The following table summarizes our PCD investment purchases with the following amounts at the time of purchase:
Three months ended June 30, 2020 |
Six months ended June 30, 2020 |
||||||||||||||
(In millions) |
Fixed maturity securities |
Mortgage loans |
Fixed maturity securities |
Mortgage loans |
|||||||||||
Purchase price |
$ |
$ |
$ |
$ |
|||||||||||
Allowance for credit losses at acquisition |
|||||||||||||||
Discount (premiums) attributable to other factors |
|||||||||||||||
Par value |
$ |
$ |
$ |
$ |
Repurchase Agreements—The following table summarizes the maturities of our repurchase agreements:
June 30, 2020 |
|||||||||||||||||||||||
Remaining Contractual Maturity |
|||||||||||||||||||||||
(In millions) |
Overnight and continuous |
Less than 30 days |
30-90 days |
91 days – 1 year |
Greater than 1 year |
Total |
|||||||||||||||||
Payables for repurchase agreements1
|
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
1 Included in payables for collateral on derivatives and securities to repurchase on the condensed consolidated balance sheets.
|
December 31, 2019 |
|||||||||||||||||||||||
Remaining Contractual Maturity |
|||||||||||||||||||||||
(In millions) |
Overnight and continuous |
Less than 30 days |
30-90 days |
91 days – 1 year |
Greater than 1 year |
Total |
|||||||||||||||||
Payables for repurchase agreements1
|
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
1 Included in payables for collateral on derivatives and securities to repurchase on the condensed consolidated balance sheets.
|
The following table summarizes the securities pledged as collateral for repurchase agreements:
June 30, 2020 |
December 31, 2019 |
||||||||||||||
(In millions) |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||
AFS securities – Corporate |
$ |
$ |
$ |
$ |
Reverse Repurchase Agreements—Reverse repurchase agreements represent the purchase of investments from a seller with the agreement that the investments will be repurchased by the seller at a specified price and date or within a specified period of time. The investments purchased, which represent collateral on a secured lending arrangement, are not reflected in our condensed consolidated balance sheets; however, the secured lending arrangement is recorded as a short-term investment for the principal amount loaned under the agreement. As of June 30, 2020 and December 31, 2019, amounts loaned under reverse repurchase agreements were $0 million and $190 million, respectively, and collateral backing the agreement was $0 million and $630 million, respectively.
23
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Mortgage Loans, including related party—Mortgage loans, net of allowances, consists of the following:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Commercial mortgage loans |
$ |
$ |
|||||
Commercial mortgage loans under development |
|||||||
Total commercial mortgage loans |
|||||||
Allowance for credit losses on commercial mortgage loans |
( |
) |
( |
) |
|||
Commercial mortgage loans, net of allowances |
|||||||
Residential mortgage loans |
|||||||
Allowance for credit losses on residential mortgage loans |
( |
) |
( |
) |
|||
Residential mortgage loans, net of allowances |
|||||||
Mortgage loans, net of allowances |
$ |
$ |
We primarily invest in commercial mortgage loans on income producing properties including office and retail buildings, apartments, hotels and industrial properties. We diversify the commercial mortgage loan portfolio by geographic region and property type to reduce concentration risk. We evaluate mortgage loans based on relevant current information to confirm if properties are performing at a consistent and acceptable level to secure the related debt.
The distribution of commercial mortgage loans, including those under development, net of allowances, by property type and geographic region, is as follows:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except for percentages) |
Net Carrying Value |
Percentage of Total |
Net Carrying Value |
Percentage of Total |
|||||||||
Property type |
|||||||||||||
Office building |
$ |
% |
$ |
% |
|||||||||
Retail |
% |
% |
|||||||||||
Apartment |
% |
% |
|||||||||||
Hotels |
% |
% |
|||||||||||
Industrial |
% |
% |
|||||||||||
Other commercial |
% |
% |
|||||||||||
Total commercial mortgage loans |
$ |
% |
$ |
% |
|||||||||
U.S. Region |
|||||||||||||
East North Central |
$ |
% |
$ |
% |
|||||||||
East South Central |
% |
% |
|||||||||||
Middle Atlantic |
% |
% |
|||||||||||
Mountain |
% |
% |
|||||||||||
New England |
% |
% |
|||||||||||
Pacific |
% |
% |
|||||||||||
South Atlantic |
% |
% |
|||||||||||
West North Central |
% |
% |
|||||||||||
West South Central |
% |
% |
|||||||||||
Total U.S. Region |
% |
% |
|||||||||||
International Region |
% |
% |
|||||||||||
Total commercial mortgage loans |
$ |
% |
$ |
% |
24
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Our residential mortgage loan portfolio includes first lien residential mortgage loans collateralized by properties in various geographic locations and is summarized by proportion of the portfolio in the following table:
June 30, 2020 |
December 31, 2019 |
||||
U.S. States |
|||||
California |
% |
% |
|||
Florida |
% |
% |
|||
Texas |
% |
% |
|||
Other1
|
% |
% |
|||
Total U.S. residential mortgage loan percentage |
% |
% |
|||
International – Ireland |
% |
% |
|||
International – Other2
|
% |
% |
|||
Total residential mortgage loan percentage |
% |
% |
|||
1 Represents all other states, with each individual state comprising less than 5% of the portfolio.
| |||||
2 Represents all other countries, with each individual country comprising less than 5% of the portfolio.
|
Loan Valuation Allowance—The allowances for our mortgage loan portfolio and other loans is summarized as follows:
Three months ended June 30, 2020 |
Six months ended June 30, 2020 |
||||||||||||||||||||||||||||||
(In millions) |
Commercial Mortgage |
Residential Mortgage |
Other Investments |
Total |
Commercial Mortgage |
Residential Mortgage |
Other Investments |
Total |
|||||||||||||||||||||||
Beginning balance |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Adoption of accounting standard |
|||||||||||||||||||||||||||||||
Provision (reversal) for expected credit losses |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Loans charged-off |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
Ending balance |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
Residential mortgage loans – Our allowance model for residential mortgage loans is based on the characteristics of the loans in our portfolio, historical economic data and loss information, and current and forecasted economic conditions. Key loan characteristics affecting the estimate include, among others: time to maturity, delinquency status, original credit scores and loan-to-value ratios. Key macroeconomic variables include unemployment rates and the housing price index. Management reviews and approves forecasted macroeconomic variables, along with the reasonable and supportable forecast period and mean reversion technique. Management also evaluates assumptions from independent third parties and these assumptions have a high degree of subjectivity. The mean reversion technique varies by macroeconomic variable and may vary by geographic location. As of June 30, 2020, our reasonable and supportable forecast period was one year, after which, we revert to the 30-year or greater historical average over a period of up to one year and then continue at those averages through the contractual life of the loan.
Commercial mortgage loans – Our allowance model for commercial mortgage loans is based on the characteristics of the loans in our portfolio, historical economic data and loss information, and current and forecasted economic conditions. Key loan characteristics affecting the estimate include, among others: time to maturity, delinquency status, loan-to-value ratios, debt service coverage ratios, etc. Key macroeconomic variables include unemployment rates, rent growth, capitalization rates, and the housing price index. Management reviews and approves forecasted macroeconomic variables, along with the reasonable and supportable forecast period and mean reversion technique. Management also evaluates assumptions from independent third parties and these assumptions have a high degree of subjectivity. The mean reversion technique varies by macroeconomic variable and may vary by geographic location. As of June 30, 2020, our reasonable and supportable forecast period ranged from one year to two years, after which, we revert to the 30-year or greater historical average over a period of up to eight years.
Other investments – The allowance model for the loans included in other investments and related party other investments derives an estimate based on historical loss data available for similarly rated unsecured corporate debt obligations, while also incorporating management’s expectations around prepayment. See Note 11 – Related Parties for further information on the related party loans.
Credit Quality Indicators
Residential mortgage loans – The underwriting process for our residential mortgage loans includes an evaluation of relevant credit information including past loan performance, credit scores, loan-to-value and other relevant information. Subsequent to purchase or origination, we closely monitor economic conditions and loan performance to manage and evaluate our exposure to credit risk in our residential mortgage loan portfolio. The primary credit quality indicator monitored for residential mortgage loans is loan performance. Nonperforming residential mortgage loans are 90 days or more past due and/or are in non-accrual status.
25
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following represents our residential loan portfolio by origination year and performance status:
June 30, 2020 |
|||||||||||||||||||||||||||
(In millions) |
2020 |
2019 |
2018 |
2017 |
2016 |
Prior |
Total |
||||||||||||||||||||
Current (less than 30 days past due) |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||
30 to 59 days past due |
43 |
||||||||||||||||||||||||||
60 to 89 days past due |
|||||||||||||||||||||||||||
Over 90 days past due |
22 |
34 |
2 |
||||||||||||||||||||||||
Total residential mortgages |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
As of December 31, 2019, $67 million of our residential mortgage loans were nonperforming.
The following represents our residential loan portfolio in non-accrual status:
(In millions) |
June 30, 2020 |
||
Beginning amortized cost of residential mortgage loans in non-accrual status |
$ |
||
Ending amortized cost of residential mortgage loans in non-accrual status |
|||
Amortized cost of residential mortgage loans in non-accrual status without a related allowance for credit losses |
During the three months and six months ended June 30, 2020, we recognized $0 million and $1 million, respectively, of interest income on residential mortgage loans in non-accrual status.
Commercial mortgage loans – The following represents our commercial mortgage loan portfolio by origination year and loan performance status:
June 30, 2020 |
|||||||||||||||||||||||||||
(In millions) |
2020 |
2019 |
2018 |
2017 |
2016 |
Prior |
Total |
||||||||||||||||||||
Current (less than 30 days past due) |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
As of December 31, 2019, none of our commercial loans were 30 days or more past due.
The following represents our commercial mortgage loan portfolio in non-accrual status:
(In millions) |
June 30, 2020 |
||
Beginning amortized cost of commercial mortgage loans in non-accrual status |
$ |
||
Ending amortized cost of commercial mortgage loans in non-accrual status |
|||
Amortized cost of commercial mortgage loans in non-accrual status without a related allowance for credit losses |
During the three months and six months ended June 30, 2020, no interest income was recognized on commercial mortgage loans in non-accrual status.
Loan-to-value and debt service coverage ratios are measures we use to assess the risk and quality of commercial mortgage loans other than those under development. Loans under development are not evaluated using these ratios as the properties underlying these loans are generally not yet income-producing and the value of the underlying property significantly fluctuates based on the progress of construction. Therefore, the risk and quality of loans under development are evaluated based on the aging and geographical distribution of such loans as shown above.
The loan-to-value ratio is expressed as a percentage of the amount of the loan relative to the value of the underlying property. A loan-to-value ratio in excess of 100% indicates the unpaid loan amount exceeds the value of the underlying collateral. Loan-to-value information is updated annually as part of the re-underwriting process supporting the NAIC risk based capital rating criteria. The following represents the loan-to-value ratio of the commercial mortgage loan portfolio, excluding those under development, by origination year:
June 30, 2020 |
|||||||||||||||||||||||||||
(In millions) |
2020 |
2019 |
2018 |
2017 |
2016 |
Prior |
Total |
||||||||||||||||||||
Less than 50% |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||
50% to 60% |
|||||||||||||||||||||||||||
61% to 70% |
|||||||||||||||||||||||||||
71% to 80% |
|||||||||||||||||||||||||||
Greater than 100% |
|||||||||||||||||||||||||||
Commercial mortgage loans |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
26
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following represents the loan-to-value ratio of the commercial mortgage loan portfolio, excluding those under development, net of valuation allowances:
(In millions) |
December 31, 2019 |
||
Less than 50% |
$ |
||
50% to 60% |
|||
61% to 70% |
|||
71% to 80% |
|||
81% to 100% |
|||
Commercial mortgage loans |
$ |
The debt service coverage ratio is expressed as a percentage of a property’s net operating income to its debt service payments. A debt service ratio of less than 1.0 indicates a property’s operations do not generate enough income to cover debt payments. Debt service coverage ratios are updated as more recent financial statements become available, at least annually or as frequently as quarterly in some cases. The following represents the debt service coverage ratio of the commercial mortgage loan portfolio, excluding those under development, by origination year:
June 30, 2020 |
|||||||||||||||||||||||||||
(In millions) |
2020 |
2019 |
2018 |
2017 |
2016 |
Prior |
Total |
||||||||||||||||||||
Greater than 1.20x |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||
1.00x – 1.20x |
|||||||||||||||||||||||||||
Less than 1.00x |
|||||||||||||||||||||||||||
Commercial mortgage loans |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
The following represents the debt service coverage ratio of the commercial mortgage loan portfolio, excluding those under development, net of valuation allowances:
(In millions) |
December 31, 2019 |
||
Greater than 1.20x |
$ |
||
1.00x – 1.20x |
|||
Less than 1.00x |
|||
Commercial mortgage loans |
$ |
27
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Investment Funds—Our investment fund portfolio consists of funds that employ various strategies and include investments in real estate, real assets, credit, equity and natural resources. Investment funds can meet the definition of VIEs. Our investment funds do not specify timing of distributions on the funds’ underlying assets.
The following summarizes our investment funds, including related party:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except for percentages) |
Carrying value |
Percent of total |
Carrying value |
Percent of total |
|||||||||
Investment funds |
|||||||||||||
Real estate |
$ |
% |
$ |
% |
|||||||||
Credit funds |
% |
% |
|||||||||||
Private equity |
% |
% |
|||||||||||
Real assets |
% |
% |
|||||||||||
Natural resources |
% |
% |
|||||||||||
Total investment funds |
% |
% |
|||||||||||
Investment funds – related parties |
|||||||||||||
Differentiated investments |
|||||||||||||
MidCap FinCo Designated Activity Company (MidCap)1
|
% |
% |
|||||||||||
AmeriHome Mortgage Company, LLC (AmeriHome)1
|
% |
% |
|||||||||||
Catalina Holdings Ltd. (Catalina) |
% |
% |
|||||||||||
Athora Holding Ltd. (Athora)1
|
% |
% |
|||||||||||
Venerable Holdings, Inc. (Venerable)1
|
% |
% |
|||||||||||
Other |
% |
% |
|||||||||||
Total differentiated investments |
% |
% |
|||||||||||
Real estate |
% |
% |
|||||||||||
Credit funds |
% |
% |
|||||||||||
Private equity |
% |
% |
|||||||||||
Real assets |
% |
% |
|||||||||||
Natural resources |
% |
% |
|||||||||||
Public equities |
% |
% |
|||||||||||
Investment in Apollo1
|
% |
% |
|||||||||||
Total investment funds – related parties |
% |
% |
|||||||||||
Total investment funds including related party |
$ |
$ |
|||||||||||
1 See further discussion on MidCap, AmeriHome, Athora, Venerable and our investment in Apollo in Note 11 – Related Parties.
|
Non-Consolidated Securities and Investment Funds
Fixed maturity securities – We invest in securitization entities as a debt holder or an investor in the residual interest of the securitization vehicle. These entities are deemed VIEs due to insufficient equity within the structure and lack of control by the equity investors over the activities that significantly impact the economics of the entity. In general, we are a debt investor within these entities and, as such, hold a variable interest; however, due to the debt holders’ lack of ability to control the decisions within the trust that significantly impact the entity, and the fact the debt holders are protected from losses due to the subordination of the equity tranche, the debt holders are not deemed the primary beneficiary. Securitization vehicles in which we hold the residual tranche are not consolidated because we do not unilaterally have substantive rights to remove the general partner, or when assessing related party interests, we are not under common control, as defined by GAAP, with the related party, nor are substantially all of the activities conducted on our behalf; therefore, we are not deemed the primary beneficiary. Debt investments and investments in the residual tranche of securitization entities are considered debt instruments and are held at fair value on the balance sheet and classified as AFS or trading.
Investment funds – Investment funds include non-fixed income, alternative investments in the form of limited partnerships or similar legal structures.
Equity securities – We invest in preferred equity securities issued by entities deemed to be VIEs due to insufficient equity within the structure.
Our risk of loss associated with our non-consolidated investments depends on the investment. Investment funds, equity securities and trading securities are limited to the carrying value plus unfunded commitments. AFS securities are limited to amortized cost plus unfunded commitments.
28
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following summarizes the carrying value and maximum loss exposure of these non-consolidated investments:
June 30, 2020 |
December 31, 2019 |
||||||||||||||
(In millions) |
Carrying Value |
Maximum Loss Exposure |
Carrying Value |
Maximum Loss Exposure |
|||||||||||
Investment funds |
$ |
$ |
$ |
$ |
|||||||||||
Investment in related parties – investment funds |
|||||||||||||||
Investment in fixed maturity securities |
|||||||||||||||
Investment in related parties – fixed maturity securities |
|||||||||||||||
Investment in related parties – equity securities |
|||||||||||||||
Total non-consolidated investments |
$ |
$ |
$ |
$ |
3. Derivative Instruments
We use a variety of derivative instruments to manage risks, primarily equity, interest rate, credit, foreign currency and market volatility. See Note 5 – Fair Value for information about the fair value hierarchy for derivatives.
The following table presents the notional amount and fair value of derivative instruments:
June 30, 2020 |
December 31, 2019 |
||||||||||||||||||||
Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
||||||||||||||||||
(In millions) |
Assets |
Liabilities |
Assets |
Liabilities |
|||||||||||||||||
Derivatives designated as hedges |
|||||||||||||||||||||
Foreign currency swaps |
$ |
$ |
$ |
$ |
|||||||||||||||||
Foreign currency forwards |
|||||||||||||||||||||
Foreign currency forwards on net investments |
|||||||||||||||||||||
Total derivatives designated as hedges |
|||||||||||||||||||||
Derivatives not designated as hedges |
|||||||||||||||||||||
Equity options |
|||||||||||||||||||||
Futures |
|||||||||||||||||||||
Total return swaps |
|||||||||||||||||||||
Foreign currency swaps |
|||||||||||||||||||||
Interest rate swaps |
|||||||||||||||||||||
Credit default swaps |
|||||||||||||||||||||
Foreign currency forwards |
|||||||||||||||||||||
Embedded derivatives |
|||||||||||||||||||||
Funds withheld including related party |
|||||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||||
Total derivatives not designated as hedges |
|||||||||||||||||||||
Total derivatives |
$ |
$ |
$ |
$ |
Derivatives Designated as Hedges
Foreign currency swaps – We use foreign currency swaps to convert foreign currency denominated cash flows of an investment to U.S. dollars to reduce cash flow fluctuations due to changes in currency exchange rates. Certain of these swaps are designated and accounted for as cash flow hedges, which will expire by December 2050. During the three months ended June 30, 2020 and 2019, we had foreign currency swap losses of $83 million and gains of $55 million, respectively, recorded in AOCI. During the six months ended June 30, 2020 and 2019, we had foreign currency swap gains of $318 million and $47 million, respectively, recorded in AOCI. There were no amounts reclassified to income and no amounts deemed ineffective for the six months ended June 30, 2020 and 2019. As of June 30, 2020, no amounts are expected to be reclassified to income within the next 12 months.
Foreign currency forwards – We use foreign currency forward contracts to hedge certain exposures to foreign currency risk. The price is agreed upon at the time of the contract and payment is made at a specified future date. Certain of these forwards are designated and accounted for as fair value hedges. As of June 30, 2020 and December 31, 2019, the carrying amount of the hedged AFS securities was $1,065 million and $456 million, respectively, and the cumulative amount of fair value hedging adjustments included in the hedged AFS securities included gains of $10 million and $1 million, respectively.
29
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following is a summary of the gains (losses) related to the derivatives and related hedged items in fair value hedge relationships, which are included in investment related gains (losses) on the condensed consolidated statements of income (loss):
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Derivatives |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
|||||
Related AFS securities |
( |
) |
( |
) |
|||||||||||
Total gains (losses) on derivatives and related hedged items |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
Foreign currency forwards on net investments – We have foreign currency forwards designated as net investment hedges. These forwards hedge the foreign currency exchange rate risk of our investments in subsidiaries that have a reporting currency other than the U.S. dollar. We assess hedge effectiveness based on the changes in forward rates. During the three months and six months ended June 30, 2020, these derivatives had losses of $11 million and gains of $2 million, respectively, which are included in foreign currency translation and other adjustments on the condensed consolidated statements of comprehensive income (loss). As of June 30, 2020 and December 31, 2019, the cumulative foreign currency translation recorded in AOCI related to these net investment hedges were gains of $1 million and losses of $2 million, respectively. During the three and six months ended June 30, 2020, there were no amounts deemed ineffective.
Derivatives Not Designated as Hedges
Equity options – We use equity indexed options to economically hedge fixed indexed 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, primarily the S&P 500. To hedge against adverse changes in equity indices, we enter into contracts to buy equity indexed options. The contracts are net settled in cash based on differentials in the indices at the time of exercise and the strike price.
Futures – Futures contracts are purchased to hedge the growth in interest credited to the customer as a direct result of increases in the related indices. We enter into exchange-traded futures with regulated futures commission clearing brokers who are members of a trading exchange. Under exchange-traded futures contracts, we agree to purchase a specified number of contracts with other parties and to post variation margin on a daily basis in an amount equal to the difference in the daily fair values of those contracts.
Total return swaps – We purchase total rate of return swaps to gain exposure and benefit from a reference asset or index without ownership. Total rate of return swaps are contracts in which one party makes payments based on a set rate, either fixed or variable, while the other party makes payments based on the return of the underlying asset or index, which includes both the income it generates and any capital gains.
Interest rate swaps – We use interest rate swaps to reduce market risks from interest rate changes and to alter interest rate exposure arising from duration mismatches between assets and liabilities. With an interest rate swap, we agree with another party to exchange the difference between fixed-rate and floating-rate interest amounts tied to an agreed-upon notional principal amount at specified intervals.
Credit default swaps – Credit default swaps provide a measure of protection against the default of an issuer or allow us to gain credit exposure to an issuer or traded index. We use credit default swaps coupled with a bond to synthetically create the characteristics of a reference bond. These transactions have a lower cost and are generally more liquid relative to the cash market. We receive a periodic premium for these transactions as compensation for accepting credit risk.
Hedging credit risk involves buying protection for existing credit risk. The exposure resulting from the agreements, which is usually the notional amount, is equal to the maximum proceeds that must be paid by a counterparty for a defaulted security. If a credit event occurs on a reference entity, then a counterparty who sold protection is required to pay the buyer the trade notional amount less any recovery value of the security.
Embedded derivatives – We have embedded derivatives which are required to be separated from their host contracts and reported as derivatives. Host contracts include reinsurance agreements structured on a modified coinsurance (modco) or funds withheld basis and indexed annuity products.
30
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following is a summary of the gains (losses) related to derivatives not designated as hedges:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Equity options |
$ |
$ |
$ |
( |
) |
$ |
|||||||||
Futures |
( |
) |
( |
) |
( |
) |
|||||||||
Swaps |
( |
) |
|||||||||||||
Foreign currency forwards |
( |
) |
( |
) |
|||||||||||
Embedded derivatives on funds withheld |
|||||||||||||||
Amounts recognized in investment related gains (losses) |
( |
) |
|||||||||||||
Embedded derivatives in indexed annuity products1
|
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Total gains (losses) on derivatives not designated as hedges |
$ |
$ |
$ |
( |
) |
$ |
|||||||||
1 Included in interest sensitive contract benefits on the condensed consolidated statements of income (loss).
|
Credit Risk—We may be exposed to credit-related losses in the event of counterparty nonperformance on derivative financial instruments. Generally, the current credit exposure of our derivative contracts is the fair value at the reporting date less any collateral received from the counterparty.
We manage credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties. Where possible, we maintain collateral arrangements and use master netting agreements that provide for a single net payment from one counterparty to another at each due date and upon termination. We have also established counterparty exposure limits, where possible, in order to evaluate if there is sufficient collateral to support the net exposure.
Collateral arrangements typically require the posting of collateral in connection with its derivative instruments. Collateral agreements often contain posting thresholds, some of which may vary depending on the posting party’s financial strength ratings. Additionally, a decrease in our financial strength rating to a specified level can result in settlement of the derivative position.
The estimated fair value of our net derivative and other financial assets and liabilities after the application of master netting agreements and collateral were as follows:
Gross amounts not offset on the condensed consolidated balance sheets |
||||||||||||||||||||||||
(In millions) |
Gross amount recognized1
|
Financial instruments2
|
Collateral (received)/pledged |
Net amount |
Off-balance sheet securities collateral3
|
Net amount after securities collateral |
||||||||||||||||||
June 30, 2020 |
||||||||||||||||||||||||
Derivative assets |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||
Derivative liabilities |
( |
) |
( |
) |
— |
( |
) |
|||||||||||||||||
December 31, 2019 |
||||||||||||||||||||||||
Derivative assets |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
( |
) |
||||||||||
Derivative liabilities |
( |
) |
— |
|||||||||||||||||||||
1 |
The gross amounts of recognized derivative assets and derivative liabilities are reported on the condensed consolidated balance sheets. As of June 30, 2020 and December 31, 2019, amounts not subject to master netting or similar agreements were immaterial.
|
|||||||||||||||||||||||
2 |
Represents amounts offsetting derivative assets and derivative liabilities that are subject to an enforceable master netting agreement or similar agreement that are not netted against the gross derivative assets or gross derivative liabilities for presentation on the condensed consolidated balance sheets. |
|||||||||||||||||||||||
3 |
For non-cash collateral received, we do not recognize the collateral on our balance sheet unless the obligor (transferor) has defaulted under the terms of the secured contract and is no longer entitled to redeem the pledged asset. Amounts do not include any excess of collateral pledged or received. |
4. Variable Interest Entities
VIE Deconsolidation—During the first quarter 2020, as a result of the Apollo Global Management, Inc. (AGM and, together with its subsidiaries, Apollo) share transaction discussed further in Note 11 – Related Parties, we reassessed the consolidation conclusions for the following VIEs which are managed by Apollo affiliates:
• |
AAA Investments (Co-Invest VI), L.P. (CoInvest VI); |
• |
AAA Investments (Co-Invest VII), L.P. (CoInvest VII); |
• |
AAA Investments (Other), L.P. (CoInvest Other); |
• |
Entities included under our agreement to purchase funds managed by Apollo entities (Strategic Partnership). |
31
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Following the share transaction, we determined that we are no longer the primary beneficiary of these entities, as a result of Apollo receiving significant economics of these entities through their increased economic ownership in us. We did not recognize a gain or loss upon deconsolidation, as the deconsolidated VIEs accounted for their assets and liabilities at fair value. The investments remaining from the deconsolidated VIEs are included at net asset value (NAV) in related party investment funds on the condensed consolidated balance sheets after March 31, 2020.
Commercial Mortgage Loan Securitization Trust—During the second quarter of 2020, we formed Hamlet Securitization Trust 2020-CRE1 (Hamlet) to securitize a portion of our commercial mortgage loan portfolio as CMBS securities, which are held by AHL subsidiaries and third-party cedant portfolios. Securitization of these commercial mortgage loans allows us to retain the full economics of these assets while being able to pledge these assets as collateral to the Federal Home Loan Bank (FHLB) under the funding agreement program. As substantially all of the activities and economics of Hamlet are conducted on our behalf, we are the primary beneficiary and consolidate Hamlet and the assets are included in mortgage loans on the condensed consolidated balance sheets. Additionally, as Hamlet is in the form of a trust, the commercial mortgage loan assets are included in the pledged assets and funds in trust table in Note 12 – Commitments and Contingencies.
ALR Aircraft Investment Ireland Limited (ALR)—ALR was formed to invest in a joint venture that provides airplane lease financing to a major commercial airline. We were the only investor in the profit participating notes and, as substantially all of the activities of ALR were conducted on our behalf, we were the primary beneficiary and consolidated ALR. During the second quarter of 2020, we received final payment on the profit participating notes and no longer consolidate ALR.
5. Fair Value
Fair value is the price we would receive to sell an asset or pay to transfer a liability (exit price) in an orderly transaction between market participants. We determine fair value based on the following fair value hierarchy:
Level 1 – Unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2 – Quoted prices for inactive markets or valuation techniques that require observable direct or indirect inputs for substantially the full term of the asset or liability. Level 2 inputs include the following:
• |
Quoted prices for similar assets or liabilities in active markets, |
• |
Observable inputs other than quoted market prices, and |
• |
Observable inputs derived principally from market data through correlation or other means. |
Level 3 – Prices or valuation techniques with unobservable inputs significant to the overall fair value estimate. These valuations use critical assumptions not readily available to market participants. Level 3 valuations are based on market standard valuation methodologies, including discounted cash flows, matrix pricing or other similar techniques.
NAV – Investment funds are typically measured using NAV as a practical expedient in determining fair value and are not classified in the fair value hierarchy. The underlying investments of the investment funds may have significant unobservable inputs, which may include but are not limited to, comparable multiples and weighted average cost of capital rates applied in valuation models or a discounted cash flow model.
The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the instrument’s fair value measurement.
We use a number of valuation sources to determine fair values. Valuation sources can include quoted market prices; third-party commercial pricing services; third-party brokers; industry-standard, vendor modeling software that uses market observable inputs; and other internal modeling techniques based on projected cash flows. We periodically review the assumptions and inputs of third-party commercial pricing services through internal valuation price variance reviews, comparisons to internal pricing models, back testing to recent trades, or monitoring trading volumes.
32
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following represents the hierarchy for our assets and liabilities measured at fair value on a recurring basis:
June 30, 2020 |
|||||||||||||||||||
(In millions) |
Total |
NAV |
Level 1 |
Level 2 |
Level 3 |
||||||||||||||
Assets |
|||||||||||||||||||
AFS securities |
|||||||||||||||||||
U.S. government and agencies |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
U.S. state, municipal and political subdivisions |
— |
||||||||||||||||||
Foreign governments |
— |
||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
CMBS |
— |
||||||||||||||||||
RMBS |
— |
||||||||||||||||||
Total AFS securities |
— |
||||||||||||||||||
Trading securities |
|||||||||||||||||||
U.S. government and agencies |
— |
||||||||||||||||||
U.S. state, municipal and political subdivisions |
— |
||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
CMBS |
— |
||||||||||||||||||
RMBS |
— |
||||||||||||||||||
Total trading securities |
— |
||||||||||||||||||
Equity securities |
— |
||||||||||||||||||
Mortgage loans |
— |
||||||||||||||||||
Investment funds |
|||||||||||||||||||
Funds withheld at interest – embedded derivative |
— |
||||||||||||||||||
Derivative assets |
— |
||||||||||||||||||
Short-term investments |
— |
||||||||||||||||||
Other investments |
— |
||||||||||||||||||
Cash and cash equivalents |
— |
||||||||||||||||||
Restricted cash |
— |
||||||||||||||||||
Investments in related parties |
|||||||||||||||||||
AFS securities |
|||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
Total AFS securities – related party |
— |
||||||||||||||||||
Trading securities |
|||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
Total trading securities – related party |
— |
||||||||||||||||||
Equity securities |
— |
||||||||||||||||||
Investment funds |
|||||||||||||||||||
Funds withheld at interest – embedded derivative |
— |
||||||||||||||||||
Reinsurance recoverable |
— |
||||||||||||||||||
Total assets measured at fair value |
$ |
$ |
$ |
$ |
$ |
||||||||||||||
(Continued) |
33
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
June 30, 2020 |
|||||||||||||||||||
(In millions) |
Total |
NAV |
Level 1 |
Level 2 |
Level 3 |
||||||||||||||
Liabilities |
|||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||
Embedded derivative |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
Universal life benefits |
— |
||||||||||||||||||
Future policy benefits |
|||||||||||||||||||
AmerUs Life Insurance Company (AmerUs) Closed Block |
— |
||||||||||||||||||
Indianapolis Life Insurance Company (ILICO) Closed Block and life benefits |
— |
||||||||||||||||||
Derivative liabilities |
— |
||||||||||||||||||
Funds withheld liability – embedded derivative |
— |
||||||||||||||||||
Total liabilities measured at fair value |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
(Concluded) |
December 31, 2019 |
|||||||||||||||||||
(In millions) |
Total |
NAV |
Level 1 |
Level 2 |
Level 3 |
||||||||||||||
Assets |
|||||||||||||||||||
AFS securities |
|||||||||||||||||||
U.S. government and agencies |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
U.S. state, municipal and political subdivisions |
— |
||||||||||||||||||
Foreign governments |
— |
||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
CMBS |
— |
||||||||||||||||||
RMBS |
— |
||||||||||||||||||
Total AFS securities |
— |
||||||||||||||||||
Trading securities |
|||||||||||||||||||
U.S. government and agencies |
— |
||||||||||||||||||
U.S. state, municipal and political subdivisions |
— |
||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
CMBS |
— |
||||||||||||||||||
RMBS |
— |
||||||||||||||||||
Total trading securities |
— |
||||||||||||||||||
Equity securities |
— |
||||||||||||||||||
Mortgage loans |
— |
||||||||||||||||||
Investment funds |
|||||||||||||||||||
Funds withheld at interest – embedded derivative |
— |
||||||||||||||||||
Derivative assets |
— |
||||||||||||||||||
Short-term investments |
— |
||||||||||||||||||
Other investments |
— |
||||||||||||||||||
Cash and cash equivalents |
— |
||||||||||||||||||
Restricted cash |
— |
||||||||||||||||||
(Continued) |
34
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
December 31, 2019 |
|||||||||||||||||||
(In millions) |
Total |
NAV |
Level 1 |
Level 2 |
Level 3 |
||||||||||||||
Investments in related parties |
|||||||||||||||||||
AFS securities |
|||||||||||||||||||
Corporate |
— |
||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
Total AFS securities – related party |
— |
||||||||||||||||||
Trading securities |
|||||||||||||||||||
CLO |
— |
||||||||||||||||||
ABS |
— |
||||||||||||||||||
Total trading securities – related party |
— |
||||||||||||||||||
Equity securities |
— |
||||||||||||||||||
Investment funds |
|||||||||||||||||||
Funds withheld at interest – embedded derivative |
— |
||||||||||||||||||
Reinsurance recoverable |
— |
||||||||||||||||||
Total assets measured at fair value |
$ |
$ |
$ |
$ |
$ |
||||||||||||||
Liabilities |
|||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||
Embedded derivative |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
Universal life benefits |
— |
||||||||||||||||||
Future policy benefits |
|||||||||||||||||||
AmerUs Closed Block |
— |
||||||||||||||||||
ILICO Closed Block and life benefits |
— |
||||||||||||||||||
Derivative liabilities |
— |
||||||||||||||||||
Funds withheld liability – embedded derivative |
— |
||||||||||||||||||
Total liabilities measured at fair value |
$ |
$ |
— |
$ |
$ |
$ |
|||||||||||||
(Concluded) |
35
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Fair Value Valuation Methods—We used the following valuation methods and assumptions to estimate fair value:
AFS and trading securities – We obtain the fair value for most marketable securities without an active market from several commercial pricing services. These are classified as Level 2 assets. The pricing services incorporate a variety of market observable information in their valuation techniques, including benchmark yields, trading activity, credit quality, issuer spreads, bids, offers and other reference data. This category typically includes U.S. and non-U.S. corporate bonds, U.S. agency and government guaranteed securities, CLO, ABS, CMBS and RMBS.
We also have fixed maturity securities priced based on indicative broker quotes or by employing market accepted valuation models. For certain fixed maturity securities, the valuation model uses significant unobservable inputs and are included in Level 3 in our fair value hierarchy. Significant unobservable inputs used include: issue specific credit adjustments, material non-public financial information, estimation of future earnings and cash flows, default rate assumptions, liquidity assumptions and indicative quotes from market makers. These inputs are usually considered unobservable, as not all market participants have access to this data.
We value privately placed fixed maturity securities based on the credit quality and duration of comparable marketable securities, which may be securities of another issuer with similar characteristics. In some instances, we use a matrix-based pricing model. These models consider the current level of risk-free interest rates, corporate spreads, credit quality of the issuer and cash flow characteristics of the security. We also consider additional factors such as net worth of the borrower, value of collateral, capital structure of the borrower, presence of guarantees and our evaluation of the borrower’s ability to compete in its relevant market. Privately placed fixed maturity securities are classified as Level 2 or 3.
Equity securities – Fair values of publicly traded equity securities are based on quoted market prices and classified as Level 1. Other equity securities, typically private equities or equity securities not traded on an exchange, we value based on other sources, such as commercial pricing services or brokers, and are classified as Level 2 or 3.
Mortgage loans – Mortgage loans for which we have elected the fair value option or those held for sale are carried at fair value. We estimate fair value on a monthly basis using discounted cash flow analysis and rates being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. The discounted cash flow model uses unobservable inputs, including estimates of discount rates and loan prepayments. Mortgage loans are classified as Level 3.
Investment funds – Certain investment funds for which we elected the fair value option are included in Level 3 and are priced based on market accepted valuation models. The valuation models use significant unobservable inputs, which include material non-public financial information, estimation of future distributable earnings and demographic assumptions. These inputs are usually considered unobservable, as not all market participants have access to this data.
Funds withheld at interest embedded derivative – We estimate the fair value of the embedded derivative based on the change in the fair value of the assets supporting the funds withheld payable under modco and funds withheld reinsurance agreements. As a result, the fair value of the embedded derivative is classified as Level 2 or 3 based on the valuation methods used for the assets held supporting the reinsurance agreements.
Derivatives – Derivative contracts can be exchange traded or over-the-counter. Exchange-traded derivatives typically fall within Level 1 of the fair value hierarchy depending on trading activity. Over-the-counter derivatives are valued using valuation models or an income approach using third-party broker valuations. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlation of the inputs. We consider and incorporate counterparty credit risk in the valuation process through counterparty credit rating requirements and monitoring of overall exposure. We also evaluate and include our own nonperformance risk in valuing derivatives. The majority of our derivatives trade in liquid markets; therefore, we can verify model inputs and model selection does not involve significant management judgment. These are typically classified within Level 2 of the fair value hierarchy.
Cash and cash equivalents, including restricted cash – The carrying amount for cash equals fair value. We estimate the fair value for cash equivalents based on quoted market prices. These assets are classified as Level 1.
Interest sensitive contract liabilities embedded derivative – Embedded derivatives related to interest sensitive contract liabilities with fixed indexed annuity products are classified as Level 3. The valuations include significant unobservable inputs associated with economic assumptions and actuarial assumptions for policyholder behavior.
AmerUs Closed Block – We elected the fair value option for the future policy benefits liability in the AmerUs Closed Block. Our valuation technique is to set the fair value of policyholder liabilities equal to the fair value of assets. There is an additional component which captures the fair value of the open block’s obligations to the closed block business. This component is the present value of the projected release of required capital and future earnings before income taxes on required capital supporting the AmerUs Closed Block, discounted at a rate which represents a market participant’s required rate of return, less the initial required capital. Unobservable inputs include estimates for these items. The AmerUs Closed Block policyholder liabilities and any corresponding reinsurance recoverable are classified as Level 3.
36
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
ILICO Closed Block – We elected the fair value option for the ILICO Closed Block. Our valuation technique is to set the fair value of policyholder liabilities equal to the fair value of assets. There is an additional component which captures the fair value of the open block’s obligations to the closed block business. This component uses the present value of future cash flows which include commissions, administrative expenses, reinsurance premiums and benefits, and an explicit cost of capital. The discount rate includes a margin to reflect the business and nonperformance risk. Unobservable inputs include estimates for these items. The ILICO Closed Block policyholder liabilities and corresponding reinsurance recoverable are classified as Level 3.
Universal life liabilities and other life benefits – We elected the fair value option for certain blocks of universal and other life business ceded to Global Atlantic. We use a present value of liability cash flows. Unobservable inputs include estimates of mortality, persistency, expenses, premium payments and a risk margin used in the discount rates that reflects the riskiness of the business. These universal life policyholder liabilities and corresponding reinsurance recoverable are classified as Level 3.
Fair Value Option—The following represents the gains (losses) recorded for instruments for which we have elected the fair value option, including related parties:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Trading securities |
$ |
$ |
$ |
( |
) |
$ |
|||||||||
Mortgage loans |
|||||||||||||||
Investment funds |
|||||||||||||||
Future policy benefits |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Total gains (losses) |
$ |
$ |
$ |
$ |
Gains and losses on trading securities are recorded in investment related gains (losses) on the condensed consolidated statements of income (loss). For fair value option mortgage loans, we record interest income in net investment income and subsequent changes in fair value in investment related gains (losses) on the condensed consolidated statements of income (loss). Gains and losses related to investment funds, including related party investment funds, are recorded in net investment income on the condensed consolidated statements of income (loss). We record the change in fair value of future policy benefits to future policy and other policy benefits on the condensed consolidated statements of income (loss).
The following summarizes information for fair value option mortgage loans:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Unpaid principal balance |
$ |
$ |
|||||
Mark to fair value |
|||||||
Fair value |
$ |
$ |
There were no fair value option mortgage loans 90 days or more past due as of June 30, 2020 and December 31, 2019.
37
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Level 3 Financial Instruments—The following tables are reconciliations for all Level 3 assets and liabilities measured at fair value on a recurring basis. All transfers in and out of Level 3 are based on changes in the availability of pricing sources, as described in the valuation methods above.
Three months ended June 30, 2020 |
|||||||||||||||||||||||||||||||
Total realized and unrealized gains (losses) |
|||||||||||||||||||||||||||||||
(In millions) |
Beginning balance |
Included in income |
Included in OCI |
Net purchases, issuances, sales and settlements |
Net transfers in (out) |
Ending balance |
Total gains (losses) included in earnings1
|
Total gains (losses) included in OCI1
|
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Corporate |
( |
) |
( |
) |
|||||||||||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||||||||||||||
CMBS |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
( |
) |
|||||||||||||||||||||||||||||
CLO |
|||||||||||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||||||||||
Equity securities |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Mortgage loans |
( |
( |
) |
||||||||||||||||||||||||||||
Investment funds |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
( |
) |
|||||||||||||||||||||||||||||
Short-term investments |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities, ABS |
|||||||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
|||||||||||||||||||||||||||||||
ABS |
|||||||||||||||||||||||||||||||
Equity securities |
( |
) |
|||||||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
( |
) |
|||||||||||||||||||||||||||||
Reinsurance recoverable |
( |
) |
|||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||||||||||||||
Embedded derivative |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
|||||||||||||||
Universal life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
Future policy benefits |
|||||||||||||||||||||||||||||||
AmerUs Closed Block |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
ILICO Closed Block and life benefits |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Derivative liabilities |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Total Level 3 liabilities |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
|||||||||||||||
1 Related to instruments held at end of period.
|
38
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three months ended June 30, 2019 |
|||||||||||||||||||||||||||
Total realized and unrealized gains (losses) |
|||||||||||||||||||||||||||
(In millions) |
Beginning balance |
Included in income |
Included in OCI |
Net purchases, issuances, sales and settlements |
Net transfers in (out) |
Ending balance |
Total gains (losses) included in earnings1
|
||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||
Corporate |
( |
) |
|||||||||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||||||
CMBS |
( |
) |
|||||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||
Corporate |
( |
) |
|||||||||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||||||||||
ABS |
|||||||||||||||||||||||||||
RMBS |
( |
) |
( |
) |
|||||||||||||||||||||||
Equity securities |
|||||||||||||||||||||||||||
Mortgage loans |
( |
) |
|||||||||||||||||||||||||
Investment funds |
( |
) |
|||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
|||||||||||||||||||||||||||
Short-term investments |
|||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||
CLO |
|||||||||||||||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
ABS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Equity securities |
( |
) |
|||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
|||||||||||||||||||||||||||
Reinsurance recoverable |
|||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
||||||||||||||||
Liabilities |
|||||||||||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||||||||||
Embedded derivative |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||
Universal life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Future policy benefits |
|||||||||||||||||||||||||||
AmerUs Closed Block |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
ILICO Closed Block and life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Derivative liabilities |
( |
) |
( |
) |
|||||||||||||||||||||||
Total Level 3 liabilities |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||
1 Related to instruments held at end of period.
|
39
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Six months ended June 30, 2020 |
|||||||||||||||||||||||||||||||
Total realized and unrealized gains (losses) |
|||||||||||||||||||||||||||||||
(In millions) |
Beginning balance |
Included in income |
Included in OCI |
Net purchases, issuances, sales and settlements |
Net transfers in (out) |
Ending balance |
Total gains (losses) included in income1
|
Total gains (losses) included in OCI1
|
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||||
Corporate |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
CLO |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
ABS |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
CMBS |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
RMBS |
|||||||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
|||||||||||||||||||||||||||||||
CLO |
( |
) |
( |
) |
|||||||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||||||||||
Equity securities |
|||||||||||||||||||||||||||||||
Mortgage loans |
( |
) |
|||||||||||||||||||||||||||||
Investment funds |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
( |
) |
|||||||||||||||||||||||||||||
Short-term investments |
( |
) |
|||||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities, ABS |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
( |
) |
( |
) |
|||||||||||||||||||||||||||
ABS |
( |
) |
( |
) |
|||||||||||||||||||||||||||
Equity securities |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
( |
) |
|||||||||||||||||||||||||||||
Reinsurance recoverable |
|||||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
|||||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||||||||||||||
Embedded derivative |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
|||||||||||||||||
Universal life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
Future policy benefits |
|||||||||||||||||||||||||||||||
AmerUs Closed Block |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
ILICO Closed Block and life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||||
Derivative liabilities |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||||
Total Level 3 liabilities |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
|||||||||||||||
1 Related to instruments held at end of period.
|
40
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Six months ended June 30, 2019 |
|||||||||||||||||||||||||||
Total realized and unrealized gains (losses) |
|||||||||||||||||||||||||||
(In millions) |
Beginning balance |
Included in income |
Included in OCI |
Net purchases, issuances, sales and settlements |
Net transfers in (out) |
Ending balance |
Total gains (losses) included in earnings1
|
||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||
Corporate |
( |
) |
|||||||||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||||||
CMBS |
( |
) |
|||||||||||||||||||||||||
RMBS |
( |
) |
|||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||
Corporate |
|||||||||||||||||||||||||||
CLO |
( |
) |
|||||||||||||||||||||||||
ABS |
|||||||||||||||||||||||||||
RMBS |
( |
) |
( |
) |
|||||||||||||||||||||||
Equity securities |
|||||||||||||||||||||||||||
Mortgage loans |
( |
) |
|||||||||||||||||||||||||
Investment funds |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Funds withheld at interest – embedded derivative |
|||||||||||||||||||||||||||
Short-term investments |
|||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||
CLO |
|||||||||||||||||||||||||||
ABS |
( |
) |
|||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||
CLO |
( |
) |
( |
) |
|||||||||||||||||||||||
ABS |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Equity securities |
( |
) |
|||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||
Funds withheld at interest – embedded derivative |
( |
) |
|||||||||||||||||||||||||
Reinsurance recoverable |
|||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
||||||||||||||||
Liabilities |
|||||||||||||||||||||||||||
Interest sensitive contract liabilities |
|||||||||||||||||||||||||||
Embedded derivative |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||
Universal life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Future policy benefits |
|||||||||||||||||||||||||||
AmerUs Closed Block |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
ILICO Closed Block and life benefits |
( |
) |
( |
) |
( |
) |
|||||||||||||||||||||
Derivative liabilities |
( |
) |
( |
) |
|||||||||||||||||||||||
Total Level 3 liabilities |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||
1 Related to instruments held at end of period.
|
41
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following represents the gross components of purchases, issuances, sales and settlements, net, and net transfers in (out) shown above:
Three months ended June 30, 2020 |
|||||||||||||||||||||||||||||||
(In millions) |
Purchases |
Issuances |
Sales |
Settlements |
Net purchases, issuances, sales and settlements |
Transfers in |
Transfers out |
Net transfers in (out) |
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
Corporate |
$ |
$ |
— |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
( |
) |
||||||||||||||
CLO |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
CMBS |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
RMBS |
— |
— |
( |
) |
( |
) |
|||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
RMBS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Mortgage loans |
— |
— |
— |
( |
) |
( |
) |
||||||||||||||||||||||||
Short-term investments |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities, ABS |
— |
||||||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
— |
( |
) |
||||||||||||||||||||||||||||
ABS |
— |
( |
) |
||||||||||||||||||||||||||||
Equity securities |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
|||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities – embedded derivative |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||
Total Level 3 liabilities |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
42
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Three months ended June 30, 2019 |
|||||||||||||||||||||||||||||||
(In millions) |
Purchases |
Issuances |
Sales |
Settlements |
Net purchases, issuances, sales and settlements |
Transfers in |
Transfers out |
Net transfers in (out) |
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
— |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||||
Corporate |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
CLO |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
CMBS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
RMBS |
— |
— |
( |
) |
( |
) |
|||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
RMBS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Mortgage loans |
— |
— |
— |
( |
) |
( |
) |
||||||||||||||||||||||||
Investment funds |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Short-term investments |
— |
( |
) |
||||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
CLO |
— |
— |
— |
||||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Equity securities |
— |
||||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
|||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities – embedded derivative |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||
Total Level 3 liabilities |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
43
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Six months ended June 30, 2020 |
|||||||||||||||||||||||||||||||
(In millions) |
Purchases |
Issuances |
Sales |
Settlements |
Net purchases, issuances, sales and settlements |
Transfers in |
Transfers out |
Net transfers in (out) |
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
Corporate |
$ |
$ |
— |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||||||
CLO |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||
CMBS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
RMBS |
— |
— |
|||||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
— |
||||||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
RMBS |
— |
( |
) |
||||||||||||||||||||||||||||
Mortgage loans |
— |
— |
— |
( |
) |
( |
) |
||||||||||||||||||||||||
Short-term investments |
— |
( |
) |
||||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities, ABS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
ABS |
— |
( |
) |
||||||||||||||||||||||||||||
Equity securities |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
|||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities – embedded derivative |
$ |
$ |
( |
) |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||||||
Total Level 3 liabilities |
$ |
$ |
( |
) |
$ |
$ |
$ |
$ |
$ |
$ |
44
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Six months ended June 30, 2019 |
|||||||||||||||||||||||||||||||
(In millions) |
Purchases |
Issuances |
Sales |
Settlements |
Net purchases, issuances, sales and settlements |
Transfers in |
Transfers out |
Net transfers in (out) |
|||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
U.S. state, municipal and political subdivisions |
$ |
$ |
— |
$ |
$ |
$ |
$ |
$ |
$ |
||||||||||||||||||||||
Corporate |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
CLO |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
CMBS |
— |
( |
) |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||
RMBS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
Corporate |
— |
||||||||||||||||||||||||||||||
CLO |
— |
||||||||||||||||||||||||||||||
ABS |
— |
||||||||||||||||||||||||||||||
RMBS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Mortgage loans |
— |
— |
— |
( |
) |
( |
) |
||||||||||||||||||||||||
Investment funds |
— |
— |
— |
( |
) |
( |
) |
||||||||||||||||||||||||
Short-term investments |
— |
( |
) |
||||||||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||||||||||
AFS securities |
|||||||||||||||||||||||||||||||
CLO |
— |
||||||||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
Trading securities |
|||||||||||||||||||||||||||||||
CLO |
— |
( |
) |
( |
) |
( |
) |
||||||||||||||||||||||||
ABS |
— |
( |
) |
( |
) |
||||||||||||||||||||||||||
Equity securities |
— |
( |
) |
||||||||||||||||||||||||||||
Investment funds |
( |
) |
|||||||||||||||||||||||||||||
Total Level 3 assets |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
|||||||||||||||
Liabilities |
|||||||||||||||||||||||||||||||
Interest sensitive contract liabilities – embedded derivative |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
|||||||||||||||||||
Total Level 3 liabilities |
$ |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
$ |
$ |
Significant Unobservable Inputs—Significant unobservable inputs occur when we could not obtain or corroborate the quantitative detail of the inputs. This applies to fixed maturity securities, equity securities, mortgage loans and certain derivatives, as well as embedded derivatives in liabilities. Additional significant unobservable inputs are described below.
AFS and trading securities – For certain fixed maturity securities, internal models are used to calculate the fair value. We use a discounted cash flow approach. The discount rate is the significant unobservable input due to the determined credit spread being internally developed, illiquid, or as a result of other adjustments made to the base rate. The base rate represents a market comparable rate for securities with similar characteristics. This excludes assets for which significant unobservable inputs are not developed internally, primarily consisting of broker quotes.
Interest sensitive contract liabilities – embedded derivative – Significant unobservable inputs we use in the fixed indexed annuities embedded derivative of the interest sensitive contract liabilities valuation include:
1. |
Nonperformance risk – For contracts we issue, we use the credit spread, relative to the U.S. Department of the Treasury (Treasury) curve, based on our public credit rating as of the valuation date. This represents our credit risk for use in the estimate of the fair value of embedded derivatives. |
2. |
Option budget – We assume future hedge costs in the derivative’s fair value estimate. The level of option budgets determines the future costs of the options and impacts future policyholder account value growth. |
3. |
Policyholder behavior – We regularly review the lapse and withdrawal assumptions (surrender rate). These are based on our initial pricing assumptions updated for actual experience. Actual experience may be limited for recently issued products. |
45
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following summarizes the unobservable inputs for AFS and trading securities and the embedded derivatives of fixed indexed annuities:
June 30, 2020 |
||||||||||||||||||||
(In millions, except for percentages) |
Fair value |
Valuation technique |
Unobservable inputs |
Minimum |
Maximum |
Weighted average |
Impact of an increase in the input on fair value |
|||||||||||||
AFS and trading securities |
$ |
Discounted cash flow |
Discount |
% |
% |
% |
1 |
Decrease |
||||||||||||
Interest sensitive contract liabilities – fixed indexed annuities embedded derivatives |
$ |
Option budget method |
Nonperformance risk |
% |
% |
% |
2 |
Decrease |
||||||||||||
Option budget |
% |
% |
% |
3 |
Increase |
|||||||||||||||
Surrender rate |
% |
% |
% |
4 |
Decrease |
|||||||||||||||
December 31, 2019 |
||||||||||||||||||||
Fair value |
Valuation technique |
Unobservable inputs |
Minimum |
Maximum |
Weighted average |
Impact of an increase in the input on fair value |
||||||||||||||
AFS and trading securities |
$ |
Discounted cash flow |
Discount |
% |
% |
% |
1 |
Decrease |
||||||||||||
Interest sensitive contract liabilities – fixed indexed annuities embedded derivatives |
$ |
Option budget method |
Nonperformance risk |
% |
% |
% |
2 |
Decrease |
||||||||||||
Option budget |
% |
% |
% |
3 |
Increase |
|||||||||||||||
Surrender rate |
% |
% |
% |
4 |
Decrease |
|||||||||||||||
1 The discount weighted average is calculated based on the relative fair values of the securities.
| ||||||||||||||||||||
2 The nonperformance risk weighted average is based on the projected excess benefits of reserves used in the calculation of the embedded derivative.
| ||||||||||||||||||||
3 The option budget weighted average is calculated based on the indexed account values.
| ||||||||||||||||||||
4 The surrender rate weighted average is calculated based on projected account values.
|
Fair Value of Financial Instruments Not Carried at Fair Value—The following represents our financial instruments not carried at fair value on the condensed consolidated balance sheets:
June 30, 2020 |
|||||||||||||||||||||||
(In millions) |
Carrying Value |
Fair Value |
NAV |
Level 1 |
Level 2 |
Level 3 |
|||||||||||||||||
Financial assets |
|||||||||||||||||||||||
Mortgage loans |
$ |
$ |
$ |
— |
$ |
$ |
$ |
||||||||||||||||
Investment funds |
|||||||||||||||||||||||
Policy loans |
— |
||||||||||||||||||||||
Funds withheld at interest |
— |
||||||||||||||||||||||
Other investments |
— |
||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||
Mortgage loans |
— |
||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||
Funds withheld at interest |
— |
||||||||||||||||||||||
Other investments |
— |
||||||||||||||||||||||
Total financial assets not carried at fair value |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Financial liabilities |
|||||||||||||||||||||||
Interest sensitive contract liabilities |
$ |
$ |
$ |
— |
$ |
$ |
$ |
||||||||||||||||
Long-term debt |
— |
||||||||||||||||||||||
Securities to repurchase |
— |
||||||||||||||||||||||
Funds withheld liability |
— |
||||||||||||||||||||||
Total financial liabilities not carried at fair value |
$ |
$ |
$ |
— |
$ |
$ |
$ |
46
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
December 31, 2019 |
|||||||||||||||||||||||
(In millions) |
Carrying Value |
Fair Value |
NAV |
Level 1 |
Level 2 |
Level 3 |
|||||||||||||||||
Financial assets |
|||||||||||||||||||||||
Mortgage loans |
$ |
$ |
$ |
— |
$ |
$ |
$ |
||||||||||||||||
Investment funds |
|||||||||||||||||||||||
Policy loans |
— |
||||||||||||||||||||||
Funds withheld at interest |
— |
||||||||||||||||||||||
Short-term investments |
— |
||||||||||||||||||||||
Other investments |
— |
||||||||||||||||||||||
Investments in related parties |
|||||||||||||||||||||||
Mortgage loans |
— |
||||||||||||||||||||||
Investment funds |
|||||||||||||||||||||||
Funds withheld at interest |
— |
||||||||||||||||||||||
Other investments |
— |
||||||||||||||||||||||
Total financial assets not carried at fair value |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Financial liabilities |
|||||||||||||||||||||||
Interest sensitive contract liabilities |
$ |
$ |
$ |
— |
$ |
$ |
$ |
||||||||||||||||
Short-term debt |
— |
||||||||||||||||||||||
Long-term debt |
— |
||||||||||||||||||||||
Securities to repurchase |
— |
||||||||||||||||||||||
Funds withheld liability |
— |
||||||||||||||||||||||
Total financial liabilities not carried at fair value |
$ |
$ |
$ |
— |
$ |
$ |
$ |
We estimate the fair value for financial instruments not carried at fair value using the same methods and assumptions as those we carry at fair value. The financial instruments presented above are reported at carrying value on the condensed consolidated balance sheets; however, in the case of policy loans, funds withheld at interest and liability, short-term investments, short-term debt, and securities to repurchase, the carrying amount approximates fair value.
Investment in related parties – Other investments – The fair value of related party other investments is determined using a discounted cash flow model using discount rates for similar investments.
Interest sensitive contract liabilities – The carrying and fair value of interest sensitive contract liabilities above includes fixed indexed and traditional fixed annuities without mortality or morbidity risks, funding agreements and payout annuities without life contingencies. The embedded derivatives within fixed indexed annuities without mortality or morbidity risks are excluded, as they are carried at fair value. The valuation of these investment contracts is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using current market risk-free interest rates, adding a spread to reflect our nonperformance risk and subtracting a risk margin to reflect uncertainty inherent in the projected cash flows.
Long-term debt – We obtain the fair value of long-term debt from commercial pricing services. These are classified as Level 2. The pricing services incorporate a variety of market observable information in their valuation techniques including benchmark yields, trading activity, credit quality, issuer spreads, bids, offers and other reference data.
6. Reinsurance
Reinsurance transactions—On June 18, 2020, we entered into a funds withheld coinsurance agreement effective June 1, 2020 with Jackson National Life Insurance Company (Jackson) to reinsure a block of fixed and fixed indexed annuities. Additionally, as part of the transaction, we made a $500 million equity investment in an indirect parent of Jackson, which closed on July 17, 2020. The following summarizes the transaction:
(In millions) |
Funds Withheld |
||
Liabilities assumed |
$ |
||
Less: Net consideration received |
|||
Unearned revenue reserve1
|
$ |
( |
) |
1 Included within interest sensitive contract liabilities on the condensed consolidated balance sheets.
|
Unearned revenue reserve balances are amortized over the life of the reinsurance agreements on a basis consistent with our DAC amortization policy.
47
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The following summarizes the effect of reinsurance on premiums and future policy and other policy benefits on the condensed consolidated statements of income (loss):
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Premiums |
|||||||||||||||
Direct |
$ |
$ |
$ |
$ |
|||||||||||
Reinsurance assumed |
|||||||||||||||
Reinsurance ceded |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Total premiums |
$ |
$ |
$ |
$ |
|||||||||||
Future policy and other policy benefits |
|||||||||||||||
Direct |
$ |
$ |
$ |
$ |
|||||||||||
Reinsurance assumed |
|||||||||||||||
Reinsurance ceded |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Total future policy and other policy benefits |
$ |
$ |
$ |
$ |
7. Deferred Acquisition Costs, Deferred Sales Inducements and Value of Business Acquired
The following represents a rollforward of deferred acquisition costs (DAC), deferred sales inducements (DSI) and value of business acquired (VOBA):
(In millions) |
DAC |
DSI |
VOBA |
Total |
|||||||||||
Balance at December 31, 2019 |
$ |
$ |
$ |
$ |
|||||||||||
Adoption of accounting standard |
|||||||||||||||
Additions |
|||||||||||||||
Amortization |
( |
) |
|||||||||||||
Impact of unrealized investment (gains) losses |
( |
) |
|||||||||||||
Balance at June 30, 2020 |
$ |
$ |
$ |
$ |
(In millions) |
DAC |
DSI |
VOBA |
Total |
|||||||||||
Balance at December 31, 2018 |
$ |
$ |
$ |
$ |
|||||||||||
Additions |
|||||||||||||||
Amortization |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Impact of unrealized investment (gains) losses |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Balance at June 30, 2019 |
$ |
$ |
$ |
$ |
8. Debt
Short-term Borrowing—During the second quarter of 2020, we converted $400 million of short-term debt outstanding with the FHLB to funding agreements. See Note 12 – Commitments and Contingencies for further discussion regarding FHLB funding agreements.
Senior Notes—During the second quarter of 2020, we issued $500 million of senior unsecured notes due April 3, 2030. The senior notes have a 6.150 % coupon rate, payable semi-annually. We can call the senior notes, in whole or in part, at any time prior to January 3, 2030, at a price equal to the greater of (1) 100% of the principal and any accrued and unpaid interest and (2) an amount equal to the sum of the present values of remaining scheduled payments, discounted from the scheduled payment date to the redemption date at the Treasury Rate (as defined in the second supplemental indenture, dated April 3, 2020) plus 50 basis points, and any accrued and unpaid interest. Thereafter, we can call the notes, in whole or in part, at a price equal to 100% of the principal and any accrued and unpaid interest.
48
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
9. Earnings Per Share
The following represents our basic and diluted earnings per share (EPS) calculations, which are calculated using unrounded amounts:
Three months ended June 30, 2020 |
|||
(In millions, except per share data) |
Class A |
||
Net income available to Athene Holding Ltd. common shareholders – basic and diluted |
$ |
||
Basic weighted average shares outstanding |
|||
Dilutive effect of stock compensation plans |
|||
Diluted weighted average shares outstanding |
|||
Earnings per share |
|||
Basic |
$ |
||
Diluted |
$ |
Three months ended June 30, 2019 |
|||||||||||||||||||||||
(In millions, except share and per share data) |
Class A |
Class B |
Class M-1 |
Class M-2 |
Class M-3 |
Class M-4 |
|||||||||||||||||
Net income available to Athene Holding Ltd. common shareholders – basic and diluted |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Basic weighted average shares outstanding |
|||||||||||||||||||||||
Dilutive effect of stock compensation plans |
|||||||||||||||||||||||
Diluted weighted average shares outstanding |
|||||||||||||||||||||||
Earnings per share |
|||||||||||||||||||||||
Basic |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Diluted |
$ |
$ |
$ |
$ |
$ |
$ |
Six months ended June 30, 2020 |
|||||||||||||||||||||||
(In millions, except share and per share data) |
Class A |
Class B |
Class M-1 |
Class M-2 |
Class M-3 |
Class M-4 |
|||||||||||||||||
Net loss available to Athene Holding Ltd. common shareholders – basic and diluted |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
|||||
Basic weighted average shares outstanding |
|||||||||||||||||||||||
Dilutive effect of stock compensation plans1
|
|||||||||||||||||||||||
Diluted weighted average shares outstanding |
|||||||||||||||||||||||
Earnings per share |
|||||||||||||||||||||||
Basic |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
|||||
Diluted |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
$ |
( |
) |
|||||
1 The dilutive effect of stock compensation plans is antidilutive as a result of the net loss available to Athene Holding Ltd. common shareholders for the six months ended June 30, 2020.
|
Six months ended June 30, 2019 |
|||||||||||||||||||||||
(In millions, except per share data) |
Class A |
Class B |
Class M-1 |
Class M-2 |
Class M-3 |
Class M-4 |
|||||||||||||||||
Net income available to Athene Holding Ltd. common shareholders – basic and diluted |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Basic weighted average shares outstanding |
|||||||||||||||||||||||
Dilutive effect of stock compensation plans |
|||||||||||||||||||||||
Diluted weighted average shares outstanding |
|||||||||||||||||||||||
Earnings per share |
|||||||||||||||||||||||
Basic |
$ |
$ |
$ |
$ |
$ |
$ |
|||||||||||||||||
Diluted |
$ |
$ |
$ |
$ |
$ |
$ |
49
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
During the first quarter of 2020, as a result of the closing of the share transaction discussed further in Note 11 – Related Parties, we converted outstanding Class B shares to Class A shares and Class M shares were converted to Class A shares and warrants. As a result, the EPS calculation for the six months ended June 30, 2020 allocates all net income for the second quarter to Class A shares and, for the first quarter, uses only the weighted average shares for the first quarter to allocate first quarter net income for Class B and Class M shares; however, for Class B and Class M shares, the weighted average shares outstanding represents only that period of time that the shares were outstanding. The warrants issued as part of the conversion of the Class M shares are evaluated for dilution within the dilutive effect of stock compensation plans.
We use the two-class method for allocating net income available to Athene Holding Ltd. common shareholders to each class of our common stock. Dilutive shares are calculated using the treasury stock method. For Class A shares, this method takes into account shares that can be settled into Class A shares, net of a conversion price. The diluted EPS calculations for Class A shares excluded 3.3 million and 31.6 million shares, restricted stock units, options and warrants as of June 30, 2020 and 2019, respectively, for the three months ended and excluded 11.2 million and 31.6 million, as of June 30, 2020 and 2019, respectively, for the six months ended.
10. Equity
Preferred Stock—We have three series of preferred stock: 6.35 % Fixed-to-Floating Rate Perpetual Non-Cumulative Preference Shares, Series A (Series A); 5.625 % Fixed Rate Perpetual Non-Cumulative Preference Shares, Series B (Series B); and 6.375 % Fixed-Rate Reset Perpetual Non-Cumulative Preference Shares, Series C (Series C) as summarized below:
Series A |
Series B |
Series C |
|||||||||
Authorized, issued and outstanding |
|||||||||||
Liquidation preference per share |
$ |
$ |
$ |
||||||||
Dividends declared and paid per share during the six months ended June 30, 2020 |
$ |
$ |
$ |
||||||||
Aggregate dividends declared and paid during the six months ended June 30, 2020 (in millions)
|
$ |
$ |
$ |
Preferred stock dividends are payable on a non-cumulative basis only when, as and if declared, quarterly in arrears on the 30th day of March, June, September and December of each year. Preferred stock ranks senior to our common stock with respect to dividends, to the extent declared, and in liquidation, to the extent of the liquidation preference.
Common Stock—During the first quarter of 2020, shareholders approved amendments to our bye-laws which eliminated our multi-class share structure at closing of the share transaction with Apollo. See Note 11 – Related Parties for further information on this transaction. On February 28, 2020, all Class B shares were converted to Class A shares on a one-to-one basis. Class M shares were converted to Class A shares representing 5 % of the Class M value and warrants representing 95 % of the Class M value. The warrants were issued with substantially the same terms, including the same economic terms, as the Class M shares.
Our bye-laws place certain restrictions on Class A shares such that a holder of Class A shares, except for shareholders permitted by our board of directors, which include members of the Apollo Group, as defined in our bye-laws, cannot control greater than 9.9 % of the total outstanding vote and if a holder of Class A shares were to control greater than 9.9 %, then such holder’s voting power is automatically reduced to 9.9 % and the other holders of Class A shares would vote the remainder on a prorated basis.
Share Repurchase Authorization
Our board of directors has approved authorizations of $1,567 million for the repurchase of our Class A shares under our repurchase program. We may repurchase shares in open market transactions, in privately negotiated transactions or otherwise. The size and timing of repurchases will depend on legal requirements, market and economic conditions and other factors, and are solely at our discretion. The program has no expiration date, but may be modified, suspended or terminated by the board at any time.
The following summarizes the activity on our share repurchase authorization:
Six months ended June 30, |
|||||||
(In millions) |
2020 |
2019 |
|||||
Beginning balance at January 1 |
$ |
$ |
|||||
Additional authorization |
|||||||
Repurchases |
( |
) |
( |
) |
|||
Ending balance at June 30 |
$ |
$ |
50
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The table below shows the changes in each class of shares issued and outstanding:
(In millions) |
Six months ended June 30, 2020 |
|
Class A |
||
Beginning balance |
||
Issued shares |
||
Forfeited shares |
( |
) |
Repurchased shares |
( |
) |
Converted from Class B shares |
||
Converted from Class M shares |
||
Ending balance |
||
Class B |
||
Beginning balance |
||
Converted to Class A shares |
( |
) |
Ending balance |
||
Class M-1 |
||
Beginning balance |
||
Converted to Class A shares |
( |
) |
Converted to warrants |
( |
) |
Ending balance |
||
Class M-2 |
||
Beginning balance |
||
Converted to Class A shares |
||
Converted to warrants |
( |
) |
Ending balance |
||
Class M-3 |
||
Beginning balance |
||
Converted to Class A shares |
||
Converted to warrants |
( |
) |
Ending balance |
||
Class M-4 |
||
Beginning balance |
||
Converted to Class A shares |
( |
) |
Converted to warrants |
( |
) |
Repurchased shares |
( |
) |
Ending balance |
Accumulated Other Comprehensive Income (Loss)—The following provides the details of AOCI and changes in AOCI:
(In millions) |
Unrealized investment gains (losses) on AFS securities without a credit allowance |
Unrealized investment gains (losses) on AFS securities with a credit allowance |
DAC, DSI, VOBA and future policy benefits adjustments on AFS securities |
Unrealized gains (losses) on hedging instruments |
Foreign currency translation and other adjustments |
Accumulated other comprehensive income (loss) |
|||||||||||||||||
Balance at March 31, 2020 |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
$ |
$ |
( |
) |
|||||||||||
Other comprehensive income (loss) before reclassifications |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||||||||||
Less: Reclassification adjustments for gains (losses) realized in net income (loss)1
|
( |
) |
( |
) |
|||||||||||||||||||
Less: Income tax expense (benefit) |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Less: Other comprehensive income (loss) attributable to NCI |
( |
) |
( |
) |
|||||||||||||||||||
Balance at June 30, 2020 |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
|||||||||||
1 Recognized in investment related gains (losses) on the condensed consolidated statements of income (loss).
|
51
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(In millions) |
Unrealized investment gains (losses) on AFS securities |
DAC, DSI, VOBA and future policy benefits adjustments on AFS securities |
Unrealized gains (losses) on hedging instruments |
Foreign currency translation and other adjustments |
Accumulated other comprehensive income (loss) |
||||||||||||||
Balance at March 31, 2019 |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||
Other comprehensive income (loss) before reclassifications |
( |
) |
( |
) |
|||||||||||||||
Less: Reclassification adjustments for gains (losses) realized in net income (loss)1
|
( |
) |
|||||||||||||||||
Less: Income tax expense (benefit) |
( |
) |
|||||||||||||||||
Balance at June 30, 2019 |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||
1 Recognized in investment related gains (losses) on the condensed consolidated statements of income (loss).
|
(In millions) |
Unrealized investment gains (losses) on AFS securities without a credit allowance |
Unrealized investment gains (losses) on AFS securities with a credit allowance |
DAC, DSI, VOBA and future policy benefits adjustments on AFS securities |
Unrealized gains (losses) on hedging instruments |
Foreign currency translation and other adjustments |
Accumulated other comprehensive income (loss) |
|||||||||||||||||
Balance at December 31, 2019 |
$ |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
|||||||||||||
Adoption of accounting standards |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Other comprehensive income (loss) before reclassifications |
( |
) |
( |
) |
( |
) |
|||||||||||||||||
Less: Reclassification adjustments for gains (losses) realized in net income (loss)1
|
( |
) |
|||||||||||||||||||||
Less: Income tax expense (benefit) |
( |
) |
|||||||||||||||||||||
Less: Other comprehensive income (loss) attributable to NCI |
( |
) |
( |
) |
|||||||||||||||||||
Balance at June 30, 2020 |
$ |
$ |
( |
) |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
|||||||||||
1 Recognized in investment related gains (losses) on the condensed consolidated statements of income (loss).
|
(In millions) |
Unrealized investment gains (losses) on AFS securities |
DAC, DSI, VOBA and future policy benefits adjustments on AFS securities |
Unrealized gains (losses) on hedging instruments |
Foreign currency translation and other adjustments |
Accumulated other comprehensive income (loss) |
||||||||||||||
Balance at December 31, 2018 |
$ |
( |
) |
$ |
$ |
$ |
( |
) |
$ |
( |
) |
||||||||
Other comprehensive income (loss) before reclassifications |
( |
) |
( |
) |
|||||||||||||||
Less: Reclassification adjustments for gains (losses) realized in net income (loss)1
|
( |
) |
|||||||||||||||||
Less: Income tax expense (benefit) |
( |
) |
|||||||||||||||||
Balance at June 30, 2019 |
$ |
$ |
( |
) |
$ |
$ |
( |
) |
$ |
||||||||||
1 Recognized in investment related gains (losses) on the condensed consolidated statements of income (loss).
|
52
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
11. Related Parties
Apollo
Current fee structure – Substantially all of our investments are managed by Apollo, which provides direct investment management, asset allocation, mergers and acquisition asset diligence and certain operational support services for our investment portfolio, including investment compliance, tax, legal and risk management support.
During the second quarter of 2019, we entered into the Seventh Amended and Restated Fee Agreement, dated as of June 10, 2019, between us and AGM’s subsidiary, Apollo Insurance Solutions Group LP (ISG) (Fee Agreement). Under the Fee Agreement, effective retroactive to January 1, 2019, we pay Apollo:
(1) |
a base management fee equal to the sum of (i) |
(2) |
with respect to each asset in an Account, subject to certain exceptions, that is managed by Apollo and that belongs to a specified asset class tier (Core, Core Plus, Yield, and High Alpha), a sub-allocation fee as follows, which will, in the case of assets acquired after January 1, 2019, be subject to a cap of |
(i) |
(ii) |
(iii) |
(iv) |
(v) |
The following represents assets based on the above sub-allocation structure:
(In millions, except percentages) |
June 30, 2020 |
Percent of Total |
December 31, 2019 |
Percent of Total |
|||||||||
Core |
$ |
% |
$ |
% |
|||||||||
Core Plus |
% |
% |
|||||||||||
Yield |
% |
% |
|||||||||||
High Alpha |
% |
% |
|||||||||||
Other |
% |
% |
|||||||||||
Total sub-allocation assets |
$ |
% |
$ |
% |
Additionally, the Fee Agreement provides for a possible payment by Apollo to us, or a possible payment by us to Apollo, equal to 0.025 % of the Incremental Value as of the end of each year, beginning on December 31, 2019, depending upon the percentage of our investments that consist of Core and Core Plus assets. If more than 60 % of our invested assets that are subject to the sub-allocation fees are invested in Core and Core Plus assets, we will receive a 0.025 % fee reduction on the Incremental Value. If less than 50 % of our invested assets that are subject to the sub-allocation fee are invested in Core and Core Plus assets, we will pay an additional fee of 0.025 % on Incremental Value.
During the three months ended June 30, 2020 and 2019, we incurred management fees, inclusive of the base and sub-allocation fees, of $123 million and $94 million, respectively. During the six months ended June 30, 2020 and 2019, we incurred management fees, inclusive of the base and sub-allocation fees, of $251 million and $186 million, respectively. Management fees are included within net investment income on the condensed consolidated statements of income (loss). As of June 30, 2020 and December 31, 2019, management fees payable were $44 million and $42 million, respectively, and are included in other liabilities on the condensed consolidated balance sheets.
53
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
In addition to the assets on our condensed consolidated balance sheets managed by Apollo, Apollo manages the assets underlying our funds withheld receivable. For these assets, the third-party cedants pay Apollo fees based upon the same fee construct we have with Apollo. Such fees directly reduce the settlement payments that we receive from the third-party cedant and, as such, we indirectly pay those fees. Finally, Apollo charges management fees and carried interest on Apollo-managed funds and other entities in which we invest. Neither the fees paid by such third-party cedants nor the fees or carried interest paid by such Apollo-managed funds or other entities are included in the investment management fee amounts cited above.
Investment management agreement (IMA) termination – Our bye-laws currently provide that we may not, and will cause our subsidiaries not to, terminate any IMA among us or any of our subsidiaries, on the one hand, and a member of the Apollo Group (as defined in our bye-laws), on the other hand, other than on June 4, 2023 or any two year anniversary of such date (each such date, an IMA Termination Election Date) and any termination on an IMA Termination Election Date requires (i) the approval of two-thirds of our Independent Directors (as defined in the bye-laws) and (ii) prior written notice to the applicable Apollo subsidiary of such termination at least 30 days, but not more than 90 days, prior to an IMA Termination Election Date. If our Independent Directors make such election to terminate and notice of such termination is delivered, the termination will be effective no earlier than the second anniversary of the applicable IMA Termination Election Date (IMA Termination Effective Date). Notwithstanding the foregoing, (A) except as set forth in clause (B) below, our board of directors may only elect to terminate an IMA on an IMA Termination Election Date if two-thirds of our Independent Directors determine, in their sole discretion and acting in good faith, that either (i) there has been unsatisfactory long-term performance materially detrimental to us by the applicable Apollo subsidiary or (ii) the fees being charged by the applicable Apollo subsidiary are unfair and excessive compared to a comparable asset manager (provided, that in either case such Independent Directors must deliver notice of any such determination to the applicable Apollo subsidiary and the applicable Apollo subsidiary will have until the applicable IMA Termination Effective Date to address such concerns, and provided, further, that in the case of such a determination that the fees being charged by the applicable Apollo subsidiary are unfair and excessive, the applicable Apollo subsidiary has the right to lower its fees to match the fees of such comparable asset manager) and (B) upon the determination by two-thirds of our Independent Directors, we or our subsidiaries may also terminate an IMA with the applicable Apollo subsidiary, on a date other than an IMA Termination Effective Date, as a result of either (i) a material violation of law relating to the applicable Apollo subsidiary’s advisory business, or (ii) the applicable Apollo subsidiary’s gross negligence, willful misconduct or reckless disregard of its obligations under the relevant agreement, in each case of this clause (B), that is materially detrimental to us, and in either case of this clause (B), subject to the delivery of written notice at least 30 days prior to such termination; provided, that in connection with an event described in clause (B)(i) or (B)(ii), the applicable Apollo subsidiary shall have the right to dispute such determination of the Independent Directors within 30 days after receiving notice from us of such determination, in which case the matter will be submitted to binding arbitration and such IMA shall continue to remain in effect during the period of the arbitration (the events described in the foregoing clauses (A) and (B) are referred to in more detail in our bye-laws as “AHL Cause”).
Governance – We have a management investment committee, which includes members of our senior management and reports to the risk committee of our board of directors. The committee focuses on strategic decisions involving our investment portfolio, such as approving investment limits, new asset classes and our allocation strategy, reviewing large asset transactions, as well as monitoring our credit risk, and the management of our assets and liabilities.
A significant voting interest in the Company is held by shareholders who are members of the Apollo Group. Also, James Belardi, our Chief Executive Officer, is an employee of ISG and receives remuneration from acting as Chief Executive Officer of ISG. Mr. Belardi also owns a 5% profit interest in ISG (Interest). It is expected that the Interest will be revised such that Mr. Belardi will receive a lesser interest in the equity of ISG and also receive a specified percentage of other fee streams earned by Apollo, potentially comprised of or including the sub-allocation fees. Additionally, six of the fifteen members of our board of directors are employees of or consultants to Apollo (including Mr. Belardi). In order to protect against potential conflicts of interest resulting from transactions into which we have entered and will continue to enter into with the Apollo Group, our bye-laws require us to maintain a conflicts committee comprised solely of directors who are not officers or employees of any member of the Apollo Group. The conflicts committee reviews and approves material transactions between us and the Apollo Group, subject to certain exceptions.
Other related party transactions
A-A Mortgage Opportunities, L.P. (A-A Mortgage) – We have an equity method investment of $594 million and $487 million as of June 30, 2020 and December 31, 2019, respectively, in A-A Mortgage, which has an investment in AmeriHome. We have a loan purchase agreement with AmeriHome. The agreement allows us to purchase residential mortgage loans which AmeriHome has purchased from correspondent sellers and pooled for sale in the secondary market. AmeriHome retains the servicing rights to the sold loans. We did not purchase any residential mortgage loans under this agreement during either the three months ended June 30, 2020 or 2019. We purchased $169 million and $0 million of residential mortgage loans under this agreement during the six months ended June 30, 2020 and 2019, respectively. Additionally, we hold ABS securities issued by AmeriHome affiliates of $162 million and $170 million as of June 30, 2020 and December 31, 2019, respectively, which are included in related party AFS securities on the condensed consolidated balances sheets. We also have commitments to make additional equity investments in A-A Mortgage of $169 million as of June 30, 2020.
54
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
MidCap – AAA Investment (Co Invest VII), L.P. (CoInvest VII) holds a significant investment in MidCap. CoInvest VII is included in related party investment funds on the condensed consolidated balance sheets and was reflected as a consolidated VIE prior to the first quarter of 2020. We have also advanced amounts under a subordinated debt facility to Midcap. During the second quarter of 2020, we also invested $67 million in MidCap redeemable preferred stock. The subordinated debt facility and redeemable preferred stock are included in related party other investments and related party trading securities, respectively, on the condensed consolidated balance sheets. The following summarizes these investments in MidCap:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Investment fund |
$ |
$ |
|||||
Subordinated debt facility |
|||||||
Redeemable preferred stock |
|||||||
Total investment in MidCap |
$ |
$ |
Additionally, we hold ABS and CLO securities issued by MidCap affiliates of $580 million and $624 million as of June 30, 2020 and December 31, 2019, respectively, which are included in related party AFS securities on the condensed consolidated balance sheets.
Athora – We have a cooperation agreement with Athora, pursuant to which, among other things, (1) for a period of 30 days from the receipt of notice of a cession, we have the right of first refusal to reinsure (i) up to 50% of the liabilities ceded from Athora’s reinsurance subsidiaries to Athora Life Re Ltd. and (ii) up to 20% of the liabilities ceded from a third party to any of Athora’s insurance subsidiaries, subject to a limitation in the aggregate of 20% of Athora’s liabilities, (2) Athora agreed to cause its insurance subsidiaries to consider the purchase of certain funding agreements and/or other spread instruments issued by our insurance subsidiaries, subject to a limitation that the fair market value of such funding agreements purchased by any of Athora’s insurance subsidiaries may generally not exceed 3% of the fair market value of such subsidiary’s total assets, (3) we provide Athora with a right of first refusal to pursue acquisition and reinsurance transactions in Europe (other than the UK) and (4) Athora provides us and our subsidiaries with a right of first refusal to pursue acquisition and reinsurance transactions in North America and the UK. Notwithstanding the foregoing, pursuant to the cooperation agreement, Athora is only required to use its reasonable best efforts to cause its subsidiaries to adhere to the provisions set forth in the cooperation agreement and therefore Athora’s ability to cause its subsidiaries to act pursuant to the cooperation agreement may be limited by, among other things, legal prohibitions or the inability to obtain the approval of the board of directors or other applicable governing body of the applicable subsidiary, which approval is solely at the discretion of such governing body. As of June 30, 2020, we have not exercised our right of first refusal to reinsure liabilities ceded to Athora’s insurance or reinsurance subsidiaries.
Our investment in Athora, which is included in related party investment funds on the condensed consolidated balance sheets, was $497 million and $132 million as of June 30, 2020 and December 31, 2019, respectively. During the second quarter of 2020, we contributed capital of $361 million to Athora. Additionally, as of June 30, 2020 and December 31, 2019, we had $112 million and $146 million, respectively, of funding agreements outstanding to Athora. We also have commitments to make additional equity investments in Athora of $371 million as of June 30, 2020.
Venerable – We have coinsurance and modco agreements with Venerable Insurance and Annuity Company (VIAC, formerly Voya Insurance and Annuity Company). VIAC is a related party due to our minority equity investment in its holding company’s parent, VA Capital Company LLC (VA Capital), which was $118 million and $99 million as of June 30, 2020 and December 31, 2019, respectively. The minority equity investment in VA Capital is included in related party investment funds on the condensed consolidated balance sheets and accounted for as an equity method investment. VA Capital is owned by a consortium of investors, led by affiliates of AGM, Crestview Partners and Reverence Capital Partners, and is the parent of Venerable, which is the parent of VIAC. Additionally, we have a 15-year term loan receivable from Venerable due in 2033, which is included in related party other investments on the condensed consolidated balance sheets. The loan is held at the principal balance less allowances and was $145 million and $148 million as of June 30, 2020 and December 31, 2019, respectively. While management views the overall transactions with Venerable as favorable to us, the stated interest rate of 6.257 % on the term loan to Venerable represents a below-market interest rate, and management considered such rate as part of its evaluation and pricing of the reinsurance transactions.
Strategic Partnership – We have an agreement pursuant to which we may invest up to $2.5 billion over three years in funds managed by Apollo entities (Strategic Partnership). This arrangement is intended to permit us to invest across the Apollo alternatives platform into credit-oriented, strategic and other alternative investments in a manner and size that is consistent with our existing investment strategy. Fees for such investments payable by us to Apollo would be more favorable to us than market rates, and consistent with our existing alternative investments, investments made under the Strategic Partnership require approval of ISG and remain subject to our existing governance processes, including approval by our conflicts committee where applicable. As of June 30, 2020 and December 31, 2019, we had $124 million and $97 million, respectively, of investments under the Strategic Partnership and these investments are included in related party investment funds on the condensed consolidated balance sheets and were reflected as consolidated VIEs in prior periods.
PK AirFinance – During the fourth quarter of 2019, we and Apollo purchased PK AirFinance (PK), an aviation lending business, including PK’s in force loan portfolio (Aviation Loans), from the Aviation Services Unit of GE Capital (GE). The Aviation Loans are generally fully secured by aircraft leases and aircraft. In connection with such transaction, Apollo acquired the PK loan origination platform, including personnel and systems and, pursuant to certain agreements entered into between us, Apollo, and certain entities managed by Apollo (collectively, PK Transaction Agreements), the existing Aviation Loans were acquired and securitized by a newly formed SPV for which Apollo acts as ABS manager (ABS-SPV). The ABS-SPV issued tranches of senior notes and subordinated notes, which are secured by the Aviation Loans.
55
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
In connection with the acquisition of the existing Aviation Loans by the ABS-SPV (i) a tranche of senior notes was acquired by third-party investors and (ii) we purchased mezzanine tranches of the senior notes and the subordinated notes. As of June 30, 2020 and December 31, 2019, our investment in securitizations of loans originated by PK was $1,262 million and $1,282 million, respectively, and are included in related party AFS or trading securities on the condensed consolidated balance sheets. We also have commitments to make additional investment in securitizations of loans originated by PK of $216 million as of June 30, 2020.
In addition to the investment in the senior notes and subordinated notes, we also have a right to acquire, whether directly, through the ABS-SPV or through a similar vehicle, all Aviation Loans originated by PK (Forward Flow Loans). All servicing and administrative costs and expenses of Apollo (determined at cost, without mark-up) that are incurred in connection with the sourcing, origination, servicing and maintaining the Forward Flow Loans, net of any service fees and servicing and administrative cost and expense reimbursement amounts received directly from the ABS-SPV or other entities investing in the Forward Flow Loans are allocated to, and reimbursed by the ABS-SPV or us, as applicable, subject to an agreed-upon annual cap.
In addition to the payment of the expenses described in the preceding paragraph and the base management fee paid to Apollo on all assets managed by Apollo, we have paid or expect to pay the following fees to Apollo or certain service providers that are affiliates of, or are companies managed by, Apollo in connection with the PK Transaction Agreements:
(A) |
To Apollo, sub-allocation fees on the senior notes based on the rates applicable to Yield assets and sub-allocation fees on the subordinated notes based on the rates applicable to High Alpha assets. |
(B) |
To Redding Ridge Asset Management LLC, a company in which certain funds managed by Apollo have an interest, as consideration for assistance with the structuring, monitoring, support and maintenance of the securitization transactions, a one-time structuring fee, as well as ongoing support fees equal to 1.5 bps on the total capitalization amount and certain other fees, which may become due upon the occurrence of certain events; and |
(C) |
To Merx Aviation Servicing Limited, a company externally managed by Apollo Investment Management, L.P., with respect to certain diligence, technical support and enforcement, remarketing and restructuring services with respect to the existing Aviation Loans and the Forward Flow Loans, a one-time servicing fee, as well as certain special situations fees, which may become due upon the occurrence of certain events. |
Apollo/Athene Dedicated Investment Program (ADIP) – Our subsidiary, Athene Co-Invest Reinsurance Affiliate 1A Ltd. (together with its subsidiaries, ACRA) is partially owned by ADIP, which is managed by AGM. As of March 31, 2020, ADIP owned 67 % of the equity interests, while we retained 100% of the voting power and 33 % of the equity interests in ACRA. On April 1, 2020, ALRe purchased 14,000 newly issued ACRA shares for $66 million, which resulted in ALRe holding 36.55 % of the economic interests in ACRA. The remaining 63.45 % of the economic interests in ACRA are held by ADIP. During the six months ended June 30, 2020, we received a capital contribution of $240 million from ADIP and paid a dividend of $46 million to ADIP.
Apollo Share Exchange and Related Transactions – On February 28, 2020, we closed a strategic transaction with AGM and certain affiliates of AGM which collectively comprise the Apollo Operating Group (AOG), pursuant to which we sold 27,959,184 newly issued Class A common shares to the AOG for an investment in Apollo of 29,154,519 newly issued AOG units valued at $1.1 billion and we sold 7,575,758 newly issued Class A common shares to the AOG for $350 million. Pursuant to the underlying transaction agreements, among other things (1) AGM has the right to purchase additional Class A common shares until August 26, 2020 to the extent AOG and certain affiliates, employees and consultants of AGM do not beneficially own at least 35% of the issued and outstanding Class A common shares (inclusive of Class A common shares over which any such persons have a valid proxy), on a fully diluted basis, in a number to achieve such 35% ownership level at a price based upon a weighted average price during the 30 days prior to the exercise of the purchase right and (2) Apollo Management Holdings, L.P. (AMH) has the right to purchase up to that number of Class A common shares that would increase by 5 percentage points the percentage of the issued and outstanding Class A common shares beneficially owned by the AOG and certain affiliates, employees and consultants of AGM (inclusive of Class A common shares over which any such persons have a valid proxy), calculated on a fully diluted basis. In connection with the closing of the transaction, we made certain amendments to our bye-laws which, among other things, eliminated our multi-class share structure.
Concurrent with our entry into the transaction agreements, AMH, James Belardi, our Chief Executive Officer, and William Wheeler, our President (each an “Other Shareholder”), entered into a voting agreement, pursuant to which each Other Shareholder irrevocably appointed AMH as its proxy and attorney-in-fact (Proxy) to vote all of such Other Shareholder’s Class A common shares at any meeting of our shareholders occurring following the closing date and in connection with any written consent of our shareholders following the closing date. The Proxy will be of no force and effect if Apollo and certain affiliates thereof cease to hold some minimum level of ownership not to exceed 7.5% of our Class A common shares.
AA Infrastructure Fund 1 LLC (AA Infrastructure) – We have an investment in preferred shares of AA Infrastructure, which is a fund managed by ISG. As of June 30, 2020 and December 31, 2019, we held $52 million and $58 million, respectively, of preferred shares, which are included in related party equity securities on the condensed consolidated balance sheets and also held AA Infrastructure ABS securities of $297 million and $267 million, respectively, which are included in related party trading securities on the condensed consolidated balance sheets. We also have commitments to make additional investments in AA Infrastructure of $52 million as of June 30, 2020.
56
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
12. Commitments and Contingencies
Contingent Commitments—We had commitments to make investments, primarily capital contributions to investment funds, inclusive of related party commitments discussed previously, of $5,108 million and $4,793 million as of June 30, 2020 and December 31, 2019, respectively. We expect most of our current commitments will be invested over the next five years; however, these commitments could become due any time upon counterparty request.
Funding Agreements—We are a member of the FHLB and, through membership, we have issued funding agreements to the FHLB in exchange for cash advances. As of June 30, 2020 and December 31, 2019, we had $2,101 million and $1,226 million, respectively, of FHLB funding agreements outstanding. We are required to provide collateral in excess of the funding agreement amounts outstanding, considering any discounts to the securities posted and prepayment penalties.
We have a funding agreement backed notes (FABN) program, which allows Athene Global Funding, a special-purpose, unaffiliated statutory trust, to offer its senior secured medium-term notes. Athene Global Funding uses the net proceeds from each sale to purchase one or more funding agreements from us. As of June 30, 2020 and December 31, 2019, we had $4,887 million and $3,700 million, respectively, of FABN funding agreements outstanding. We had $4,013 million of FABN capacity remaining as of June 30, 2020.
Pledged Assets and Funds in Trust (Restricted Assets)—The total restricted assets included on the condensed consolidated balance sheets are as follows:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
AFS securities |
$ |
$ |
|||||
Trading securities |
|||||||
Equity securities |
|||||||
Mortgage loans |
|||||||
Investment funds |
|||||||
Derivative assets |
|||||||
Short-term investments |
|||||||
Other investments |
|||||||
Restricted cash |
|||||||
Total restricted assets |
$ |
$ |
The restricted assets are primarily related to reinsurance trusts established in accordance with coinsurance agreements and the FHLB funding agreements described above.
Letters of Credit—We have undrawn letters of credit totaling $1,418 million as of June 30, 2020. These letters of credit were issued for our reinsurance program and expire between December 10, 2020 and June 19, 2023.
Litigation, Claims and Assessments
Corporate-owned Life Insurance (COLI) Matter – In 2000 and 2001, two insurance companies, which were subsequently merged into Athene Annuity and Life Company (AAIA), purchased broad based variable COLI policies from American General Life Insurance Company (American General) that, as of June 30, 2020, had an asset value of $396 million, and is included in other assets on the condensed consolidated balance sheets. In January 2012, the COLI policy administrator delivered to AAIA a supplement to the existing COLI policies and advised that American General and ZC Resource Investment Trust (ZC Trust) had unilaterally implemented changes set forth in the supplement that, if effective, would: (1) potentially negatively impact the crediting rate for the policies and (2) change the exit and surrender protocols set forth in the policies. In March 2013, AAIA filed suit against American General, ZC Trust, and ZC Resource LLC in Chancery Court in Delaware, seeking, among other relief, a declaration that the changes set forth in the supplement were ineffectual and in breach of the parties’ agreement. The parties filed cross motions for judgment as a matter of law, and the court granted defendants’ motion and dismissed without prejudice on ripeness grounds. The issue that negatively impacts the crediting rate for one of the COLI policies has subsequently been triggered and, on April 3, 2018, we filed suit against the same defendants in Chancery Court in Delaware seeking substantially similar relief. Defendants moved to dismiss and the court heard oral arguments on February 13, 2019. The court issued an opinion on July 31, 2019 that did not address the merits, but found that the Chancery Court did not have jurisdiction over our claims and directed us to either amend our complaint or transfer the matter to Delaware Superior Court. The matter has been transferred to the Delaware Superior Court. Defendants renewed their motion to dismiss and the Superior Court heard oral arguments on December 18, 2019. The Superior Court issued an opinion on May 18, 2020 in which it granted in part and denied in part defendants’ motion. The Superior Court denied defendants’ motion with respect to the issue that negatively impacts the crediting rate for one of the COLI policies, which issue will proceed to discovery. The Superior Court granted defendants’ motion and dismissed without prejudice on ripeness grounds claims related to the exit and surrender protocols set forth in the policies, and dismissed defendant ZC Resource LLC. If the supplement is ultimately deemed to be effective, the purported changes to the policies could impair AAIA’s ability to access the value of guarantees associated with the policies. The value of the guarantees included within the asset value reflected above is $196 million as of June 30, 2020.
57
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
Regulatory Matters – Beginning in 2015, our U.S. insurance subsidiaries have experienced increased complaints related to the conversion and administration of the block of life insurance business acquired in connection with our acquisition of Aviva USA and reinsured to affiliates of Global Atlantic. The life insurance policies included in this block have been and are currently being administered by AllianceOne Inc. (AllianceOne), a subsidiary of DXC Technology Company, which was retained by such Global Atlantic affiliates to provide third party administration services on such policies. AllianceOne also administers a small block of annuity policies that were on Aviva USA’s legacy policy administration systems that were also converted in connection with the acquisition of Aviva USA and have experienced some similar service and administration issues, but to a lesser degree.
As a result of the difficulties experienced with respect to the administration of such policies, we have received notifications from several state regulators, including but not limited to New York State Department of Financial Services (NYSDFS), the California Department of Insurance (CDI) and the Texas Department of Insurance, indicating, in each case, that the respective regulator planned to undertake a market conduct examinations or enforcement proceeding of the applicable U.S. insurance subsidiary relating to the treatment of policyholders subject to our reinsurance agreements with affiliates of Global Atlantic and the conversion of the life and annuity policies, including the administration of such blocks by AllianceOne. We have entered into consent orders with several states, including the NYSDFS, to resolve underlying matters in those states. All fines and costs, including those associated with remediation plans, paid in connection with the consent orders are subject to indemnification by Global Atlantic or affiliates of Global Atlantic. Global Atlantic is currently finalizing negotiations with the CDI to resolve the pending joint action related to the converted life insurance policies, and we expect to enter into a Stipulation and Waiver with the CDI to resolve that action in the near future.
In addition to the examinations and proceedings initiated to date, it is possible that other regulators may pursue similar formal examinations, inquiries or enforcement proceedings and that any examinations, inquiries and/or enforcement proceedings may result in fines, administrative penalties and payments to policyholders. While we do not expect the amount of any such fines, penalties or payments arising from these matters to be material to our financial condition, results of operations or cash flows, it is possible that such amounts could be material.
Pursuant to the terms of the reinsurance agreements between us and the relevant affiliates of Global Atlantic, the applicable affiliates of Global Atlantic have financial responsibility for the ceded life block and are subject to significant administrative service requirements, including compliance with applicable law. The agreements also provide for indemnification to us, including for administration issues.
On January 23, 2019, we received a letter from the NYSDFS, with respect to a pension risk transfer (PRT) transaction, which expressed concerns with our interpretation and reliance upon certain exemptions from licensing in New York in connection with certain activities performed by employees in our PRT channel, including specific activities performed within New York. On April 13, 2020, we entered into a consent order with the NYSDFS to resolve this matter. Pursuant to the consent order, the NYSDFS imposed a fine of $45 million, which was accrued in other liabilities on the consolidated balance sheets as of December 31, 2019, and paid during the second quarter of 2020.
Caldera Matters – On May 3, 2018, AHL filed a writ commencing litigation in the Supreme Court of Bermuda against a former officer of AHL, a former director of AHL (who is also considered a former officer pursuant to Bermuda law), and Caldera Holdings, Ltd. (Caldera). AHL alleges in the writ, among other things, that the defendants breached various duties owed to AHL under Bermuda law by using AHL’s confidential information in their attempted acquisition of a company referred to in the litigation as Company A. AHL is seeking injunctive relief and damages. Athene amended its writ on October 16, 2018. The trial court denied two separate motions to dismiss made by defendant Caldera on June 28, 2018 and by the former officer and former director defendants on January 14, 2019. On September 20, 2019, the Bermuda Court of Appeal affirmed both trial court rulings and dismissed the defendants’ appeal. Defendants have not further pursued an appeal of this decision to the Judicial Committee of the Privy Council, the court of final appeal for matters litigated in Bermuda. On March 17, 2020, we filed an application for leave to amend the complaint to more broadly assert defendants’ breaches of duties.
On May 3, 2018, following AHL’s filing of the writ in Bermuda described above, Caldera, Caldera Life Reinsurance Company, and Caldera Shareholder, L.P., commenced an action in the Supreme Court of the State of New York, County of New York, by filing a Summons with Notice against AHL, Apollo, certain affiliates of Apollo and Leon Black, a founder of Apollo. On July 12, 2018, plaintiffs filed a complaint alleging claims for tortious interference with prospective business relations, defamation, and unfair competition related to plaintiffs’ attempt to purchase Company A and seeking alleged damages of “no less than $1.5 billion.” AHL has moved to dismiss the complaint. On January 21, 2019, plaintiffs filed an amended complaint, which revised certain allegations about jurisdiction, venue and the merits of the plaintiffs’ claims. We have renewed our motion to dismiss and, on December 20, 2019, the court granted our motion to dismiss. Plaintiffs have filed an appeal, but failed to timely effectuate the appeal. Unless plaintiffs belatedly try to perfect their appeal, or to extend their time to do so, and are successful in such efforts, we believe that this litigation is concluded.
58
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
13. Segment Information
We operate our core business strategies out of one reportable segment, Retirement Services. In addition to Retirement Services, we report certain other operations in Corporate and Other.
Retirement Services—Retirement Services is comprised of our U.S. and Bermuda operations, which issue and reinsure retirement savings products and institutional products. Retirement Services has retail operations, which provide annuity retirement solutions to our policyholders. Retirement Services also has reinsurance operations, which reinsure multi-year guaranteed annuities, fixed indexed annuities, traditional one-year guarantee fixed deferred annuities, immediate annuities and institutional products from our reinsurance partners. In addition, our institutional operations, including funding agreements and group annuities, are included in our Retirement Services segment.
Corporate and Other—Corporate and Other includes certain other operations related to our corporate activities such as corporate allocated expenses, merger and acquisition costs, debt costs, preferred stock dividends, certain integration and restructuring costs, certain stock-based compensation and intersegment eliminations. In addition, we also hold capital in excess of the level of capital we hold in Retirement Services to support our operating strategy.
Financial Measures—Segment adjusted operating income available to common shareholders is an internal measure used by the chief operating decision maker to evaluate and assess the results of our segments.
Adjusted operating revenue is a component of adjusted operating income available to common shareholders and excludes market volatility and adjustments for other non-operating activity. Our adjusted operating revenue equals our total revenue, adjusted to eliminate the impact of the following non-operating adjustments:
• |
Change in fair values of derivatives and embedded derivatives – index annuities, net of offsets; |
• |
Investment gains (losses), net of offsets; and |
• |
VIE expenses, noncontrolling interests and other adjustments to revenues. |
The table below reconciles segment adjusted operating revenues to total revenues presented on the condensed consolidated statements of income (loss):
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Retirement Services |
$ |
$ |
$ |
$ |
|||||||||||
Corporate and Other |
446 |
24 |
56 |
||||||||||||
Non-operating adjustments |
|||||||||||||||
Change in fair values of derivatives and embedded derivatives – index annuities, net of offsets |
( |
) |
|||||||||||||
Investment gains (losses), net of offsets |
( |
) |
|||||||||||||
VIE expenses, noncontrolling interests and other adjustments to revenues |
|||||||||||||||
Total revenues |
$ |
$ |
$ |
$ |
Adjusted operating income available to common shareholders is an internal measure used to evaluate our financial performance excluding market volatility and expenses related to integration, restructuring, stock compensation and certain other expenses. Our adjusted operating income available to common shareholders equals net income available to Athene Holding Ltd. common shareholders adjusted to eliminate the impact of the following non-operating adjustments:
• |
Investment gains (losses), net of offsets; |
• |
Change in fair values of derivatives and embedded derivatives – index annuities, net of offsets; |
• |
Integration, restructuring and other non-operating expenses; |
• |
Stock-based compensation, excluding the long-term incentive plan (LTIP); and |
• |
Income tax (expense) benefit – non-operating. |
59
ATHENE HOLDING LTD.
Notes to Condensed Consolidated Financial Statements (Unaudited)
The table below reconciles segment adjusted operating income available to common shareholders to net income available to Athene Holding Ltd. common shareholders presented on the condensed consolidated statements of income (loss):
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Retirement Services |
$ |
$ |
$ |
$ |
|||||||||||
Corporate and Other |
( |
) |
( |
) |
( |
) |
|||||||||
Non-operating adjustments |
|||||||||||||||
Investment gains (losses), net of offsets |
( |
) |
|||||||||||||
Change in fair values of derivatives and embedded derivatives – index annuities, net of offsets |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Integration, restructuring and other non-operating expenses |
( |
) |
( |
) |
( |
) |
( |
) |
|||||||
Stock-based compensation, excluding LTIP |
( |
) |
( |
) |
( |
) |
|||||||||
Income tax (expense) benefit – non-operating |
( |
) |
( |
) |
|||||||||||
Net income (loss) available to Athene Holding Ltd. common shareholders |
$ |
$ |
$ |
( |
) |
$ |
The following represents total assets by segment:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Retirement Services |
$ |
$ |
|||||
Corporate and Other |
|||||||
Total assets |
$ |
$ |
60
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Index to Management’s Discussion and Analysis of Financial Condition and Results of Operations
61
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a leading retirement services company that issues, reinsures and acquires retirement savings products designed for the increasing number of individuals and institutions seeking to fund retirement needs. We generate attractive financial results for our policyholders and shareholders by combining our two core competencies of (1) sourcing long-term, generally illiquid liabilities and (2) investing in a high-quality investment portfolio, which takes advantage of the illiquid nature of our liabilities. Our steady and significant base of earnings generates capital that we opportunistically invest across our business to source attractively-priced liabilities and capitalize on opportunities.
We have established a significant base of earnings and, as of June 30, 2020, have an expected annual net investment spread for our Retirement Services segment, which measures our investment performance less the total cost of our liabilities, of 1–2% over the 9.2 year weighted-average life of our reserve liabilities. The weighted-average life includes deferred annuities, PRT group annuities, funding agreements, payout annuities and other products.
We operate our core business strategies out of one reportable segment, Retirement Services. In addition to Retirement Services, we report certain other operations in Corporate and Other. Retirement Services is comprised of our U.S. and Bermuda operations which issue and reinsure retirement savings products and institutional products. Corporate and Other includes certain other operations related to our corporate activities.
Our consolidated annualized ROE for the six months ended June 30, 2020 and the year ended December 31, 2019 was (3.4)% and 19.7%, respectively, and our consolidated annualized adjusted operating ROE was 7.8% and 14.1%, respectively. For the six months ended June 30, 2020 and the year ended December 31, 2019, in our Retirement Services segment, we generated an annualized net investment spread of 1.00% and 1.50%, respectively, and an annualized adjusted operating ROE of 11.4% and 17.3%, respectively. Our Retirement Services segment generated an annualized investment margin on deferred annuities of 1.81% and 2.46% for the six months ended June 30, 2020 and the year ended December 31, 2019, respectively. As of June 30, 2020, our deferred annuities had a weighted-average life of 8.7 years and made up a significant portion of our reserve liabilities.
The following table presents the deposits generated from our organic and inorganic channels:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Retail sales |
$ |
1,791 |
$ |
1,909 |
$ |
3,037 |
$ |
3,725 |
|||||||
Flow reinsurance |
2,265 |
1,125 |
3,126 |
2,145 |
|||||||||||
Funding agreements1
|
2,636 |
299 |
3,459 |
299 |
|||||||||||
Pension risk transfer |
229 |
706 |
1,246 |
2,629 |
|||||||||||
Total organic deposits |
6,921 |
4,039 |
10,868 |
8,798 |
|||||||||||
Inorganic deposits |
28,792 |
— |
28,792 |
— |
|||||||||||
Gross deposits |
35,713 |
4,039 |
39,660 |
8,798 |
|||||||||||
Deposits attributable to ACRA noncontrolling interest |
(18,268 |
) |
— |
(18,268 |
) |
— |
|||||||||
Net deposits |
$ |
17,445 |
$ |
4,039 |
$ |
21,392 |
$ |
8,798 |
|||||||
1 Funding agreements are comprised of our funding agreement backed note program, Federal Home Loan Bank secured funding agreements and long-term repurchase agreements.
|
Our organic channels, including retail, flow reinsurance and institutional products, provided deposits of $10.9 billion and $8.8 billion in the six months ended June 30, 2020 and 2019, respectively, which were underwritten to attractive, at-or-above target returns despite the historically low interest rate environment. Organic deposits increased $2.1 billion, or 24%, reflecting the strength of our multi-channel distribution platform despite a challenging macroeconomic backdrop amidst the ongoing COVID-19 crisis. Withdrawals on our deferred annuities, maturities of our funding agreements, payments on payout annuities and pension risk benefit payments (collectively, liability outflows), in the aggregate, were $6.0 billion and $5.7 billion for the six months ended June 30, 2020 and 2019, respectively. We believe that our credit profile, our current product offerings and product design capabilities as well as our growing reputation as both a seasoned funding agreement issuer and a reliable PRT counterparty will continue to enable us to grow our existing organic channels and allow us to source additional volumes of profitably underwritten liabilities in various market environments. We plan to continue to grow organically by expanding each of our retail, flow reinsurance and institutional distribution channels. We believe that we have the right people, infrastructure and scale to position us for continued growth.
62
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Within our retail channel, we had fixed annuity sales of $3.0 billion and $3.7 billion for the six months ended June 30, 2020 and 2019, respectively. The decrease in our retail channel was primarily driven by a significant decline in industry-wide sales volumes as a result of the economic impacts of the spread of COVID-19, as well as the mitigation measures undertaken to combat the spread, which has complicated the sales process. The decrease was partially offset by relatively strong company performance amidst this industry backdrop as we continued to experience strong production in the bank and broker-dealer channels and demonstrate strong sales execution despite the challenging sales environment. Despite the significant headwinds, we have maintained our disciplined approach to pricing, including with respect to targeted underwritten returns. We aim to grow our retail channel by deepening our relationships with our approximately 50 independent marketing organizations (IMO); approximately 53,000 independent agents; and our growing network of 14 small and mid-sized banks and 94 regional broker-dealers. Our strong financial position and capital efficient products allow us to be dependable partners with IMOs, banks and broker-dealers as well as consistently write new business. We expect our retail channel to continue to benefit from our credit profile and recent product launches. We believe this should support growth in sales at our desired cost of funds through increased volumes via current IMOs, while also allowing us to continue to expand our bank and broker-dealer channels. Additionally, we are focusing on hiring and training a specialized sales force and creating products to capture new potential distribution opportunities.
In our flow reinsurance channel, we target reinsurance business consistent with our preferred liability characteristics and, as such, flow reinsurance provides another opportunistic channel for us to source liabilities with attractive crediting rates. We generated deposits through our flow reinsurance channel of $3.1 billion and $2.2 billion for the six months ended June 30, 2020 and 2019, respectively. The increase in our flow reinsurance channel from prior year was driven by strong volumes with existing partnerships. In July we established a new flow reinsurance partnership with a large Japanese financial institution, marking our entry into the large Japanese annuity market. We expect that our credit profile and our reputation as a solutions provider will help us continue to source additional reinsurance partners, which will further diversify our flow reinsurance channel.
Within our institutional channel, we generated deposits of $4.7 billion and $2.9 billion for the six months ended June 30, 2020 and 2019, respectively. The increase in our institutional channel was driven by higher funding agreement deposits, partially offset by lower PRT deposits. During the six months ended June 30, 2020, we issued funding agreements in the aggregate principal amount of $3.5 billion and $299 million for the six months ended June 30, 2020 and 2019, respectively, including our inaugural Euro denominated FABN. Funding agreements are comprised of our funding agreement backed note program, Federal Home Loan Bank secured funding agreements and long-term repurchase agreements with deposits in the aggregate principal amount of $2.0 billion, $875 million and $598 million for the six months ended June 30, 2020, respectively. We closed two PRT transactions and issued group annuity contracts in the aggregate principal amount of $1.3 billion, compared to $2.6 billion during the six months ended June 30, 2019. Since entering the PRT channel in 2017 through June 30, 2020, we have closed 18 deals involving more than 181,000 plan participants resulting in the issuance of group annuities of $12.1 billion. We expect to grow our institutional channel by continuing to engage in PRT transactions and opportunistic issuances of funding agreements.
Our inorganic channel has contributed significantly to our growth through both acquisitions and block reinsurance transactions. On June 18, 2020, we entered into an agreement with Jackson, effective June 1, 2020, pursuant to which we agreed to reinsure a block of fixed and fixed indexed annuities on a funds withheld coinsurance basis providing $28.8 billion of gross deposits. Utilizing the strategic benefits of ACRA, approximately 63% of the total capital deployment for the transaction will be funded by third-party investors and approximately 37% will be funded by ALRe. Additionally, as part of the transaction, ACRA made a $500 million equity investment in an indirect parent of Jackson, which closed on July 17, 2020. We expect that our inorganic channel will continue to be an important source of profitable growth in the future. We believe our internal transactions team, with support from Apollo, has an industry-leading ability to source, underwrite and expeditiously close transactions. With support from Apollo, we are a solutions provider with a proven track record of closing transactions, which we believe makes us the ideal partner to insurance companies seeking to restructure their business.
Executing our growth strategy requires that we have sufficient capital available to deploy. We believe that we have significant capital available to us to support our growth aspirations. As of June 30, 2020, we estimate that we have approximately $7.3 billion in capital available to deploy, consisting of approximately $3.0 billion in excess capital, $2.5 billion in untapped debt capacity (assuming a peer average adjusted debt to capitalization ratio of 25%) and $1.8 billion in available uncalled capital at ACRA, subject, in the case of debt capacity, to favorable market conditions and general availability.
In order to support our growth strategies and capital deployment opportunities, we established ACRA as a long-duration, on-demand capital vehicle. Effective April 1, 2020, ALRe purchased additional shares in ACRA increasing our ownership from the original 33% to 36.55% of the economic interests, with the remaining 63.45% of the economic interests being owned by ADIP, a series of funds managed by an affiliate of Apollo. ACRA is expected to participate in qualifying transactions and certain other transactions by drawing a portion of the required capital for such transactions from third-party investors equal to ADIP’s proportionate economic interest in ACRA. This shareholder-friendly, strategic capital solution is expected to allow us the flexibility to simultaneously deploy capital across multiple accretive avenues, while maintaining a strong financial position.
Strategic Transaction with Apollo
On February 28, 2020, we closed a transaction with Apollo in which Apollo acquired an incremental stake in us for AOG units valued at $1.1 billion, upon close, and $350 million of cash. Additionally, we converted our Class B common shares to Class A common shares and our Class M common shares to Class A common shares and warrants, eliminating our multi-class share structure. The AOG units are reflected within the change in fair value of Apollo investment, net of tax line item and may present future volatility in our results of operations due to changes in the valuation of the AOG units. See Note 11 – Related Parties to the consolidated financial statements for further discussion.
63
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Industry Trends and Competition
Market Conditions
Market performance in the second quarter was primarily characterized by the significant rally seen across risk assets. Equity markets moved higher at a pace with limited historical precedent, coming close to reversing the significant underperformance of the first quarter by the middle of June. Fixed income securities rallied as well, with credit spreads on investment grade securities tightening approximately 250 basis points from the maximum levels by the end of the quarter, and parts of structured product, high yield, and other sectors outperforming to an even greater degree relative to their maximum levels (credit spreads on AAA-rated CLOs tightened 360 basis points and credit spreads on high yield securities tightened 435 basis points in the same time period). Energy markets, particularly oil, which was a secondary cause of volatility in the first quarter, saw more modest improvements, but in general, the market tone broadly stood in stark contrast to that of the first three months of the year. The nature of the response to COVID-19 by global central banks was the primary reason for the rally observed during the second quarter, and the various backstops, economic protections, and purchase programs put in place thus far significantly exceed all historical measures undertaken, including those undertaken in the midst of the Global Financial Crisis, with respect to both size and speed. Not all sectors have benefited equally from the rally and there are meaningful segments of the markets and the economy that remain challenged as a result - travel and leisure, transportation, entertainment, dining, brick and mortar retail, autos and lodging all face significant challenges in the near-term, and early indications from the second quarter earnings season suggest banks and other sectors are preparing for a challenged economic environment as well.
Interest Rate Environment
Both as a result of significant central bank intervention and a continued flight-to-quality trade (coupled with the ongoing global search for yield), interest rates remained close to all-time lows throughout the quarter. Importantly, yields outside of the U.S., which had been close to zero, and in some cases negative, moved even lower, exacerbating demand. Communications from global central banks suggest that market support will continue, although there remains significant additional purchasing to complete relating to previously announced programs, both in the U.S. and elsewhere.
The environment for yield focused buyers remains challenging. Quality names and structures will remain well-bid ensuring that yields on these assets remains relatively low. Credit spreads have a good amount of room to tighten before they come close to the lows of the last three years (approximately 40-50 basis points on U.S. investment grade credit, for example), and so will likely continue to attract buyers. On the supply side, the new issues market remains robust, even considering the current credit spread environment. Therefore, deployment challenges are likely to persist.
Our investment portfolio consists predominantly of fixed maturity investments. See –Consolidated Investment Portfolio. If prevailing interest rates were to rise, we believe the yield on our new investment purchases may also rise and our investment income from floating rate investments would increase, while the value of our existing investments may decline. If prevailing interest rates were to decline, it is likely that the yield on our new investment purchases may decline and our investment income from floating rate investments would decrease, while the value of our existing investments may increase. Year-to-date trends have entailed decreasing interest rates leading to a decrease in our investment income from floating rate investments, whereas widening credit spreads have resulted in an overall increase in asset yields, which we expect would result in an increase in the yield on our new investment purchases and a decline in the value of our existing investments.
We address interest rate risk through managing the duration of the liabilities we source with assets we acquire through ALM modeling. As part of our investment strategy, we purchase floating rate investments, which we expect would perform well in a rising interest rate environment and which we expect would underperform in a declining rate environment, such as has been experienced during the first half of 2020. Our investment portfolio includes $23.5 billion of floating rate investments, or 17% of our net invested assets as of June 30, 2020.
If prevailing interest rates were to rise, we believe our products would be more attractive to consumers and our sales would likely increase. If prevailing interest rates were to decline, it is likely that our products would be less attractive to consumers and our sales would likely decrease. In periods of prolonged low interest rates, the net investment spread may be negatively impacted by reduced investment income to the extent that we are unable to adequately reduce policyholder crediting rates due to policyholder guarantees in the form of minimum crediting rates or otherwise due to market conditions. As of June 30, 2020, most of our products were fixed annuities with 23% of our FIAs at the minimum guarantees and 42% of our fixed rate annuities at the minimum crediting rates. As of June 30, 2020, minimum guarantees on all of our deferred annuities, including those with crediting rates already at their minimum guarantees, were, on average, greater than 100 basis points below the crediting rates on such deferred annuities, allowing us room to reduce rates before reaching the minimum guarantees. Our remaining liabilities are associated with immediate annuities, pension risk transfer obligations, funding agreements and life contracts for which we have little to no discretionary ability to change the rates of interest payable to the respective policyholder. A significant majority of our deferred annuity products have crediting rates that we may reset annually upon renewal, following the expiration of the current guaranteed period. While we have the contractual ability to lower these crediting rates to the guaranteed minimum levels, our willingness to do so may be limited by competitive pressures.
64
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
See Part I—Item 3. Quantitative and Qualitative Disclosures About Market Risks to this report and Part II—Item 7A. Quantitative and Qualitative Disclosures About Market Risks in our 2019 Annual Report, which includes a discussion regarding interest rate and other significant risks and our strategies for managing these risks.
COVID-19
The spread of COVID-19 has resulted in significant volatility in the financial markets. The extent to which COVID-19 and the resulting impact on economic conditions and the financial markets may impact our business will depend on future developments and represents a material uncertainty to our business.
Risks and Mitigation Measures
The spread of COVID-19 presents three principal risks to our business: 1) business continuity risk; 2) market risk and 3) liquidity risk, including that resulting from policyholder behavior.
Business Continuity Risk. The spread of COVID-19 threatens the health and safety of our most valuable asset, our people. To mitigate the risk that the virus infects members of our workforce, to ensure the continuity of our operations throughout the duration of this pandemic and to ensure uninterrupted servicing of the policyholders who have entrusted us for their retirement needs, during March 2020 we implemented our business continuity plan. Pursuant to that plan, we implemented remote work protocols pursuant to which the significant majority of our employees worked remotely, with only certain operationally essential employees working at our facilities, to the extent lawfully permitted. For the operationally essential employees who continued working at our facilities, we implemented new safety protocols that incorporated recommendations, guidelines and regulations from the Center for Disease Control and other national, state and local health authorities, including mandated temperature screenings upon entering the building; the appropriate practice of social distancing, which includes but is not limited to a reduction in the number of people allowed in conference rooms and limiting elevator car capacity; the requirement to wear face coverings; and limitations on movement in the building, among other requirements designed to reduce the risk of transmission between employees (collectively, Safety Protocols). In addition, we implemented enhanced cleaning protocols, which include increased staff to clean common areas; availability of cleaning supplies, face coverings and hand sanitizer throughout our facilities that are operational; and actively encouraging our employees to adopt enhanced hygiene practices. On June 1, 2020, we commenced our repopulation plan with the first wave of employees returning to the office. Thereafter, employees returned in three additional waves, with each wave following the prior by at least two weeks. We expect a final wave, comprised of individuals with special circumstances, to return to the office in the coming months as their individual circumstances allow. As of July 31, 2020, a majority of our workforce had returned to the office. Prior to the commencement of our repopulation plan, all employees were required to complete a comprehensive training covering our repopulation plan and our Safety Protocols. We have implemented case investigation and contact tracing procedures to appropriately identify and quarantine those individuals who have been or may have been exposed to the virus. As of July 31, 2020, we had eight employees who had been certified as contact tracers through Johns Hopkins University. We have been successful in implementing our business continuity and repopulation plans and to date have experienced no material impairment to our business operations. We continue to closely monitor our situation and the recommendations and guidelines issued by national, state and local health authorities.
Market Risk. The effects of the spread of COVID-19 on economic conditions and the financial markets may trigger or increase the market risks to which we are subject, namely interest rate risk, credit risk and public equity risk. The spread of COVID-19 and the Federal Reserve’s responsive measures have resulted in abrupt and significant decreases in interest rates and abrupt and significant increases in credit spreads. Changes in interest rates and credit spreads may result in a decrease in the value of our invested assets. To the extent that we needed to sell assets at these decreased values in order to satisfy our obligations, we would realize losses. However, approximately 75% of our deferred annuities have surrender charges, and 58% have market value adjustment features, which we believe greatly reduce the likelihood and magnitude of unexpected withdrawals. Further, our PRT and funding agreement obligations are predominantly non-surrenderable. In addition, we mitigate interest rate risk by managing the effective duration of our assets and liabilities. In doing so, we closely monitor and manage our net duration mismatch as well as our cash inflows and outflows. Decreases in interest rates impact the interest income that we receive on our floating rate assets. For the six months ended June 30, 2020, we recognized $92 million less in floating rate income than we recognized for the six months ended June 30, 2019, primarily as a result of the declines in interest rates occurring during the six months ended June 30, 2020.
A greater proportion of the companies that issued the securities that we hold in our investment portfolio are more likely to experience financial hardship as a result of the economic effects of COVID-19. We mitigate such risk by actively managing our investment portfolio and attempting to exit or reduce exposures we deem to carry disproportionate risk when compared to their return profile. For the six months ended June 30, 2020, we recognized increased intent to sell impairments of $8 million when compared to the six months ended June 30, 2019, as a result of our active portfolio management.
65
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We are exposed to public equity risk through the index crediting on our FIA products, our AOG unit holdings and our common stock holdings in OneMain Holdings, Inc. (OneMain). We effectively eliminate the public equity risk arising from the index crediting on our FIA products by hedging the relevant index performance over the crediting period. Though this results in an effective hedge for economic purposes, because the instruments used to hedge the index crediting period are for a shorter term than the FIA contract, the hedge is not deemed effective for accounting purposes and results in the recognition of gains and losses from period to period. The public equity volatility arising from our holdings of AOG Units and OneMain stock is unhedged. During the six months ended June 30, 2020, we recognized an income statement impact of $(197) million resulting from our FIA products (net of offsets) and decreases in the market value of our OneMain holding, partially offset by an increase in the market value of our AOG holding, as the share price in the second quarter rebounded following market value decreases in the first quarter.
Liquidity Risk. In the current market environment, liquidity risk can arise in several areas of our business, including but not limited to asset-liability mismatch and policyholder behavior risk. As noted above, most of our deferred annuities have surrender charges and market value adjustments, which reduce the likelihood and magnitude of expected withdrawals, and our PRT and funding agreement obligations are predominantly non-surrenderable.
To be prepared to capitalize on growth opportunities that may arise in the current market environment as well as to manage any near-term liquidity risk, we have strategically increased our available liquidity. As of June 30, 2020, excluding the impact of the reinsurance transaction with Jackson National, we had approximately $8.5 billion of available liquidity comprised of $5.2 billion of cash and approximately $3.3 billion of undrawn capacity under various financing facilities. We have taken measures to increase our financial flexibility, including negotiating new committed lending facilities and retaining a portion of the proceeds received from our organic channels in cash and other highly liquid assets. We have also entered into several new securities repurchase arrangements with different financial institutions to provide access to additional short-term liquidity, to the extent available. As economic conditions stabilize, we will seek to invest our excess liquidity in yield producing assets.
With a record number of individuals finding themselves abruptly out of work and searching for sources of liquidity, we face policyholder behavior risk in the form of increased withdrawal levels and lapse rates may be elevated. We have been closely monitoring policyholder behavior on a daily basis. As of July 31, 2020, we had noticed no material adverse change in policyholder behavior. We mitigate policyholder behavior risk by monitoring and projecting cash inflows and outflows and by maintaining greater levels of available liquidity.
Emerging Trends
As a result of the spread of COVID-19, the resulting impact on economic conditions and the financial markets and the mitigation efforts we have undertaken in response, we expect to see several trends impacting our future operating results.
First, we have held and could continue to hold a greater proportion of our invested assets in cash and other liquid assets which could impact our net investment earned rates and net spread. As economic conditions stabilize, we expect to see this trend begin to reverse as we seek to invest our excess liquidity in yield producing assets and also as we continue to redeploy the Jackson investment portfolio.
Second, we expect that the current market environment will cause certain issuers of securities held in our investment portfolio to experience financial hardship, resulting in recognition of credit losses or impairments. For the six months ended June 30, 2020, we had a provision for credit losses, net of noncontrolling interests, of $281 million. While we cannot predict the duration or severity of the current economic downturn, we regularly perform stress testing of our investment portfolio under two hypothetical scenarios: a baseline recession scenario and a deep recession scenario. The assumptions for each hypothetical scenario and past experience are included in the chart below.
Athene Assumptions |
Sample Historical Recession Data Peak to Trough for Calendar Year |
||||||||||
Baseline
Recession
Scenario
|
Deep
Recession
Scenario
|
1990 |
2001 |
2008 |
Euro 2016 |
||||||
10 Yr US Treasury Yield |
Down 60% |
Down 83% |
Up 4% |
Down 21% |
Down 43% |
Down 84%1
|
|||||
Absolute Spreads
(BBB / B)
|
279bps /
802bps
|
636bps / 1,789bps |
240bps /
NA
|
318bps /
1,083bps
|
642bps /
1,913bps
|
317bps /
876bps
|
|||||
Equity Markets2
|
(25)% |
(49)% |
(20)% |
(30)% |
(49)% |
(12)% |
|||||
FI Defaults
(BBB / B)
|
0.70% /
12.9%
|
1.4% /
13.7%
|
0.30% /
13.7%
|
1.01% /
9.2%
|
0.9% /
7.1%
|
0.0% /
2.4%
|
|||||
Housing Price
(Peak to Trough)
|
(3)% |
(27)% |
(3)% |
No Decline |
(33)% |
No Decline |
|||||
1 German 10-year bund yield.
| |||||||||||
2 Primarily for representative purposes. Stress scenarios apply customized stresses as relevant for Alternatives sub-categories.
|
66
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In March 2020, we evaluated our investment portfolio under these hypothetical stress scenarios and estimated that absent any management intervention, we would recognize credit losses and impairments, net of DAC and tax offsets, as well as losses in our alternatives portfolio, of approximately $1 billion and $2 billion under the baseline recession scenario and deep recession scenario, respectively. These scenarios are hypothetical and are not representative of the current economic environment and even if representative, actual results may differ materially from estimates.
Third, we have experienced downward pressure on the valuation of our alternative investments portfolio. During the six months ended June 30, 2020, we experienced a decrease in net income of $137 million attributed to mark-to-market performance of our alternative investments. A significant driver of this decrease is the fact that approximately 60% of our alternatives portfolio is accounted for on a one to three month lag. Therefore, the adverse impact of the economic environment during the three months ended March 31, 2020 drove the unfavorable performance. We would expect to see some of the second quarter recovery reflected in our third quarter performance for those alternatives reported on a lag.
Fourth, the substantial decrease in interest rates during the six months ended June 30, 2020 will have a negative impact on adjusted operating income if the current rates persist for a prolonged period. Currently, we estimate that a 25 basis point decrease in interest rates that persists for a 12-month period will result in an approximate $30 – $35 million decrease in adjusted operating income.
The spread of COVID-19, the resulting impact on economic conditions and the financial markets and the mitigating efforts we have and will undertake may have consequences to our business that are unforeseen at this time. The emerging trends identified above do not purport to be complete and actual experience may differ materially from our current expectations.
Discontinuation of LIBOR
The UK Financial Conduct Authority (FCA) has announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. It is expected that a number of private-sector banks currently reporting information used to set LIBOR will stop doing so after 2021 when their current reporting commitment ends, which could either cause LIBOR to stop publication immediately or cause the FCA to determine that the quality of LIBOR has degraded to the degree that LIBOR is no longer representative of its underlying market. With an estimated $200 trillion in notional transactions referencing USD LIBOR in the cash and derivatives markets, including more than $35 trillion extending past 2021, the discontinuation of LIBOR could have a significant impact on the financial markets and represents a material uncertainty to our business.
To manage the uncertainty surrounding the discontinuation of LIBOR we have established a plan, which involves the following six phases: (1) identify and quantify our exposure to LIBOR; (2) establish a counterparty communication strategy; (3) evaluate the specific risks to our business arising as a result of the transition; (4) identify actions that we can take to mitigate the risks identified in phase 3; (5) monitor market developments regarding the adoption of a replacement rate; and (6) transition to the market consensus rate or rates once such rate or rates emerge and are operational.
The phases of our plan are not discrete and need not occur in chronological order. Our plan is subject to change as we gain additional information. We have created an Executive Steering Committee composed of senior executives to coordinate and oversee the execution of our plan.
As of June 30, 2020, we had contracts tied to LIBOR in the notional amounts set forth in the table below:
(In millions) |
Total Exposure |
Extending Beyond 2021 |
|||||
Investments |
$ |
22,952 |
$ |
19,673 |
|||
Product Liabilities |
13,680 |
3,128 |
|||||
Derivatives Hedging Product Liabilities |
18,761 |
1,143 |
|||||
Other Derivatives |
477 |
477 |
|||||
Other Contracts |
2,963 |
2,663 |
|||||
Total notional of contracts tied to LIBOR |
$ |
58,833 |
$ |
27,084 |
67
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Investments
As of June 30, 2020, our investments tied to LIBOR were in the following asset classes:
(In millions) |
Total Exposure |
Extending Beyond 2021 |
|||||
Multi-lateral Arrangements |
|||||||
Corporates |
$ |
900 |
$ |
504 |
|||
RMBS |
4,208 |
3,983 |
|||||
CMBS |
346 |
45 |
|||||
CLO |
11,525 |
11,438 |
|||||
ABS |
1,511 |
1,435 |
|||||
Bank Loans |
459 |
280 |
|||||
Total Multi-lateral Arrangements |
18,949 |
17,685 |
|||||
Bi-lateral Arrangements |
|||||||
CML |
3,864 |
1,849 |
|||||
RML |
139 |
139 |
|||||
Total Bi-lateral Arrangements |
4,003 |
1,988 |
|||||
Total investments tied to LIBOR |
$ |
22,952 |
$ |
19,673 |
Of the total notional value of investment-related contracts tied to LIBOR, extending beyond 2021, $17.7 billion or 89.9% relate to multi-lateral arrangements. These arrangements are typically characterized by a large, diverse set of unrelated holders, the majority or all of whom must consent to amendments to the terms of the underlying investment instrument. Generally, when the amendments concern a material term such as the determination of interest, consent must be unanimous. Given the collective action issues inherent in such structures, such consent is typically impracticable and beyond our control. To the extent that such legacy arrangements do not contemplate the permanent discontinuation of LIBOR, we would look to some broad-based solution, such as the Alternative Reference Rates Committee’s proposed New York law amendment, to rectify such deficiency. To the extent that the fallback rates ultimately used to determine interest payable on such investments do not align with the fallback rates used to determine interest payable on the underlying assets, economic losses could be sustained on the overall structure.
The remaining notional value of investment-related contracts tied to LIBOR extending beyond 2021 of $2.0 billion or 10.1% relates to bi-lateral arrangements that are capable of being amended through negotiation with the relevant counterparty.
As our investment manager, Apollo maintains the documentation associated with the assets in our investment portfolio. We are therefore dependent upon Apollo for the successful completion of our LIBOR transition efforts relating to our investment portfolio. See Part II–Item 1A. Risk Factors–Uncertainty relating to the LIBOR Calculation process and potential phasing out of LIBOR after 2021 may adversely affect the value of our investment portfolio, our ability to achieve our hedging objectives and our ability to issue funding agreements bearing a floating rate of interest. Apollo’s failure to fulfill its responsibilities could have an adverse impact on our results of operations and ability to timely report accurate financial information.
Product Liabilities and Associated Hedging Instruments
As of June 30, 2020, we had product liabilities with a notional value of approximately $13.7 billion for which LIBOR is a component in the determination of interest credited, of which we expect $3.1 billion to extend beyond 2021. Generally, there are two categories of indices that use LIBOR in the determination of interest credited, “excess return” indices (return of index in excess of LIBOR), for which we have previously disclosed exposure values, and indices that use LIBOR as a means to control volatility, which we identified during the current period. The indices to which these products are tied are primarily proprietary indices for which key inputs are determined by the index sponsor. The index sponsor has the right to unilaterally change the reference rate upon the discontinuation of LIBOR. As a result, we do not anticipate any administrative concerns in connection with the transition from LIBOR to a replacement rate with respect to these products.
As of June 30, 2020, we held derivatives with a notional value of approximately $18.8 billion to hedge our exposure to these product liabilities, of which we expect $1.1 billion to extend beyond 2021. Included within this category are $4.3 billion of Eurodollar futures, of which we expect $1.1 billion to extend beyond 2021. Exchange traded products such as Eurodollar futures will follow the CME Group Inc.’s approach regarding the discontinuation of LIBOR. The remaining derivatives in this category are primarily purchased to hedge the current crediting period. We expect that substantially all of such derivatives will expire before the end of 2021. We will be required to purchase new derivatives in future periods to hedge future crediting periods associated with the related existing product liabilities, which will expose us to potential basis mismatch to the extent that the reference rate for the product liability is not the same as the reference rate for the derivative instrument.
68
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Other Derivatives
Our other derivative contracts tied to LIBOR are generally entered into pursuant to an ISDA Master Agreement. We believe that fallbacks contemplating a permanent discontinuation of LIBOR will be integrated into the ISDA Master Agreement and applied to our outstanding obligations via standard protocol counterparty consent. To the extent that the fallbacks ultimately incorporated into our other derivative contracts result in the use of a replacement rate that differs from that employed in the contract being hedged, we may experience basis mismatch. We will continue to evaluate this risk as fallbacks become better defined.
Other Contracts and Other Sources of Exposure
Other contracts is comprised of our credit agreement, floating rate funding agreements and fixed-to-float Series A preference shares, all of which contemplate the permanent discontinuation of LIBOR or have fallback provisions in place that provide for the determination of interest after the discontinuation of LIBOR. In addition to the other contracts for which we have quantified our exposure, we are party to contracts that are tied to LIBOR based upon the occurrence of some remote contingency, such as the accrual of penalty interest, or for which LIBOR is otherwise not a material term of the contract. These contracts do not lend themselves to quantification and are lower in priority in our LIBOR remediation efforts. Finally, LIBOR is used as a component in our internal derivative valuation models. We intend to transition the benchmark yield curve in such models from LIBOR to the Secured Overnight Financing Rate prior to the discontinuation of LIBOR. Such transition may affect the valuation of our derivative instruments.
We can provide no assurance that we will be successful at completing all the phases of our plan prior to the discontinuation of LIBOR. Completion of certain phases of our plan are contingent upon market developments and are therefore not fully within our control. To the extent management effort and attention is focused on other matters, such as responding to the risks posed by COVID-19, the timely completion of our plan could become more difficult. Failure to complete all phases of our plan prior to the discontinuation of LIBOR may have a material adverse effect on our business, financial position, results of operations and cash flows and on our ability to timely report accurate financial information.
Demographics
Over the next four decades, the retirement-age population is expected to experience unprecedented growth. Technological advances and improvements in healthcare are projected to continue to contribute to increasing average life expectancy, and aging individuals must be prepared to fund retirement periods that will last longer than ever before. Further, many working households in the United States do not have adequate retirement savings. As a tool for addressing the unmet need for retirement planning, we believe that many Americans have begun to look to tax-efficient savings products with low-risk or guaranteed return features and potential equity market upside. Our tax-efficient savings products are well positioned to meet this increasing customer demand.
Competition
We operate in highly competitive markets. We face a variety of large and small industry participants, including diversified financial institutions and insurance and reinsurance companies. These companies compete in one form or another for the growing pool of retirement assets driven by a number of external factors such as the continued aging of the population and the reduction in safety nets provided by governments and private employers. In the markets in which we operate, scale and the ability to provide value-added services and build long-term relationships are important factors to compete effectively. We believe that our leading presence in the retirement market, diverse range of capabilities and broad distribution network uniquely position us to effectively serve consumers’ increasing demand for retirement solutions, particularly in the FIA market.
According to LIMRA, total fixed annuity market sales in the United States were $29.9 billion for the three months ended March 31, 2020, a 21.5% decrease from the same time period in 2019 as interest rates pulled down crediting rates in all fixed product lines. In the total fixed annuity market, for the three months ended March 31, 2020 (the most recent period for which specific market share data is available), we were the 7th largest company based on sales of $1.2 billion, translating to a 4.1% market share. For the three months ended March 31, 2019, our market share was 4.8% with sales of $1.8 billion.
According to LIMRA, total fixed annuity sales in the United States were $139.8 billion for the year ended December 31, 2019, a 4.7% increase from the year ended December 31, 2018. In the total fixed annuity market, for the year ended December 31, 2019, we were the 5th largest company based on sales of $6.8 billion, translating to a 4.8% market share. For the year ended December 31, 2018, our market share was 5.6% with sales of $7.5 billion.
FIAs have been one of the fastest growing annuity products, having grown from $27.3 billion in sales for the year ended December 31, 2005 to $73.5 billion in sales for the year ended December 31, 2019. According to LIMRA data, for the three months ended March 31, 2020 (the most recent period for which specific market share data is available), we were the 4th largest provider of FIAs based on sales of $1.1 billion, and our market share for the same period was 6.7%. For the three months ended March 31, 2019, we were the 2nd largest provider of FIAs based on sales of $1.6 billion, translating to an 8.9% market share.
According to LIMRA, for the year ended December 31, 2019, we were the 2nd largest provider of FIAs based on sales of $6.1 billion, and our market share for the same period was 8.3%. For the year ended December 31, 2018, we were the 2nd largest provider of FIAs based on sales of $6.6 billion, translating to a 9.4% market share.
69
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Key Operating and Non-GAAP Measures
In addition to our results presented in accordance with GAAP, we present certain financial information that includes non-GAAP measures. Management believes the use of these non-GAAP measures, together with the relevant GAAP measures, provides information that may enhance an investor’s understanding of our results of operations and the underlying profitability drivers of our business. The majority of these non-GAAP measures are intended to remove from the results of operations the impact of market volatility (other than with respect to alternative investments) as well as integration, restructuring and certain other expenses which are not part of our underlying profitability drivers, as such items fluctuate from period to period in a manner inconsistent with these drivers. These measures should be considered supplementary to our results in accordance with GAAP and should not be viewed as a substitute for the corresponding GAAP measures.
Adjusted Operating Income (Loss) Available to Common Shareholders
Adjusted operating income (loss) available to common shareholders is a non-GAAP measure used to evaluate our financial performance excluding market volatility and expenses related to integration, restructuring, stock compensation and other expenses. Our adjusted operating income (loss) available to common shareholders equals net income (loss) available to AHL common shareholders adjusted to eliminate the impact of the following (collectively, the non-operating adjustments):
• |
Investment Gains (Losses), Net of Offsets—Consists of the realized gains and losses on the sale of AFS securities, the change in fair value of reinsurance assets, unrealized gains and losses, allowances, and other investment gains and losses. Unrealized, allowances and other investment gains and losses are comprised of the fair value adjustments of trading securities (other than CLOs) and investments held under the fair value option, derivative gains and losses not hedging FIA index credits, and the change in credit loss allowances recognized in operations net of the change in AmerUs Closed Block fair value reserve related to the corresponding change in fair value of investments and the change in unit-linked reserves related to the corresponding trading securities. Investment gains and losses are net of offsets related to DAC, DSI, and VOBA amortization and changes to guaranteed lifetime withdrawal benefit (GLWB) and guaranteed minimum death benefit (GMDB) reserves (together, GLWB and GMDB reserves represent rider reserves) as well as the market value adjustments (MVA) associated with surrenders or terminations of contracts.
|
• |
Change in Fair Values of Derivatives and Embedded Derivatives – FIAs, Net of Offsets—Consists of impacts related to the fair value accounting for derivatives hedging the FIA index credits and the related embedded derivative liability fluctuations from period to period. The index reserve is measured at fair value for the current period and all periods beyond the current policyholder index term. However, the FIA hedging derivatives are purchased to hedge only the current index period. Upon policyholder renewal at the end of the period, new FIA hedging derivatives are purchased to align with the new term. The difference in duration between the FIA hedging derivatives and the index credit reserves creates a timing difference in earnings. This timing difference of the FIA hedging derivatives and index credit reserves is included as a non-operating adjustment, net of offsets related to DAC, DSI, and VOBA amortization and changes to rider reserves.
|
We primarily hedge with options that align with the index terms of our FIA products (typically 1–2 years). From an economic basis, we believe this is suitable because policyholder accounts are credited with index performance at the end of each index term. However, because the term of an embedded derivative in an FIA contract is longer-dated, there is a duration mismatch which may lead to mismatches for accounting purposes.
• |
Integration, Restructuring, and Other Non-operating Expenses—Consists of restructuring and integration expenses related to acquisitions and block reinsurance costs as well as certain other expenses, which are not predictable or related to our underlying profitability drivers.
|
• |
Stock Compensation Expense—Consists of stock compensation expenses associated with our share incentive plans, excluding our long-term incentive plan, which are not related to our underlying profitability drivers and fluctuate from time to time due to the structure of our plans.
|
• |
Bargain Purchase Gain—Consists of adjustments to net income (loss) available to AHL common shareholders as they are not related to our underlying profitability drivers.
|
• |
Income Tax (Expense) Benefit – Non-operating—Consists of the income tax effect of non-operating adjustments and is computed by applying the appropriate jurisdiction’s tax rate to the non-operating adjustments that are subject to income tax.
|
70
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We consider these non-operating adjustments to be meaningful adjustments to net income (loss) available to AHL common shareholders for the reasons discussed in greater detail above. Accordingly, we believe using a measure which excludes the impact of these items is useful in analyzing our business performance and the trends in our results of operations. Together with net income (loss) available to AHL common shareholders, we believe adjusted operating income (loss) available to common shareholders provides a meaningful financial metric that helps investors understand our underlying results and profitability. Adjusted operating income (loss) available to common shareholders should not be used as a substitute for net income (loss) available to AHL common shareholders.
Adjusted Operating ROE
Adjusted operating ROE is a non-GAAP measure used to evaluate our financial performance excluding the impacts of AOCI and the cumulative change in fair value of funds withheld and modco reinsurance assets, net of DAC, DSI, rider reserve and tax offsets. Adjusted AHL common shareholders’ equity is calculated as the ending AHL shareholders’ equity excluding AOCI, the cumulative change in fair value of funds withheld and modco reinsurance assets and preferred stock. Adjusted operating ROE is calculated as the adjusted operating income (loss) available to common shareholders, divided by average adjusted AHL common shareholders’ equity. These adjustments fluctuate period to period in a manner inconsistent with our underlying profitability drivers as the majority of such fluctuation is related to the market volatility of the unrealized gains and losses associated with our AFS securities. Except with respect to reinvestment activity relating to acquired blocks of businesses, we typically buy and hold AFS investments to maturity throughout the duration of market fluctuations, therefore, the period-over-period impacts in unrealized gains and losses are not necessarily indicative of current operating fundamentals or future performance. Accordingly, we believe using measures which exclude AOCI and the cumulative change in fair value of funds withheld and modco reinsurance assets are useful in analyzing trends in our operating results. To enhance the ability to analyze these measures across periods, interim periods are annualized. Adjusted operating ROE should not be used as a substitute for ROE. However, we believe the adjustments to net income (loss) available to AHL common shareholders and equity are significant to gaining an understanding of our overall financial performance.
71
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Adjusted Operating Earnings (Loss) Per Common Share, Weighted Average Common Shares Outstanding – Adjusted Operating and Adjusted Book Value Per Common Share
Adjusted operating earnings (loss) per common share, weighted average common shares outstanding – adjusted operating and adjusted book value per common share are non-GAAP measures used to evaluate our financial performance and financial condition. The non-GAAP measures adjust the number of shares included in the corresponding GAAP measures to reflect the conversion or settlement of all shares and other stock-based awards outstanding. We believe using these measures represent an economic view of our share counts and provide a simplified and consistent view of our outstanding shares. Adjusted operating earnings (loss) per common share is calculated as the adjusted operating income (loss) available to common shareholders, over the weighted average common shares outstanding – adjusted operating. Adjusted book value per common share is calculated as the adjusted AHL common shareholders’ equity divided by the adjusted operating common shares outstanding. Effective February 28, 2020, all Class B common shares were converted into Class A common shares and all Class M common shares were converted into warrants and Class A common shares. Our Class B common shares were economically equivalent to Class A common shares and could have been converted to Class A common shares on a one-for-one basis at any time. Our Class M common shares were in the legal form of shares but economically functioned as options as they were convertible into Class A common shares after vesting and settlement of the conversion price. In calculating Class A diluted earnings per share on a GAAP basis, we are required to apply sequencing rules to determine the dilutive impacts, if any, of our Class B common shares, Class M common shares and any other stock-based awards. To the extent our Class B common shares, Class M common shares and/or any other stock-based awards were not dilutive, after considering the dilutive effects of the more dilutive securities in the sequence, they were excluded. Weighted average common shares outstanding – adjusted operating and adjusted operating common shares outstanding assume conversion or settlement of all outstanding items that are able to be converted to or settled in Class A common shares, including the impacts of Class B common shares on a one-for-one basis, the impacts of all Class M common shares net of the conversion price and any other stock-based awards, but excluding any awards for which the exercise or conversion price exceeds the market value of our Class A common shares on the applicable measurement date. For certain historical periods, Class M shares were not included due to issuance restrictions which were contingent upon our IPO. Adjusted operating earnings (loss) per common share, weighted average common shares outstanding – adjusted operating and adjusted book value per common share should not be used as a substitute for basic earnings (loss) per share – Class A common shares, basic weighted average common shares outstanding – Class A or book value per common share. However, we believe the adjustments to the shares and equity are significant to gaining an understanding of our overall results of operations and financial condition.
Adjusted Debt to Capital Ratio
Adjusted debt to capital ratio is a non-GAAP measure used to evaluate our capital structure excluding the impacts of AOCI and the cumulative change in fair value of funds withheld and modco reinsurance assets, net of DAC, DSI, rider reserve and tax offsets. Adjusted debt to capital ratio is calculated as total debt divided by adjusted AHL shareholders’ equity. Adjusted debt to capital ratio should not be used as a substitute for the debt to capital ratio. However, we believe the adjustments to total debt and shareholders’ equity are significant to gaining an understanding of our capitalization, debt utilization and debt capacity.
Retirement Services Net Investment Spread, Investment Margin on Deferred Annuities and Operating Expenses
Net investment spread is a key measurement of the profitability of our Retirement Services segment. Net investment spread measures our investment performance less the total cost of our liabilities. Net investment earned rate is a key measure of our investment performance, while cost of funds is a key measure of the cost of our policyholder benefits and liabilities. Investment margin on our deferred annuities measures our investment performance less the cost of crediting for our deferred annuities, which make up a significant portion of our net reserve liabilities.
Net investment earned rate is a non-GAAP measure we use to evaluate the performance of our net invested assets that does not correspond to GAAP net investment income. Net investment earned rate is computed as the income from our net invested assets divided by the average net invested assets, excluding the impacts of our investment in Apollo, for the relevant period. To enhance the ability to analyze these measures across periods, interim periods are annualized. The adjustments to arrive at our net investment earned rate add (a) alternative investment gains and losses, (b) gains and losses related to trading securities for CLOs, (c) net VIE impacts (revenues, expenses and noncontrolling interest), (d) forward points gains and losses on foreign exchange derivative hedges and (e) the change in fair value of reinsurance assets, and removes the proportionate share of the ACRA net investment income associated with the ACRA noncontrolling interest as well as the gain or loss on our investment in Apollo. We include the income and assets supporting our change in fair value of reinsurance assets by evaluating the underlying investments of the funds withheld at interest receivables and we include the net investment income from those underlying investments which does not correspond to the GAAP presentation of change in fair value of reinsurance assets. We exclude the income and assets supporting business that we have exited through ceded reinsurance including funds withheld agreements. We believe the adjustments for reinsurance provide a net investment earned rate on the assets for which we have economic exposure.
Cost of funds includes liability costs related to cost of crediting on both deferred annuities and institutional products as well as other liability costs, but does not include the proportionate share of the ACRA cost of funds associated with the noncontrolling interest. Cost of funds is computed as the total liability costs divided by the average net invested assets, excluding our investment in Apollo, for the relevant period. To enhance the ability to analyze these measures across periods, interim periods are annualized.
72
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cost of crediting includes the costs for both deferred annuities and institutional products. Cost of crediting on deferred annuities is the interest credited to the policyholders on our fixed strategies as well as the option costs on the indexed annuity strategies. With respect to FIAs, the cost of providing index credits includes the expenses incurred to fund the annual index credits, and where applicable, minimum guaranteed interest credited. Cost of crediting on institutional products is comprised of PRT costs including interest credited, benefit payments and other reserve changes, net of premiums received when issued, as well as funding agreement costs including the interest payments and other reserve changes. Cost of crediting is computed as the cost of crediting for deferred annuities and institutional products divided by the average net invested assets, excluding the investment in Apollo, for the relevant periods. Cost of crediting on deferred annuities is computed as the net interest credited on fixed strategies and option costs on indexed annuity strategies divided by the average net account value of our deferred annuities. Cost of crediting on institutional products is computed as the PRT and funding agreement costs divided by the average net institutional reserve liabilities. Our average net invested assets, excluding our investment in Apollo, net account values and net institutional reserve liabilities are averaged over the number of quarters in the relevant period to obtain our associated cost of crediting for such period. To enhance the ability to analyze these measures across periods, interim periods are annualized.
Other liability costs include DAC, DSI and VOBA amortization, change in rider reserves, the cost of liabilities on products other than deferred annuities and institutional products, excise taxes, premiums, product charges and other revenues. We believe a measure like other liability costs is useful in analyzing the trends of our core business operations and profitability. While we believe other liability costs is a meaningful financial metric and enhances our understanding of the underlying profitability drivers of our business, it should not be used as a substitute for total benefits and expenses presented under GAAP.
Net investment earned rate, cost of funds, net investment spread and investment margin on deferred annuities are non-GAAP measures we use to evaluate the profitability of our business. We believe these metrics are useful in analyzing the trends of our business operations, profitability and pricing discipline. While we believe each of these metrics are meaningful financial metrics and enhance our understanding of the underlying profitability drivers of our business, they should not be used as a substitute for net investment income, interest sensitive contract benefits or total benefits and expenses presented under GAAP.
Operating expenses excludes integration, restructuring and other non-operating expenses, stock compensation expense, interest expense and policy acquisition expenses. We believe a measure like operating expenses is useful in analyzing the trends of our core business operations and profitability. While we believe operating expenses is a meaningful financial metric and enhances our understanding of the underlying profitability drivers of our business, it should not be used as a substitute for policy and other operating expenses presented under GAAP.
Net Invested Assets
In managing our business, we analyze net invested assets, which does not correspond to total investments, including investments in related parties, as disclosed in our consolidated financial statements and notes thereto. Net invested assets represents the investments that directly back our net reserve liabilities as well as surplus assets. Net invested assets, excluding our investment in Apollo, is used in the computation of net investment earned rate, which allows us to analyze the profitability of our investment portfolio. Net invested assets includes (a) total investments on the consolidated balance sheets with AFS securities at cost or amortized cost, excluding derivatives, (b) cash and cash equivalents and restricted cash, (c) investments in related parties, (d) accrued investment income, (e) VIE assets, liabilities and noncontrolling interest adjustments, (f) net investment payables and receivables, (g) policy loans ceded (which offset the direct policy loans in total investments) and (h) an allowance for credit losses. Net invested assets also excludes assets associated with funds withheld liabilities related to business exited through reinsurance agreements and derivative collateral (offsetting the related cash positions). We include the underlying investments supporting our assumed funds withheld and modco agreements in our net invested assets calculation in order to match the assets with the income received. We believe the adjustments for reinsurance provide a view of the assets for which we have economic exposure. Net invested assets includes our proportionate share of ACRA investments, based on our economic ownership, but does not include the proportionate share of investments associated with the noncontrolling interest. Net invested assets also includes our investment in Apollo. Our net invested assets, excluding our investment in Apollo, are averaged over the number of quarters in the relevant period to compute our net investment earned rate for such period. While we believe net invested assets is a meaningful financial metric and enhances our understanding of the underlying drivers of our investment portfolio, it should not be used as a substitute for total investments, including related parties, presented under GAAP.
Net Reserve Liabilities
In managing our business, we also analyze net reserve liabilities, which does not correspond to total liabilities as disclosed in our consolidated financial statements and notes thereto. Net reserve liabilities represent our policyholder liability obligations net of reinsurance and is used to analyze the costs of our liabilities. Net reserve liabilities include (a) the interest sensitive contract liabilities, (b) future policy benefits, (c) dividends payable to policyholders, and (d) other policy claims and benefits, offset by reinsurance recoverable, excluding policy loans ceded. Net reserve liabilities include our proportionate share of ACRA reserve liabilities, based on our economic ownership, but does not include the proportionate share of reserve liabilities associated with the noncontrolling interest. Net reserve liabilities is net of the ceded liabilities to third-party reinsurers as the costs of the liabilities are passed to such reinsurers and, therefore, we have no net economic exposure to such liabilities, assuming our reinsurance counterparties perform under our agreements. The majority of our ceded reinsurance is a result of reinsuring large blocks of life business following acquisitions. For such transactions, GAAP requires the ceded liabilities and related reinsurance recoverables to continue to be recorded in our consolidated financial statements despite the transfer of economic risk to the counterparty in connection with the reinsurance transaction. While we believe net reserve liabilities is a meaningful financial metric and enhances our understanding of the underlying profitability drivers of our business, it should not be used as a substitute for total liabilities presented under GAAP.
73
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Sales
Sales statistics do not correspond to revenues under GAAP but are used as relevant measures to understand our business performance as it relates to deposits generated during a specific period of time. Our sales statistics include deposits for fixed rate annuities and FIAs and align with the LIMRA definition of all money paid into an individual annuity, including money paid into new contracts with initial purchase occurring in the specified period and existing contracts with initial purchase occurring prior to the specified period (excluding internal transfers). While we believe sales is a meaningful metric and enhances our understanding of our business performance, it should not be used as a substitute for premiums presented under GAAP.
Consolidated Results of Operations
The following summarizes the consolidated results of operations:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions, except percentages) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Revenues |
$ |
4,398 |
$ |
3,423 |
$ |
2,849 |
$ |
8,418 |
|||||||
Benefits and expenses |
3,317 |
2,673 |
3,150 |
6,928 |
|||||||||||
Income (loss) before income taxes
|
1,081 |
750 |
(301 |
) |
1,490 |
||||||||||
Income tax expense (benefit) |
150 |
30 |
(16 |
) |
62 |
||||||||||
Net income (loss)
|
931 |
720 |
(285 |
) |
1,428 |
||||||||||
Less: Net income (loss) attributable to noncontrolling interests
|
88 |
— |
(81 |
) |
— |
||||||||||
Net income (loss) attributable to Athene Holding Ltd. |
843 |
720 |
(204 |
) |
1,428 |
||||||||||
Less: Preferred stock dividends |
19 |
— |
37 |
— |
|||||||||||
Net income (loss) available to AHL common shareholders |
$ |
824 |
$ |
720 |
$ |
(241 |
) |
$ |
1,428 |
||||||
ROE |
26.8 |
% |
25.6 |
% |
(3.4 |
)% |
27.7 |
% |
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
In this section, references to 2020 refer to the three months ended June 30, 2020 and references to 2019 refer to the three months ended June 30, 2019.
Net Income Available to AHL Common Shareholders
Net income available to AHL common shareholders increased by $104 million, or 14%, to $824 million in 2020 from $720 million in 2019. ROE increased to 26.8% from 25.6% in 2019. The increase in net income available to AHL common shareholders was driven by a $1.0 billion increase in revenues, partially offset by a increase of $644 million in benefits and expenses and a $120 million increase in income tax expense.
Revenues
Revenues increased by $1.0 billion to $4.4 billion in 2020 from $3.4 billion in 2019. The increase was driven by an increase in investment related gains and losses and an increase in net investment income, partially offset by a decrease in premiums.
Investment related gains and losses increased by $1.2 billion to $2.5 billion in 2020 from $1.3 billion in the prior year, primarily due to the change in fair value of reinsurance assets, the change in fair value of FIA hedging derivatives, and the change in fair value of trading securities. The change in fair value of reinsurance assets increased $894 million primarily driven by the change in the value of the underlying assets related to credit spreads tightening. The change in fair value of FIA hedging derivatives increased $233 million driven by the favorable performance of the indices upon which our call options are based. The majority of our call options are based on the S&P 500 index which increased 20.0% in 2020, compared to an increase of 3.8% in 2019. The favorable change in fair value of trading securities of $112 million was comprised primarily of an increase in AmerUs Closed Block assets of $42 million, CLO equity securities, non-redeemable preferred stock and other trading securities primarily due to credit spreads tightening.
Net investment income increased by $154 million to $1.3 billion in 2020 from $1.2 billion in the prior year, primarily driven by an unrealized gain on our investment in Apollo of $481 million due to the increase in share price, partially offset by unfavorable alternative investment performance and lower floating rate income due to the lower interest rate environment.
Premiums decreased by $432 million to $355 million in 2020 from $787 million in the prior year, driven by lower PRT premiums compared to prior year.
74
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Benefits and Expenses
Benefits and expenses increased by $644 million to $3.3 billion in 2020 from $2.7 billion in 2019. The increase was driven by an increase in interest sensitive contract benefits and an increase in DAC, DSI and VOBA amortization, partially offset by a decrease in future policy and other policy benefits.
Interest sensitive contract benefits increased by $1.0 billion to $2.1 billion in 2020 from $1.1 billion in 2019, driven by an increase in FIA fair value embedded derivatives of $942 million and growth in the block of business. The change in the FIA fair value embedded derivatives was primarily due to the unfavorable change in discount rates used in our embedded derivative calculations as the current year experienced a larger decrease in discount rates compared to 2019, as well as the performance of the equity indices to which our FIA policies are linked, primarily the S&P 500 index, which experienced an increase of 20.0% in 2020, compared to an increase of 3.8% in 2019.
DAC, DSI and VOBA amortization increased by $66 million to $340 million in 2020 from $274 million in 2019, primarily due to the favorable change in investment related gains and losses as a result of a favorable change in reinsurance embedded derivatives, partially offset by the unfavorable net change in FIA derivatives, favorable impacts from equity market performance, and lower gross profits.
Future policy and other policy benefits decreased by $437 million to $674 million in 2020 from $1.1 billion in 2019, primarily attributable to lower PRT obligations and a decrease in the change in rider reserves, partially offset by an increase in the change in AmerUs Closed Block fair value liability. The change in rider reserve of $73 million was primarily due to unfavorable net change in FIA derivatives and favorable impacts from equity market performance. The unfavorable change in the AmerUs Closed Block fair value liability of $39 million was primarily driven by the increase in unrealized gains on the underlying investments related to credit spreads tightening.
Taxes
Income tax expense (benefit) increased by $120 million to $150 million in 2020 from $30 million in 2019. The income tax expense for 2020 was primarily driven by higher income before tax resulting from the favorable change in reinsurance embedded derivatives and unrealized gains on our investment in Apollo.
Our effective tax rate in the second quarter of 2020 was 14% and 4% in 2019. Our effective tax rates may vary period to period depending upon the relationship of income and loss subject to tax compared to consolidated income and loss before income taxes.
Noncontrolling Interest
Noncontrolling interest increased by $88 million to $88 million in 2020 from $0 million in 2019, driven by net income related to noncontrolling interests in ACRA following the sale of a 67% interest in ACRA to ADIP on October 1, 2019. Effective April 1, 2020, ALRe purchased additional shares in ACRA increasing our ownership from 33% to 36.55%. There was no significant noncontrolling interest prior to the ACRA sale to ADIP.
Preferred Stock Dividends
Preferred stock dividends increased by $19 million to $19 million in 2020 from $0 million in 2019, driven by dividends paid on the preferred stock we issued in June and September of 2019.
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
In this section, references to 2020 refer to the six months ended June 30, 2020 and references to 2019 refer to the six months ended June 30, 2019.
Net Income (Loss) Available to AHL Common Shareholders
Net income (loss) available to AHL common shareholders decreased by $1.7 billion, or 117%, to $(241) million in 2020 from $1.4 billion in 2019. ROE decreased to (3.4)% from 27.7% in 2019. The decrease in net income (loss) available to AHL common shareholders was driven by a $5.6 billion decrease in revenues, an $81 million decrease in noncontrolling interests and a $37 million increase in preferred stock dividends, partially offset by a decrease of $3.8 billion in benefits and expenses and a $78 million decrease in income tax expense.
Revenues
Revenues decreased by $5.6 billion to $2.8 billion in 2020 from $8.4 billion in 2019. The decrease was driven by a decrease in investment related gains and losses, a decrease in premiums, and a decrease in net investment income.
Investment related gains and losses decreased by $4.1 billion to $(1.0) billion in 2020 from $3.1 billion in the prior year, primarily due to the change in fair value of FIA hedging derivatives, the change in fair value of reinsurance assets, the change in provision for credit losses, the change in fair value of trading securities and a decrease in equity securities reflecting the decline in financial markets. The change in fair value of FIA hedging derivatives decreased $2.2 billion driven by the unfavorable performance of the indices upon which our call options are based.
75
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The majority of our call options are based on the S&P 500 index which decreased 4.0% in 2020, compared to an increase of 17.3% in 2019. The change in fair value of reinsurance assets decreased $1.4 billion primarily driven by the change in the value of the underlying assets related to credit spreads widening. The unfavorable change in gross provision for credit losses of $289 million was primarily a result of the forecasted economic downturn from the spread of COVID-19. The unfavorable change in fair value of trading securities of $167 million was comprised primarily of a decrease in AmerUs Closed Block assets of $56 million, CLO equity securities, non-redeemable preferred stock and other trading securities primarily due to credit spreads widening.
Premiums decreased by $1.3 billion to $1.5 billion in 2020 from $2.8 billion in the prior year, driven by lower PRT premiums compared to prior year.
Net investment income decreased by $183 million to $2.1 billion in 2020 from $2.3 billion in the prior year, primarily driven by unfavorable alternative investment performance and lower floating rate income due to the lower interest rate environment, partially offset by an unrealized gain on our investment in Apollo of $184 million due to the increase in share price.
Benefits and Expenses
Benefits and expenses decreased by $3.8 billion to $3.1 billion in 2020 from $6.9 billion in 2019. The decrease was driven by a decrease in interest sensitive contract benefits, a decrease in future policy and other policy benefits and a decrease in DAC, DSI and VOBA amortization.
Interest sensitive contract benefits decreased by $1.9 billion to $757 million in 2020 from $2.6 billion in 2019, driven by a decrease in FIA fair value embedded derivatives of $1.9 billion, partially offset by growth in the block of business. The change in the FIA fair value embedded derivatives was primarily due the performance of the equity indices to which our FIA policies are linked, primarily the S&P 500 index, which experienced a decrease of 4% in 2020, compared to an increase of 17.3% in 2019, as well as a favorable change in discount rates used in our embedded derivative calculations as the current year experienced a smaller decrease in discount rates compared to 2019.
Future policy and other policy benefits decreased by $1.4 billion to $2.0 billion in 2020 from $3.4 billion in 2019, primarily attributable to lower PRT obligations, a decrease in the change in rider reserves and a decrease in the change in AmerUs Closed Block fair value liability. The change in rider reserve of $119 million was primarily due to the unfavorable change in reinsurance embedded derivatives and the unfavorable net change in FIA derivatives, partially offset by the unfavorable impacts from equity market performance and growth in the block of business. The favorable change in the AmerUs Closed Block fair value liability of $66 million was primarily driven by the increase in unrealized losses on the underlying investments related to credit spreads widening, partially offset by the decrease in U.S. Treasury rates compared to prior year.
DAC, DSI and VOBA amortization decreased by $573 million to $(63) million in 2020 from $510 million in 2019, primarily due to the unfavorable change in investment related gains and losses as a result of an unfavorable change in reinsurance embedded derivatives and the unfavorable net change in FIA derivatives partially offset by the unfavorable impacts from equity market performance and growth in the block of business.
Taxes
Income tax expense (benefit) decreased by $78 million to $(16) million in 2020 from $62 million in 2019. The income tax benefit for 2020 was primarily driven by lower income before tax resulting from the unfavorable change in reinsurance embedded derivatives, partially offset by unrealized gains on our investment in Apollo.
Our effective tax rate in 2020 was 5% and 4% in 2019. Our effective tax rates may vary period to period depending upon the relationship of income and loss subject to tax compared to consolidated income and loss before income taxes.
Noncontrolling Interest
Noncontrolling interest decreased by $81 million to $(81) million in 2020 from $0 million in 2019, driven by a net loss related to noncontrolling interests in ACRA following the sale of a 67% interest in ACRA to ADIP on October 1, 2019. Effective April 1, 2020, ALRe purchased additional shares in ACRA increasing our ownership in ACRA from 33% to 36.55%. There was no significant noncontrolling interest prior to the ACRA sale to ADIP.
Preferred Stock Dividends
Preferred stock dividends increased by $37 million to $37 million in 2020 from $0 million in 2019, driven by dividends we paid on preferred stock we issued in June and September of 2019.
76
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations by Segment
The following summarizes our adjusted operating income (loss) available to common shareholders by segment:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions, except percentages) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Net income (loss) available to AHL common shareholders |
$ |
824 |
$ |
720 |
$ |
(241 |
) |
$ |
1,428 |
||||||
Non-operating adjustments |
|||||||||||||||
Realized gains (losses) on sale of AFS securities |
(11 |
) |
41 |
1 |
53 |
||||||||||
Unrealized, allowances and other investment gains (losses) |
52 |
10 |
(317 |
) |
39 |
||||||||||
Change in fair value of reinsurance assets |
1,113 |
570 |
(164 |
) |
1,186 |
||||||||||
Offsets to investment gains (losses) |
(379 |
) |
(204 |
) |
116 |
(403 |
) |
||||||||
Investment gains (losses), net of offsets |
775 |
417 |
(364 |
) |
875 |
||||||||||
Change in fair values of derivatives and embedded derivatives – FIAs, net of offsets |
(405 |
) |
(57 |
) |
(340 |
) |
(84 |
) |
|||||||
Integration, restructuring and other non-operating expenses |
(9 |
) |
(11 |
) |
(13 |
) |
(12 |
) |
|||||||
Stock compensation expense |
— |
(3 |
) |
(10 |
) |
(6 |
) |
||||||||
Income tax (expense) benefit – non-operating |
(27 |
) |
4 |
104 |
(2 |
) |
|||||||||
Less: Total non-operating adjustments |
334 |
350 |
(623 |
) |
771 |
||||||||||
Adjusted operating income available to common shareholders |
$ |
490 |
$ |
370 |
$ |
382 |
$ |
657 |
|||||||
Adjusted operating income (loss) available to common shareholders by segment |
|||||||||||||||
Retirement Services |
$ |
208 |
$ |
376 |
$ |
412 |
$ |
662 |
|||||||
Corporate and Other |
282 |
(6 |
) |
(30 |
) |
(5 |
) |
||||||||
Adjusted operating income available to common shareholders |
$ |
490 |
$ |
370 |
$ |
382 |
$ |
657 |
|||||||
Adjusted operating ROE |
19.4 |
% |
16.2 |
% |
7.8 |
% |
14.6 |
% |
|||||||
Retirement Services adjusted operating ROE |
11.1 |
% |
18.9 |
% |
11.4 |
% |
17.1 |
% |
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
Adjusted Operating Income Available to Common Shareholders
Adjusted operating income available to common shareholders increased by $120 million, or 32%, to $490 million in 2020 from $370 million in 2019. Adjusted operating ROE was 19.4%, up from 16.2% in 2019. Adjusted operating income available to common shareholders excluding the investment in Apollo, net of tax was $118 million for the three months ended June 30, 2020. The increase in adjusted operating income available to common shareholders was primarily driven by an increase in our Corporate and Other segment of $288 million, partially offset by a decrease in our Retirement Services segment of $168 million.
Our consolidated net investment earned rate was 3.29% in 2020, a decrease from 4.67% in 2019, primarily due to the unfavorable performance in our alternative portfolio as well as less favorable performance in our fixed and other investment portfolio. Alternative net investment earned rate was (6.75)% in 2020, a decrease from 14.13% in 2019, primarily driven by the unfavorable performance of alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter 2020, partially offset by an increase in AmeriHome returns. Fixed and other net investment earned rate was 3.78% in 2020, a decrease from 4.26% in 2019, driven by lower floating rate investment income, higher levels of cash than in the prior year, lower returns on the assets from the Jackson reinsurance transaction and lower bond call income and mortgage prepayments.
Non-operating Adjustments
Non-operating adjustments decreased by $16 million to $334 million in 2020 from $350 million in 2019. The decrease in non-operating adjustments was primarily driven by the unfavorable change in net FIA derivatives, partially offset by the favorable changes in fair value of reinsurance assets. Net FIA derivatives were unfavorable by $348 million primarily due to the unfavorable change in discount rates used in our embedded derivative calculations, partially offset by the favorable performance of the equity indices to which our FIA policies are linked, primarily the S&P 500 index. The change in fair value of reinsurance assets were favorable by $543 million primarily due to credit spreads tightening.
77
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
Adjusted Operating Income Available to Common Shareholders
Adjusted operating income available to common shareholders decreased by $275 million, or 42%, to $382 million in 2020 from $657 million in 2019. Adjusted operating ROE was 7.8%, down from 14.6% in 2019. Adjusted operating income available to common shareholders excluding the investment in Apollo, net of tax was $249 million for the six months ended June 30, 2020. The decrease in adjusted operating income available to common shareholders was primarily driven by a decrease in our Retirement Services segment of $250 million, as well as a decrease in our Corporate and Other segment of $25 million.
Our consolidated net investment earned rate was 3.56% in 2020, a decrease from 4.48% in 2019, primarily due to the unfavorable performance in our alternative portfolio as well as less favorable performance of our fixed and other investment portfolio. Alternative net investment earned rate was (4.70)% in 2020, a decrease from 9.28% in 2019, driven by unfavorable performance on alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter 2020, a decrease in market value of the equity position in OneMain and lower MidCap returns, partially offset by favorable AmeriHome returns. Fixed and other net investment earned rate was 3.97% in 2020, a decrease from 4.27% in 2019, driven by lower floating rate investment income, higher levels of cash than in the prior year and lower returns on the assets from the Jackson reinsurance transaction.
Non-operating Adjustments
Non-operating adjustments decreased by $1.4 billion to $(623) million in 2020 from $771 million in 2019. The decrease in non-operating adjustments was primarily driven by the unfavorable changes in fair value of reinsurance assets, change in provision for credit loss and the unfavorable change in net FIA derivatives. The change in fair value of reinsurance assets were unfavorable $1.4 billion due to credit spreads widening, partially offset by a decrease in U.S. Treasury rates. The unfavorable change in net provision for credit loss in 2020 of $281 million was primarily a result of the forecasted economic downturn from the spread of COVID-19. Net FIA derivatives were unfavorable by $256 million primarily due to the unfavorable performance of the equity indices to which our FIA policies are linked, primarily the S&P 500 index, partially offset by the favorable change in discount rates used in our embedded derivative calculations.
Retirement Services
Retirement Services is comprised of our United States and Bermuda operations which issue and reinsure retirement savings products and institutional products. Retirement Services has retail operations, which provide annuity retirement solutions to our policyholders. Retirement Services also has reinsurance operations, which reinsure FIAs, MYGAs, traditional one year guarantee fixed deferred annuities, immediate annuities and institutional products from our reinsurance partners. In addition, our institutional operations, including funding agreements and PRT obligations, are included in our Retirement Services segment.
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
Adjusted Operating Income Available to Common Shareholders
Adjusted operating income available to common shareholders decreased by $168 million, or 45%, to $208 million in 2020, from $376 million in 2019. Adjusted operating ROE was 11.1%, down from 18.9% in the prior period. The decrease in adjusted operating income available to common shareholders was driven by lower net investment earnings, partially offset by lower cost of funds. Net investment earnings decreased $246 million primarily driven by unfavorable alternative investment performance, lower floating rate income, and higher levels of cash than in the prior year related to strong deposits in the quarter and raising liquidity during the second quarter, partially offset by $10.9 billion of growth in our average net invested assets from prior year attributed to a strong growth in deposits and the Jackson reinsurance transaction. Cost of funds were $67 million lower primarily related to favorable rider reserves and DAC amortization related to lower gross profits and favorable impacts from equity market performance.
Net Investment Spread
Three months ended June 30, |
|||||
2020 |
2019 |
||||
Net investment earned rate |
3.44 |
% |
4.63 |
% |
|
Cost of funds |
2.48 |
% |
2.95 |
% |
|
Net investment spread |
0.96 |
% |
1.68 |
% |
78
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Net investment spread, which measures the spread on our investment performance less the total cost of our liabilities, decreased 72 basis points to 0.96% in 2020 from 1.68% in 2019. Net investment earned rate decreased due to a decline in both the alternative net investment earned rate and fixed and other net investment earned rate. The alternative net investments earned rate decreased in 2020 to (4.38)% from 14.46% in 2019, driven by unfavorable performance on alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter of 2020, partially offset by higher AmeriHome returns mainly due to an increase in valuation reflecting higher origination volumes and increased gains on sales driven by increased spreads. The fixed and other net investment earned rate decreased in 2020 to 3.78% from 4.26% in 2019, primarily attributed to lower floating rate income, higher levels of cash compared to the prior year, lower returns on the assets from the Jackson reinsurance transaction and lower bond call income and mortgage prepayments.
Cost of funds decreased by 47 basis points to 2.48% in 2020, from 2.95% in 2019, primarily driven by favorable rider reserves and DAC amortization primarily due to lower gross profits and favorable impacts from equity market performance. Cost of crediting decreased 11 basis points primarily driven by a decrease in floating rate and recent funding agreement rates, a decrease in recent PRT rates and favorable rate actions on deferred annuities.
Investment Margin on Deferred Annuities
Three months ended June 30, |
|||||
2020 |
2019 |
||||
Net investment earned rate |
3.44 |
% |
4.63 |
% |
|
Cost of crediting on deferred annuities |
1.94 |
% |
1.98 |
% |
|
Investment margin on deferred annuities |
1.50 |
% |
2.65 |
% |
Investment margin on deferred annuities, which measures our investment performance less the cost of crediting for our deferred annuities, decreased by 115 basis points to 1.50% in 2020, from 2.65% in 2019, driven by a decrease in the net investment earned rate, partially offset by a decrease in the cost of crediting on deferred annuities from the prior year as we continue to focus on pricing discipline, managing interest rates credited to policyholders and managing the cost of options to fund the annual index credits on our FIA products.
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
Adjusted Operating Income Available to Common Shareholders
Adjusted operating income available to common shareholders decreased by $250 million, or 38%, to $412 million in 2020, from $662 million in 2019. Adjusted operating ROE was 11.4%, down from 17.1% in the prior period. The decrease in adjusted operating income available to common shareholders was driven by lower net investment earnings and slightly higher cost of funds. Net investment earnings decreased $233 million primarily driven by unfavorable alternative investment performance, lower floating rate income and higher levels of cash than in the prior year, partially offset by $8.5 billion of growth in our average net invested assets from prior year attributed to a strong growth in deposits. Cost of funds were $20 million higher primarily related to unfavorable rider reserves and DAC amortization related to unfavorable impacts from equity market performance and growth in the block of business, partially offset by lower gross profits.
Net Investment Spread
Six months ended June 30, |
|||||
2020 |
2019 |
||||
Net investment earned rate |
3.73 |
% |
4.42 |
% |
|
Cost of funds |
2.73 |
% |
2.90 |
% |
|
Net investment spread |
1.00 |
% |
1.52 |
% |
Net investment spread, which measures the spread on our investment performance less the total cost of our liabilities, decreased 52 basis points to 1.00% in 2020 from 1.52% in 2019. Net investment earned rate decreased due to a decline in alternative net investment earned rate and fixed and other net investment earned rate. The alternative net investments earned rate decreased in 2020 to (1.95)% from 8.42% in 2019, driven by unfavorable performance on alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter 2020 and a lower MidCap return mainly due to a decrease in valuation reflecting an increase in loan loss assumptions and lower origination volumes reflecting the current interest rate environment, partially offset by higher AmeriHome return mainly due to an increase in valuation reflecting higher origination volumes and increased gains on sales driven by increased spreads. The fixed and other net investment earned rate decreased in 2020 to 3.98% from 4.27% in 2019, primarily attributed to lower floating rate investment income, higher levels of cash than in the prior year and lower returns on the assets from the Jackson reinsurance transaction.
Cost of funds decreased by 17 basis points to 2.73% in 2020, from 2.90% in 2019, primarily driven by lower cost of crediting and other liability costs. Cost of crediting decreased 11 basis points primarily driven by a decrease in floating rate and recent funding agreement rates, a decrease in recent PRT rates and favorable rate actions on deferred annuities. Other liability costs decreased 6 basis points primarily driven by lower rider reserves and DAC amortization related to lower gross profits, partially offset by unfavorable impacts from equity market performance.
79
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Investment Margin on Deferred Annuities
Six months ended June 30, |
|||||
2020 |
2019 |
||||
Net investment earned rate |
3.73 |
% |
4.42 |
% |
|
Cost of crediting on deferred annuities |
1.92 |
% |
1.98 |
% |
|
Investment margin on deferred annuities |
1.81 |
% |
2.44 |
% |
Investment margin on deferred annuities, which measures our investment performance less the cost of crediting for our deferred annuities, decreased by 63 basis points to 1.81% in 2020, from 2.44% in 2019, driven by a decrease in the net investment earned rate, partially offset by a decrease in the cost of crediting on deferred annuities from the prior year as we continue to focus on pricing discipline, managing interest rates credited to policyholders and managing the cost of options to fund the annual index credits on our FIA products.
Corporate and Other
Corporate and Other includes certain other operations related to our corporate activities such as corporate allocated expenses, merger and acquisition costs, debt costs, preferred stock dividends, certain integration and restructuring costs, certain stock-based compensation and intersegment eliminations. In addition, we also hold capital in excess of the level of capital we hold in Retirement Services to support our operating strategy.
Adjusted Operating Income (Loss) Available to Common Shareholders
Adjusted operating income (loss) available to common shareholders increased by $288 million to $282 million from $(6) million for the three months ended June 30, 2020 and 2019, respectively. The increase in adjusted operating income (loss) available to common shareholders was primarily driven by a $372 million gain on our investment in Apollo, net of tax, partially offset by unfavorable alternative investment performance on alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter 2020, as well as preferred stock dividends.
Adjusted operating income (loss) available to common shareholders decreased by $25 million to $(30) million from $(5) million for the six months ended June 30, 2020 and 2019, respectively. The decrease in adjusted operating income (loss) available to common shareholders was primarily driven by unfavorable alternative investment performance on alternatives reported on a lag reflecting the economic downturn from the spread of COVID-19 in the first quarter 2020, as well as preferred stock dividends, partially offset by a gain of $133 million on our investment in Apollo, net of tax.
Consolidated Investment Portfolio
We had consolidated investments, including related parties, of $163.0 billion and $130.6 billion as of June 30, 2020 and December 31, 2019, respectively. Our investment strategy seeks to achieve sustainable risk-adjusted returns through the disciplined management of our investment portfolio against our long-duration liabilities, coupled with the diversification of risk. The investment strategies utilized by our investment managers focus primarily on a buy and hold asset allocation strategy that may be adjusted periodically in response to changing market conditions and the nature of our liability profile. Substantially all of our investment portfolio is managed by Apollo, which provides a full suite of services, including direct investment management, asset allocation, mergers and acquisition asset diligence, and certain operational support services, including investment compliance, tax, legal and risk management support. Our relationship with Apollo allows us to take advantage of our generally illiquid liability profile by identifying investment opportunities with an emphasis on earning incremental yield by taking liquidity and complexity risk rather than assuming solely credit risk. Apollo’s investment team and credit portfolio managers utilize their deep experience to assist us in sourcing and underwriting complex asset classes. Apollo has selected a diverse array of corporate bonds and more structured, but highly rated asset classes. We also maintain holdings in floating rate and less rate-sensitive instruments, including CLOs, non-agency RMBS and various types of structured products. In addition to our fixed income portfolio, we opportunistically allocate 5–10% of our portfolio to alternative investments where we primarily focus on fixed income-like, cash flow-based investments.
Net investment income on the condensed consolidated statements of income (loss) included management fees under our investment management arrangements with Apollo, inclusive of base and sub-allocation fees, of $123 million and $94 million, respectively, during the three months ended June 30, 2020 and 2019, and $251 million and $186 million, respectively, during the six months ended June 30, 2020 and 2019.
80
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The total amounts we have incurred, directly and indirectly, from Apollo and its affiliates were as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Investment management agreements1,2
|
$ |
139 |
$ |
128 |
$ |
291 |
$ |
244 |
|||||||
Fund investments3
|
29 |
21 |
11 |
41 |
|||||||||||
Other4
|
13 |
6 |
22 |
12 |
|||||||||||
Gross fees |
181 |
155 |
324 |
297 |
|||||||||||
ACRA noncontrolling interest5
|
9 |
— |
14 |
— |
|||||||||||
Net fees |
$ |
172 |
$ |
155 |
$ |
310 |
$ |
297 |
|||||||
1 Excludes $1 million and $1 million of sub-advisory fees paid to ISG for the benefit of third-party sub-advisors for the three months ended June 30, 2020 and 2019, respectively, and excludes $1 million and $2 million for the six months ended June 30, 2020 and 2019, respectively.
| |||||||||||||||
2 Includes $24 million and $36 million of fees charged by Apollo to third-party cedants for the three months ended June 30, 2020 and 2019, respectively, and $48 million and $60 million for the six months ended June 30, 2020 and 2019, respectively, with respect to assets supporting obligations reinsured to us. Third-party cedants bear legal responsibility for payment of the investment management fees charged; however, we are the beneficiaries of the services performed and the fees ultimately reduce the settlement payments received from such third-party cedants.
| |||||||||||||||
3 Includes total management fees, carried interest (including unrealized but accrued carried interest fees) and other fees, including with respect to those investments we hold as equity method investments.
| |||||||||||||||
4 Other primarily relates to fees resulting from shared services, advisory and other agreements with Apollo or its affiliates.
| |||||||||||||||
5 Represents those fees incurred directly and indirectly attributable to ACRA, based upon the economic ownership of the noncontrolling interest in ACRA.
|
Our net invested assets, which are those that directly back our net reserve liabilities as well as surplus assets, were $137.3 billion and $117.5 billion as of June 30, 2020 and December 31, 2019, respectively. Apollo’s knowledge of our funding structure and regulatory requirements allows it to design customized strategies and investments for our portfolio. Apollo manages our asset portfolio within the limits and constraints set forth in our Investment and Credit Risk Policy. Under this policy, we set limits on investments in our portfolio by asset class, such as corporate bonds, emerging markets securities, municipal bonds, non-agency RMBS, CMBS, CLOs, commercial mortgage whole loans and mezzanine loans and investment funds. We also set credit risk limits for exposure to a single issuer that vary based on the issuer’s ratings. In addition, our investment portfolio is constrained by its scenario-based capital ratio limit and its stressed liquidity limit.
The following table presents the carrying values of our total investments and investments in related parties:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Carrying Value |
Percent of Total |
Carrying Value |
Percent of Total |
|||||||||
AFS securities, at fair value |
$ |
74,735 |
45.8 |
% |
$ |
71,374 |
54.7 |
% |
|||||
Trading securities, at fair value |
2,075 |
1.3 |
% |
2,070 |
1.6 |
% |
|||||||
Equity securities, at fair value |
237 |
0.1 |
% |
247 |
0.2 |
% |
|||||||
Mortgage loans, net of allowances |
15,203 |
9.4 |
% |
14,306 |
11.0 |
% |
|||||||
Investment funds |
682 |
0.4 |
% |
750 |
0.6 |
% |
|||||||
Policy loans |
393 |
0.2 |
% |
417 |
0.3 |
% |
|||||||
Funds withheld at interest |
42,269 |
25.9 |
% |
15,181 |
11.6 |
% |
|||||||
Derivative assets |
2,379 |
1.5 |
% |
2,888 |
2.2 |
% |
|||||||
Short-term investments |
364 |
0.2 |
% |
596 |
0.5 |
% |
|||||||
Other investments |
359 |
0.2 |
% |
158 |
0.1 |
% |
|||||||
Total investments |
138,696 |
85.0 |
% |
107,987 |
82.8 |
% |
|||||||
Investments in related parties |
|||||||||||||
AFS securities, at fair value |
4,070 |
2.5 |
% |
3,804 |
2.9 |
% |
|||||||
Trading securities, at fair value |
872 |
0.5 |
% |
785 |
0.6 |
% |
|||||||
Equity securities, at fair value |
52 |
— |
% |
64 |
— |
% |
|||||||
Mortgage loans, net of allowances |
626 |
0.4 |
% |
653 |
0.5 |
% |
|||||||
Investment funds |
5,278 |
3.3 |
% |
3,550 |
2.7 |
% |
|||||||
Funds withheld at interest |
12,971 |
8.0 |
% |
13,220 |
10.1 |
% |
|||||||
Other investments, net of allowances |
474 |
0.3 |
% |
487 |
0.4 |
% |
|||||||
Total related party investments |
24,343 |
15.0 |
% |
22,563 |
17.2 |
% |
|||||||
Total investments including related party |
$ |
163,039 |
100.0 |
% |
$ |
130,550 |
100.0 |
% |
81
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The increase in our total investments, including related party, as of June 30, 2020 of $32.5 billion compared to December 31, 2019 was primarily driven by an increase in funds withheld at interest assets as a result of the Jackson reinsurance transaction, growth from gross organic deposits of $10.9 billion in excess of liability outflows of $6.0 billion and an increase in investment funds driven by our investment in Apollo of $1.3 billion. The increase was partially offset by a decrease in derivative assets due to unfavorable equity market performance as well as an effort to increase liquidity following the economic downturn from the spread of COVID-19.
Our investment portfolio consists largely of high quality fixed maturity securities, loans and short-term investments, as well as additional opportunistic holdings in investment funds and other instruments, including equity holdings. Fixed maturity securities and loans include publicly issued corporate bonds, government and other sovereign bonds, privately placed corporate bonds and loans, mortgage loans, CMBS, RMBS, CLOs and ABS.
While the substantial majority of our investment portfolio has been allocated to corporate bonds and structured credit products, a key component of our investment strategy is the opportunistic acquisition of investment funds with attractive risk and return profiles. Our investment fund portfolio consists of funds that employ various strategies including real estate and other real asset funds, credit funds and private equity funds. We have a strong preference for assets that have some or all of the following characteristics, among others: (1) investments that constitute a direct investment or an investment in a fund with a high degree of co-investment; (2) investments with credit- or debt-like characteristics (for example, a stipulated maturity and par value), or alternatively, investments with reduced volatility when compared to pure equity; or (3) investments that we believe have less downside risk.
We hold derivatives for economic hedging purposes to reduce our exposure to the cash flow variability of assets and liabilities, equity market risk, interest rate risk, credit risk and foreign exchange risk. Our primary use of derivative instruments relates to providing the income needed to fund the annual indexed credits on our FIA products. We primarily use fixed indexed options to economically hedge FIA products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specific market index.
With respect to derivative positions, we transact with highly rated counterparties, and expect the counterparties to fulfill their obligations under the contracts. We generally use industry standard agreements and annexes with bilateral collateral provisions to further reduce counterparty credit exposure.
AFS Securities
We invest in AFS securities with the intent to hold investments to maturity. In selecting investments we attempt to source investments that match our future cash flow needs. However, we may sell any of our investments in advance of maturity in order to timely satisfy our liabilities as they become due or in order to respond to a change in the credit profile or other characteristics of the particular investment.
AFS securities are carried at fair value, less allowances for expected credit losses, on our condensed consolidated balance sheets. Changes in fair value of our AFS securities, net of related DAC, DSI and VOBA amortization and the change in rider reserves, are charged or credited to other comprehensive income, net of tax. All changes in the allowance for expected credit losses, whether due to passage of time, change in expected cash flows, or change in fair value are recorded through credit loss expense within investment related gains (losses) on the condensed consolidated statements of income (loss).
82
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The distribution of our AFS securities, including related parties, by type is as follows:
June 30, 2020 |
||||||||||||||||||||||
(In millions, except percentages) |
Amortized Cost |
Allowance for Credit Losses |
Unrealized Gains |
Unrealized Losses |
Fair Value |
Percent of Total |
||||||||||||||||
AFS securities |
||||||||||||||||||||||
U.S. government and agencies |
$ |
71 |
$ |
— |
$ |
3 |
$ |
— |
$ |
74 |
0.1 |
% |
||||||||||
U.S. state, municipal and political subdivisions |
799 |
— |
146 |
(2 |
) |
943 |
1.2 |
% |
||||||||||||||
Foreign governments |
318 |
— |
20 |
(1 |
) |
337 |
0.4 |
% |
||||||||||||||
Corporate |
47,251 |
(31 |
) |
4,608 |
(629 |
) |
51,199 |
65.0 |
% |
|||||||||||||
CLO |
8,441 |
(1 |
) |
19 |
(507 |
) |
7,952 |
10.1 |
% |
|||||||||||||
ABS |
4,923 |
(2 |
) |
110 |
(258 |
) |
4,773 |
6.1 |
% |
|||||||||||||
CMBS |
2,402 |
(10 |
) |
53 |
(148 |
) |
2,297 |
2.9 |
% |
|||||||||||||
RMBS |
7,010 |
(129 |
) |
343 |
(64 |
) |
7,160 |
9.1 |
% |
|||||||||||||
Total AFS securities |
71,215 |
(173 |
) |
5,302 |
(1,609 |
) |
74,735 |
94.9 |
% |
|||||||||||||
AFS securities – related party |
||||||||||||||||||||||
Corporate |
18 |
— |
2 |
— |
20 |
— |
% |
|||||||||||||||
CLO |
1,297 |
(2 |
) |
5 |
(61 |
) |
1,239 |
1.6 |
% |
|||||||||||||
ABS |
2,858 |
— |
26 |
(73 |
) |
2,811 |
3.5 |
% |
||||||||||||||
Total AFS securities – related party |
4,173 |
(2 |
) |
33 |
(134 |
) |
4,070 |
5.1 |
% |
|||||||||||||
Total AFS securities including related party |
$ |
75,388 |
$ |
(175 |
) |
$ |
5,335 |
$ |
(1,743 |
) |
$ |
78,805 |
100.0 |
% |
December 31, 2019 |
||||||||||||||||||
(In millions, except percentages) |
Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Fair Value |
Percent of Total |
|||||||||||||
AFS securities |
||||||||||||||||||
U.S. government and agencies |
$ |
35 |
$ |
1 |
$ |
— |
$ |
36 |
— |
% |
||||||||
U.S. state, municipal and political subdivisions |
1,322 |
220 |
(1 |
) |
1,541 |
2.1 |
% |
|||||||||||
Foreign governments |
298 |
29 |
— |
327 |
0.4 |
% |
||||||||||||
Corporate |
44,106 |
3,332 |
(210 |
) |
47,228 |
62.8 |
% |
|||||||||||
CLO |
7,524 |
21 |
(196 |
) |
7,349 |
9.8 |
% |
|||||||||||
ABS |
5,018 |
124 |
(24 |
) |
5,118 |
6.8 |
% |
|||||||||||
CMBS |
2,304 |
104 |
(8 |
) |
2,400 |
3.2 |
% |
|||||||||||
RMBS |
6,872 |
513 |
(10 |
) |
7,375 |
9.8 |
% |
|||||||||||
Total AFS securities |
67,479 |
4,344 |
(449 |
) |
71,374 |
94.9 |
% |
|||||||||||
AFS securities – related party |
||||||||||||||||||
Corporate |
18 |
1 |
— |
19 |
— |
% |
||||||||||||
CLO |
951 |
3 |
(18 |
) |
936 |
1.3 |
% |
|||||||||||
ABS |
2,814 |
37 |
(2 |
) |
2,849 |
3.8 |
% |
|||||||||||
Total AFS securities – related party |
3,783 |
41 |
(20 |
) |
3,804 |
5.1 |
% |
|||||||||||
Total AFS securities including related party |
$ |
71,262 |
$ |
4,385 |
$ |
(469 |
) |
$ |
75,178 |
100.0 |
% |
83
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We maintain a diversified AFS portfolio of corporate fixed maturity securities across industries and issuers, and a diversified portfolio of structured securities. The composition of our AFS securities, including related parties, is as follows:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Fair Value |
Percent of Total |
Fair Value |
Percent of Total |
|||||||||
Corporate |
|||||||||||||
Industrial other1
|
$ |
16,726 |
21.2 |
% |
$ |
14,956 |
19.9 |
% |
|||||
Financial |
16,114 |
20.4 |
% |
15,286 |
20.3 |
% |
|||||||
Utilities |
12,258 |
15.6 |
% |
11,217 |
14.9 |
% |
|||||||
Communication |
2,966 |
3.8 |
% |
2,739 |
3.7 |
% |
|||||||
Transportation |
3,155 |
4.0 |
% |
3,049 |
4.1 |
% |
|||||||
Total corporate |
51,219 |
65.0 |
% |
47,247 |
62.9 |
% |
|||||||
Other government-related securities |
|||||||||||||
U.S. state, municipal and political subdivisions |
943 |
1.2 |
% |
1,541 |
2.1 |
% |
|||||||
Foreign governments |
337 |
0.4 |
% |
327 |
0.4 |
% |
|||||||
U.S. government and agencies |
74 |
0.1 |
% |
36 |
— |
% |
|||||||
Total non-structured securities |
52,573 |
66.7 |
% |
49,151 |
65.4 |
% |
|||||||
Structured securities |
|||||||||||||
CLO |
9,191 |
11.7 |
% |
8,285 |
11.0 |
% |
|||||||
ABS |
7,584 |
9.6 |
% |
7,967 |
10.6 |
% |
|||||||
CMBS |
2,297 |
2.9 |
% |
2,400 |
3.2 |
% |
|||||||
RMBS |
|||||||||||||
Agency |
48 |
0.1 |
% |
3 |
— |
% |
|||||||
Non-agency |
7,112 |
9.0 |
% |
7,372 |
9.8 |
% |
|||||||
Total structured securities |
26,232 |
33.3 |
% |
26,027 |
34.6 |
% |
|||||||
Total AFS securities including related party |
$ |
78,805 |
100.0 |
% |
$ |
75,178 |
100.0 |
% |
|||||
1 Includes securities within various industry segments including capital goods, basic industry, consumer cyclical, consumer non-cyclical, industrial and technology.
|
The fair value of our AFS securities, including related parties, was $78.8 billion and $75.2 billion as of June 30, 2020 and December 31, 2019, respectively. The increase was mainly driven by strong growth from organic deposits of $10.9 billion in excess of liability outflows of $6.0 billion.
The Securities Valuation Office (SVO) of the NAIC is responsible for the 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 filing on the relevant schedule of the NAIC Financial Statement. The SVO conducts credit analysis on these securities for the purpose of assigning an NAIC designation and/or unit price. Generally, the process for assigning an NAIC designation varies based upon whether a security is considered “filing exempt” (General Designation Process). Subject to certain exceptions, a security is typically considered “filing exempt” if it has been rated by a Nationally Recognized Statistical Rating Organization (NRSRO). For securities that are not “filing exempt,” insurance companies assign temporary designations based upon a subjective evaluation of credit quality. The insurance company generally must then submit the securities to the SVO within 120 days of acquisition to receive an NAIC designation. For securities considered “filing exempt,” the SVO utilizes the NRSRO rating and assigns an NAIC designation based upon the following system:
NAIC designation |
NRSRO equivalent rating |
|
1 |
AAA/AA/A |
|
2 |
BBB |
|
3 |
BB |
|
4 |
B |
|
5 |
CCC |
|
6 |
CC and lower |
84
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
An important exception to the General Designation Process occurs in the case of certain loan-backed and structured securities (LBaSS). The NRSRO ratings methodology is focused on the likelihood of recovery of all contractual payments, including principal at par, regardless of an investor’s carrying value. In effect, the NRSRO rating assumes that the holder is the original purchaser at par. In contrast, the SVO’s LBaSS methodology is focused on determining the risk associated with the recovery of the amortized cost of each security. Because the NAIC’s methodology explicitly considers amortized cost and the likelihood of recovery of such amount, we view the NAIC’s methodology as the most appropriate means of evaluating the credit quality of our fixed maturity portfolio since a large portion of our holdings were purchased and are carried at significant discounts to par.
The SVO has developed a designation process and provides instruction on both modeled and non-modeled LBaSS. For modeled LBaSS, the process is specific to the non-agency RMBS and CMBS asset classes. In order to establish ratings at the individual security level, the SVO obtains loan-level analysis of each RMBS and CMBS using a selected vendor’s proprietary financial model. The SVO ensures that the vendor has extensive internal quality-control processes in place and the SVO conducts its own quality-control checks of the selected vendor’s valuation process. The SVO has retained the services of Blackrock, Inc. (Blackrock) to model non-agency RMBS and CMBS owned by U.S. insurers for all years presented herein. Blackrock provides five prices (breakpoints), based on each U.S. insurer’s statutory book value price, to utilize in determining the NAIC designation for each modeled LBaSS.
Prior to January 1, 2019, certain non-modeled LBaSS (including CLOs and ABS, other than RMBS and CMBS) underwent ratings evaluation by an NAIC credit rating provider (CRP). Such securities were subject to an exemption from the General Designation Process (MFE Exemption) and received NAIC designations through a prescribed process (MFE Process). Pursuant to the MFE Process, CRP ratings were translated to an NAIC designation equivalent. If the translation process resulted in an NAIC designation equivalent of NAIC 1 or NAIC 6, then such designation was considered the final NAIC designation. If the translation process resulted in an NAIC designation equivalent of NAIC 2 through NAIC 5, then the NAIC designation equivalent was used to select the appropriate breakpoint from a pricing matrix and such breakpoint was applied to the amortized cost or fair value (in each instance, as a percentage of par), as applicable, to determine the final NAIC designation. Effective January 1, 2019, the MFE Exemption was eliminated, and as a result, NAIC designations for all non-modeled LBaSS are thereafter determined through the General Designation Process.
The NAIC designation determines the associated level of risk-based capital (RBC) that an insurer is required to hold for all securities owned by the insurer. In general, under the modeled LBaSS process and, prior to January 1, 2019, the non-modeled LBaSS process, the larger the discount to par value at the time of determination, the higher the NAIC designation the LBaSS will have.
A summary of our AFS securities, including related parties, by NAIC designation is as follows:
June 30, 2020 |
December 31, 2019 |
||||||||||||||||||||
(In millions, except percentages) |
Amortized Cost |
Fair Value |
Percent of Total |
Amortized Cost |
Fair Value |
Percent of Total |
|||||||||||||||
NAIC designation |
|||||||||||||||||||||
1 |
$ |
37,502 |
$ |
39,700 |
50.4 |
% |
$ |
36,392 |
$ |
38,667 |
51.4 |
% |
|||||||||
2 |
32,569 |
34,124 |
43.3 |
% |
30,752 |
32,336 |
43.0 |
% |
|||||||||||||
Total investment grade |
70,071 |
73,824 |
93.7 |
% |
67,144 |
71,003 |
94.4 |
% |
|||||||||||||
3 |
4,143 |
3,916 |
5.0 |
% |
3,237 |
3,300 |
4.4 |
% |
|||||||||||||
4 |
882 |
827 |
1.0 |
% |
740 |
740 |
1.0 |
% |
|||||||||||||
5 |
188 |
149 |
0.2 |
% |
102 |
94 |
0.1 |
% |
|||||||||||||
6 |
104 |
89 |
0.1 |
% |
39 |
41 |
0.1 |
% |
|||||||||||||
Total below investment grade |
5,317 |
4,981 |
6.3 |
% |
4,118 |
4,175 |
5.6 |
% |
|||||||||||||
Total AFS securities including related party |
$ |
75,388 |
$ |
78,805 |
100.0 |
% |
$ |
71,262 |
$ |
75,178 |
100.0 |
% |
A significant majority of our AFS portfolio, 93.7% and 94.4% as of June 30, 2020 and December 31, 2019, respectively, was invested in assets considered investment grade with a NAIC designation of 1 or 2.
85
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
A summary of our AFS securities, including related parties, by NRSRO ratings is set forth below:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Fair Value |
Percent of Total |
Fair Value |
Percent of Total |
|||||||||
NRSRO rating agency designation |
|||||||||||||
AAA/AA/A |
$ |
30,238 |
38.4 |
% |
$ |
28,299 |
37.7 |
% |
|||||
BBB |
28,443 |
36.1 |
% |
29,032 |
38.6 |
% |
|||||||
Non-rated1
|
11,142 |
14.2 |
% |
10,014 |
13.3 |
% |
|||||||
Total investment grade |
69,823 |
88.7 |
% |
67,345 |
89.6 |
% |
|||||||
BB |
4,347 |
5.5 |
% |
3,403 |
4.5 |
% |
|||||||
B |
1,042 |
1.3 |
% |
813 |
1.1 |
% |
|||||||
CCC |
1,845 |
2.3 |
% |
1,981 |
2.6 |
% |
|||||||
CC and lower |
1,080 |
1.4 |
% |
1,076 |
1.4 |
% |
|||||||
Non-rated1
|
668 |
0.8 |
% |
560 |
0.8 |
% |
|||||||
Total below investment grade |
8,982 |
11.3 |
% |
7,833 |
10.4 |
% |
|||||||
Total AFS securities including related party |
$ |
78,805 |
100.0 |
% |
$ |
75,178 |
100.0 |
% |
|||||
1 Securities denoted as non-rated by the NRSRO were classified as investment or non-investment grade according to the security’s respective NAIC designation. With respect to modeled LBaSS, the NAIC designation methodology differs in significant respects from the NRSRO rating methodology.
|
Consistent with the NAIC Process and Procedures Manual, an NRSRO rating was assigned based on the following criteria: (a) the equivalent S&P rating when the security is rated by one NRSRO; (b) the equivalent S&P rating of the lowest NRSRO when the security is rated by two NRSROs; and (c) the equivalent S&P rating of the second lowest NRSRO when the security is rated by three or more NRSROs. If the lowest two NRSRO ratings are equal, then such rating will be the assigned rating. NRSRO ratings available for the periods presented were S&P, Fitch, Moody’s Investor Service, DBRS, and Kroll Bond Rating Agency, Inc, as well as NAIC SVO Private Letter designations.
The portion of our AFS portfolio that was considered below investment grade based on NRSRO ratings was 11.3% and 10.4% as of June 30, 2020 and December 31, 2019, respectively. The primary driver of the difference in the percentage of securities considered below investment grade by NRSROs as compared to the securities considered below investment grade by the NAIC is the difference in methodologies between the NRSRO and NAIC for RMBS due to investments acquired and/or carried at a discount to par value, as discussed above.
As of June 30, 2020 and December 31, 2019, non-rated securities were comprised 64% and 61%, respectively, of corporate private placement securities for which we have not sought individual ratings from the NRSRO, and 22% and 24%, respectively, were comprised of RMBS, many of which were acquired at a significant discount to par. We rely on internal analysis and designations assigned by the NAIC to evaluate the credit risk of our portfolio. As of June 30, 2020 and December 31, 2019, 94% and 95%, respectively, of the non-rated securities were designated NAIC 1 or 2.
Asset-backed Securities – We invest in ABS which are securitized by pools of assets such as consumer loans, automobile loans, student loans, insurance-linked securities, operating cash flows of corporations and cash flows from various types of business equipment. Our ABS holdings were $7.6 billion and $8.0 billion as of June 30, 2020 and December 31, 2019, respectively. The decrease in our ABS portfolio is mainly driven by unrealized losses due to credit spreads widening, partially offset by the lower interest rate environment. As of June 30, 2020 and December 31, 2019, our ABS portfolio included $7.0 billion (92% of the total) and $7.4 billion (92% of the total), respectively, of securities that are considered investment grade based on NAIC designations, while $6.9 billion (91% of the total) and $7.4 billion (92% of the total), respectively, of securities were considered investment grade based on NRSRO ratings.
86
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Collateralized Loan Obligations – We also invest in CLOs which pay principal and interest from cash flows received from underlying corporate loans. These holdings were $9.2 billion and $8.3 billion as of June 30, 2020 and December 31, 2019, respectively.
A summary of our AFS CLO portfolio, including related parties, by NAIC designations and NRSRO quality ratings is as follows:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Fair Value |
Percent of Total |
Fair Value |
Percent of Total |
|||||||||
NAIC designation |
|||||||||||||
1 |
$ |
5,641 |
61.4 |
% |
$ |
4,626 |
55.9 |
% |
|||||
2 |
3,462 |
37.6 |
% |
3,499 |
42.2 |
% |
|||||||
Total investment grade |
9,103 |
99.0 |
% |
8,125 |
98.1 |
% |
|||||||
3 |
81 |
0.9 |
% |
133 |
1.6 |
% |
|||||||
4 |
7 |
0.1 |
% |
20 |
0.2 |
% |
|||||||
5 |
— |
— |
% |
7 |
0.1 |
% |
|||||||
6 |
— |
— |
% |
— |
— |
% |
|||||||
Total below investment grade |
88 |
1.0 |
% |
160 |
1.9 |
% |
|||||||
Total AFS CLO including related party |
$ |
9,191 |
100.0 |
% |
$ |
8,285 |
100.0 |
% |
|||||
NRSRO rating agency designation |
|||||||||||||
AAA/AA/A |
$ |
5,641 |
61.4 |
% |
$ |
4,626 |
55.9 |
% |
|||||
BBB |
3,462 |
37.6 |
% |
3,499 |
42.2 |
% |
|||||||
Non-rated |
— |
— |
% |
— |
— |
% |
|||||||
Total investment grade |
9,103 |
99.0 |
% |
8,125 |
98.1 |
% |
|||||||
BB |
81 |
0.9 |
% |
133 |
1.6 |
% |
|||||||
B |
7 |
0.1 |
% |
20 |
0.2 |
% |
|||||||
CCC |
— |
— |
% |
7 |
0.1 |
% |
|||||||
CC and lower |
— |
— |
% |
— |
— |
% |
|||||||
Non-rated |
— |
— |
% |
— |
— |
% |
|||||||
Total below investment grade |
88 |
1.0 |
% |
160 |
1.9 |
% |
|||||||
Total AFS CLO including related party |
$ |
9,191 |
100.0 |
% |
$ |
8,285 |
100.0 |
% |
As of June 30, 2020 and December 31, 2019, a substantial majority of our AFS CLO portfolio, 99.0% and 98.1%, respectively, was invested in assets considered to be investment grade based upon application of the NAIC’s methodology and based on NRSRO ratings. The increase in our CLO portfolio is mainly driven by additional asset purchases, partially offset by unrealized losses due to credit spreads widening.
Commercial Mortgage-backed Securities – A portion of our AFS portfolio is invested in CMBS. CMBS are constructed from pools of commercial mortgages. These holdings were $2.3 billion and $2.4 billion as of June 30, 2020 and December 31, 2019, respectively. As of June 30, 2020 and December 31, 2019, our CMBS portfolio included $2.1 billion (89% of the total) and $2.1 billion (89% of the total), respectively, of securities that are considered investment grade based on NAIC designations, while $1.7 billion (74% of the total) and $1.7 billion (72% of the total), respectively, of securities were considered investment grade based on NRSRO ratings.
Residential Mortgage-backed Securities – A portion of our AFS portfolio is invested in RMBS, which are securities constructed from pools of residential mortgages. These holdings were $7.2 billion and $7.4 billion as of June 30, 2020 and December 31, 2019, respectively.
87
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
A summary of our AFS RMBS portfolio by NAIC designations and NRSRO quality ratings is as follows:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Fair Value |
Percent of Total |
Fair Value |
Percent of Total |
|||||||||
NAIC designation |
|||||||||||||
1 |
$ |
6,546 |
91.4 |
% |
$ |
6,701 |
90.9 |
% |
|||||
2 |
243 |
3.4 |
% |
330 |
4.5 |
% |
|||||||
Total investment grade |
6,789 |
94.8 |
% |
7,031 |
95.4 |
% |
|||||||
3 |
243 |
3.4 |
% |
289 |
3.9 |
% |
|||||||
4 |
39 |
0.6 |
% |
52 |
0.7 |
% |
|||||||
5 |
43 |
0.6 |
% |
3 |
— |
% |
|||||||
6 |
46 |
0.6 |
% |
— |
— |
% |
|||||||
Total below investment grade |
371 |
5.2 |
% |
344 |
4.6 |
% |
|||||||
Total AFS RMBS |
$ |
7,160 |
100.0 |
% |
$ |
7,375 |
100.0 |
% |
|||||
NRSRO rating agency designation |
|||||||||||||
AAA/AA/A |
$ |
701 |
9.8 |
% |
$ |
715 |
9.7 |
% |
|||||
BBB |
555 |
7.8 |
% |
606 |
8.2 |
% |
|||||||
Non-rated1
|
2,459 |
34.3 |
% |
2,428 |
32.9 |
% |
|||||||
Total investment grade |
3,715 |
51.9 |
% |
3,749 |
50.8 |
% |
|||||||
BB |
255 |
3.6 |
% |
281 |
3.8 |
% |
|||||||
B |
262 |
3.6 |
% |
232 |
3.2 |
% |
|||||||
CCC |
1,735 |
24.2 |
% |
1,890 |
25.6 |
% |
|||||||
CC and lower |
1,080 |
15.1 |
% |
1,074 |
14.6 |
% |
|||||||
Non-rated1
|
113 |
1.6 |
% |
149 |
2.0 |
% |
|||||||
Total below investment grade |
3,445 |
48.1 |
% |
3,626 |
49.2 |
% |
|||||||
Total AFS RMBS |
$ |
7,160 |
100.0 |
% |
$ |
7,375 |
100.0 |
% |
|||||
1 Securities denoted as non-rated by the NRSRO were classified as investment or non-investment grade according to the security’s respective NAIC designations. The NAIC designation methodology differs in significant respects from the NRSRO rating methodology.
|
A significant majority of our RMBS portfolio, 94.8% and 95.4% as of June 30, 2020 and December 31, 2019, respectively, was invested in assets considered to be investment grade based upon an application of the NAIC designations. The NAIC’s methodology with respect to RMBS gives explicit effect to the amortized cost at which an insurance company carries each such investment. Because we invested in RMBS after the stresses related to U.S. housing had caused significant downward pressure on prices of RMBS, we carry most of our investments in RMBS at significant discounts to par value, which results in an investment grade NAIC designation. In contrast, our understanding is that in setting ratings, NRSROs focus on the likelihood of recovering all contractual payments including principal at par value. As a result of a fundamental difference in approach, as of June 30, 2020 and December 31, 2019, NRSRO characterized 51.9% and 50.8%, respectively, of our RMBS portfolio as investment grade.
Unrealized Losses
Our investments in AFS securities, including related parties, are reported at fair value with changes in fair value recorded in other comprehensive income. Certain of our AFS securities, including related parties, have experienced declines in fair value that we consider temporary in nature. As of June 30, 2020, our AFS securities, including related party, had a fair value of $78.8 billion, which was 4.5% above amortized cost of $75.4 billion. As of December 31, 2019, our AFS securities, including related party, had a fair value of $75.2 billion, which was 5.5% above amortized cost of $71.3 billion. These investments are held to support our product liabilities, and we currently have the intent and ability to hold these securities until sale or maturity, and believe the securities will recover the amortized cost basis prior to sale or maturity.
88
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following tables reflect the unrealized losses on the AFS portfolio, including related parties, for which an allowance for credit losses has not been recorded, by NAIC designations:
June 30, 2020 |
|||||||||||||||||||||
(In millions, except percentages) |
Amortized Cost of AFS Securities with Unrealized Loss |
Gross Unrealized Losses |
Fair Value of AFS Securities with Unrealized Loss |
Fair Value to Amortized Cost Ratio |
Fair Value of Total AFS Securities |
Gross Unrealized Losses to Total AFS Fair Value |
|||||||||||||||
NAIC designation |
|||||||||||||||||||||
1 |
$ |
10,718 |
$ |
(499 |
) |
$ |
10,219 |
95.3 |
% |
$ |
39,700 |
(1.3 |
)% |
||||||||
2 |
9,267 |
(706 |
) |
8,561 |
92.4 |
% |
34,124 |
(2.1 |
)% |
||||||||||||
Total investment grade |
19,985 |
(1,205 |
) |
18,780 |
94.0 |
% |
73,824 |
(1.6 |
)% |
||||||||||||
3 |
2,554 |
(264 |
) |
2,290 |
89.7 |
% |
3,916 |
(6.7 |
)% |
||||||||||||
4 |
599 |
(56 |
) |
543 |
90.7 |
% |
827 |
(6.8 |
)% |
||||||||||||
5 |
113 |
(35 |
) |
78 |
69.0 |
% |
149 |
(23.5 |
)% |
||||||||||||
6 |
36 |
(11 |
) |
25 |
69.4 |
% |
89 |
(12.4 |
)% |
||||||||||||
Total below investment grade |
3,302 |
(366 |
) |
2,936 |
88.9 |
% |
4,981 |
(7.3 |
)% |
||||||||||||
Total |
$ |
23,287 |
$ |
(1,571 |
) |
$ |
21,716 |
93.3 |
% |
$ |
78,805 |
(2.0 |
)% |
The following tables reflect the unrealized losses on the AFS portfolio, including related parties, by NAIC designations:
December 31, 2019 |
|||||||||||||||||||||
(In millions, except percentages) |
Amortized Cost of AFS Securities with Unrealized Loss |
Gross Unrealized Losses |
Fair Value of AFS Securities with Unrealized Loss |
Fair Value to Amortized Cost Ratio |
Fair Value of Total AFS Securities |
Gross Unrealized Losses to Total AFS Fair Value |
|||||||||||||||
NAIC designation |
|||||||||||||||||||||
1 |
$ |
5,672 |
$ |
(160 |
) |
$ |
5,512 |
97.2 |
% |
$ |
38,667 |
(0.4 |
)% |
||||||||
2 |
5,252 |
(223 |
) |
5,029 |
95.8 |
% |
32,336 |
(0.7 |
)% |
||||||||||||
Total investment grade |
10,924 |
(383 |
) |
10,541 |
96.5 |
% |
71,003 |
(0.5 |
)% |
||||||||||||
3 |
945 |
(41 |
) |
904 |
95.7 |
% |
3,300 |
(1.2 |
)% |
||||||||||||
4 |
338 |
(34 |
) |
304 |
89.9 |
% |
740 |
(4.6 |
)% |
||||||||||||
5 |
79 |
(11 |
) |
68 |
86.1 |
% |
94 |
(11.7 |
)% |
||||||||||||
6 |
1 |
— |
1 |
100.0 |
% |
41 |
— |
% |
|||||||||||||
Total below investment grade |
1,363 |
(86 |
) |
1,277 |
93.7 |
% |
4,175 |
(2.1 |
)% |
||||||||||||
Total |
$ |
12,287 |
$ |
(469 |
) |
$ |
11,818 |
96.2 |
% |
$ |
75,178 |
(0.6 |
)% |
The gross unrealized losses on AFS securities, including related parties, were $1.6 billion and $469 million as of June 30, 2020 and December 31, 2019, respectively. The increase in unrealized losses was driven by credit spreads widening, partially offset by the decrease in U.S. Treasury rates during the six months ended June 30, 2020.
As of June 30, 2020 and December 31, 2019, we held $5.8 billion and $5.6 billion, respectively, in energy sector fixed maturity securities, or 7%, of the total fixed maturity securities, including related parties. The gross unrealized capital losses on these securities were $208 million and $65 million, or 13% and 14% of the total unrealized losses, respectively.
Provision for Credit Losses
For our credit loss accounting policies and the assumptions used in the allowances, see Note 1 – Business, Basis of Presentation and Significant Accounting Policies and Note 2 – Investments to the condensed consolidated financial statements, as well as Critical Accounting Estimates and Judgments.
89
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As of June 30, 2020, we held an allowance for credit loss on AFS securities of $175 million. During the six months ended June 30, 2020, we recorded a change in provision for credit losses on AFS securities of $158 million, of which $97 million had an income statement impact. These changes were primarily driven by an increase in RMBS and corporate allowances. The intent-to-sell impairments for the six months ended June 30, 2020 were $15 million primarily related to corporates. During the six months ended June 30, 2019, we recorded $7 million of OTTI impairments. The annualized intent-to-sell impairments we experienced for the six months ended June 30, 2020 translate into 2 basis points of average net invested assets, which exclude the ACRA noncontrolling interest. The annualized OTTI losses we experienced for the six months ended June 30, 2019 translate into 1 basis point of average net invested assets.
International Exposure
A portion of our AFS securities are invested in securities with international exposure. As of June 30, 2020 and December 31, 2019, 32% of the carrying value of our AFS securities, including related parties, was comprised of securities of issuers based outside of the United States and debt securities of foreign governments. These securities are either denominated in U.S. dollars or do not expose us to significant foreign currency risk as a result of foreign currency swap arrangements.
The following table presents our international exposure in our AFS portfolio, including related parties, by country or region:
June 30, 2020 |
December 31, 2019 |
||||||||||||||||||||
(In millions, except percentages) |
Amortized Cost |
Fair Value |
Percent of Total |
Amortized Cost |
Fair Value |
Percent of Total |
|||||||||||||||
Country of risk |
|||||||||||||||||||||
Ireland |
$ |
1,468 |
$ |
1,421 |
5.6 |
% |
$ |
1,109 |
$ |
1,137 |
4.7 |
% |
|||||||||
Italy |
6 |
7 |
— |
% |
6 |
7 |
— |
% |
|||||||||||||
Spain |
66 |
71 |
0.3 |
% |
66 |
71 |
0.2 |
% |
|||||||||||||
Total Ireland, Italy, Greece, Spain and Portugal1
|
1,540 |
1,499 |
5.9 |
% |
1,181 |
1,215 |
4.9 |
% |
|||||||||||||
Other Europe |
7,424 |
7,800 |
30.6 |
% |
7,333 |
7,711 |
32.1 |
% |
|||||||||||||
Total Europe |
8,964 |
9,299 |
36.5 |
% |
8,514 |
8,926 |
37.0 |
% |
|||||||||||||
Non-U.S. North America |
12,604 |
12,190 |
47.8 |
% |
11,650 |
11,670 |
48.5 |
% |
|||||||||||||
Australia & New Zealand |
1,880 |
2,034 |
8.0 |
% |
1,853 |
1,966 |
8.2 |
% |
|||||||||||||
Central & South America |
522 |
535 |
2.1 |
% |
473 |
501 |
2.1 |
% |
|||||||||||||
Africa & Middle East |
830 |
865 |
3.4 |
% |
350 |
379 |
1.6 |
% |
|||||||||||||
Asia/Pacific |
558 |
573 |
2.2 |
% |
580 |
616 |
2.6 |
% |
|||||||||||||
Total |
$ |
25,358 |
$ |
25,496 |
100.0 |
% |
$ |
23,420 |
$ |
24,058 |
100.0 |
% |
|||||||||
1 As of each of the respective periods, we had no holdings in Greece or Portugal.
|
Approximately 95.8% of these securities are investment grade by NAIC designation as of both June 30, 2020 and December 31, 2019. As of June 30, 2020, 10% of our AFS securities, including related parties, were invested in CLOs of Cayman Islands issuers (included in Non-U.S. North America) for which underlying investments are largely loans to U.S. issuers and 22% were invested in securities of other non-U.S. issuers.
Portugal, Ireland, Italy, Greece and Spain continue to represent credit risk as economic conditions in these countries continue to be volatile, especially within the financial and banking sectors. We had $1.5 billion and $1.2 billion of exposure in these countries as of June 30, 2020 and December 31, 2019, respectively.
As of June 30, 2020, we held United Kingdom and Channel Islands AFS securities of $3.2 billion, or 4.1% of our AFS securities, including related parties. As of June 30, 2020, these securities were in a net unrealized gain position of $101 million. Our investment managers analyze each holding for credit risk by economic and other factors of each country and industry.
Trading Securities
Trading securities, including related parties, were $2.9 billion as of both June 30, 2020 and December 31, 2019. Trading securities are primarily comprised of AmerUs Closed Block securities for which we have elected the fair value option valuation, CLO equity tranche securities, structured securities with embedded derivatives, and investments which support various reinsurance arrangements.
90
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Mortgage Loans
The following is a summary of our mortgage loan portfolio by collateral type:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Net Carrying Value |
Percent of Total |
Net Carrying Value |
Percent of Total |
|||||||||
Property type |
|||||||||||||
Office building |
$ |
3,545 |
22.4 |
% |
$ |
2,899 |
19.3 |
% |
|||||
Retail |
2,080 |
13.1 |
% |
2,182 |
14.6 |
% |
|||||||
Apartment |
2,401 |
15.2 |
% |
2,142 |
14.3 |
% |
|||||||
Hotels |
1,131 |
7.1 |
% |
1,104 |
7.4 |
% |
|||||||
Industrial |
1,385 |
8.8 |
% |
1,448 |
9.7 |
% |
|||||||
Other commercial1
|
689 |
4.4 |
% |
730 |
4.9 |
% |
|||||||
Total net commercial mortgage loans |
11,231 |
71.0 |
% |
10,505 |
70.2 |
% |
|||||||
Residential loans |
4,598 |
29.0 |
% |
4,454 |
29.8 |
% |
|||||||
Total mortgage loans, net of allowances |
$ |
15,829 |
100.0 |
% |
$ |
14,959 |
100.0 |
% |
|||||
1 Other commercial loans include investments in nursing homes, other healthcare institutions, parking garages, storage facilities and other commercial properties.
|
We invest a portion of our investment portfolio in mortgage loans, which are generally comprised of high quality commercial first lien and mezzanine real estate loans. Our mortgage loan holdings were $15.8 billion and $15.0 billion as of June 30, 2020 and December 31, 2019, respectively. This included $2.0 billion and $1.9 billion of mezzanine mortgage loans as of June 30, 2020 and December 31, 2019, respectively. We have acquired mortgage loans through acquisitions and reinsurance arrangements, as well as through an active program to invest in new mortgage loans. We invest in CMLs on income producing properties including hotels, apartments, retail and office buildings, and other commercial and industrial properties. Our RML portfolio primarily consists of first lien RMLs collateralized by properties located in the U.S. Loan-to-value ratios at the time of loan approval are generally 75% or less.
Our mortgage loans are primarily stated at unpaid principal balance, adjusted for any unamortized premium or discount, and net of credit loss allowances. Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Amortization of premiums and discounts is recorded using the effective interest method. Interest income, amortization of premiums and discounts, and prepayment fees are reported in net investment income.
It is our policy to cease to accrue interest on loans that are over 90 days delinquent. For loans less than 90 days delinquent, interest is accrued unless it is determined that the accrued interest is not collectible. If a loan becomes over 90 days delinquent, it is our general policy to initiate foreclosure proceedings unless a workout arrangement to bring the loan current is in place. As of June 30, 2020 and December 31, 2019, we had $130 million and $67 million, respectively, of mortgage loans that were 90 days past due, of which $38 million and $33 million, respectively, were in the process of foreclosure. We will continue to evaluate these policies with regard to the economic downturn brought about by the spread of COVID-19. Our ability to initiate foreclosure proceedings may be limited by legislation passed and executive orders issued in response to the spread of COVID-19.
See Note 2 – Investments to the condensed consolidated financial statements for information regarding credit loss allowance for collection loss, loan-to-value, and debt service coverage.
As of June 30, 2020, we had valuation allowances of $379 million comprising of $294 million of CML and $85 million of RML allowances. During the six months ended June 30, 2020, we recorded a change in provision for credit losses on CMLs of $117 million and RMLs of $42 million. The increase in provision for credit losses was primarily a result of the adoption of CECL and the economic downturn experienced from the spread of COVID-19. As of December 31, 2019, we had a valuation allowance of $11 million.
Investment Funds
Our investment funds investment strategy primarily focuses on funds with core holdings of credit assets, real assets, real estate, preferred equity and income producing assets. Our investment funds generally meet the definition of a VIE, and in certain cases these investment funds are consolidated in our financial statements because we meet the criteria of the primary beneficiary.
91
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table illustrates our investment funds, including related party:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Carrying Value |
Percent of Total |
Carrying Value |
Percent of Total |
|||||||||
Investment funds |
|||||||||||||
Real estate |
$ |
274 |
4.6 |
% |
$ |
277 |
6.4 |
% |
|||||
Credit funds |
115 |
1.9 |
% |
153 |
3.6 |
% |
|||||||
Private equity |
232 |
3.9 |
% |
236 |
5.5 |
% |
|||||||
Real assets |
61 |
1.0 |
% |
83 |
2.0 |
% |
|||||||
Natural resources |
— |
— |
% |
1 |
— |
% |
|||||||
Total investment funds |
682 |
11.4 |
% |
750 |
17.5 |
% |
|||||||
Investment funds – related parties |
|||||||||||||
Differentiated investments |
|||||||||||||
MidCap |
517 |
8.7 |
% |
547 |
12.7 |
% |
|||||||
AmeriHome |
594 |
10.0 |
% |
487 |
11.3 |
% |
|||||||
Catalina |
295 |
4.9 |
% |
271 |
6.3 |
% |
|||||||
Athora |
497 |
8.3 |
% |
132 |
3.1 |
% |
|||||||
Venerable |
118 |
2.0 |
% |
99 |
2.3 |
% |
|||||||
Other |
246 |
4.1 |
% |
222 |
5.2 |
% |
|||||||
Total differentiated investments |
2,267 |
38.0 |
% |
1,758 |
40.9 |
% |
|||||||
Real estate |
709 |
11.9 |
% |
853 |
19.8 |
% |
|||||||
Credit funds |
363 |
6.1 |
% |
370 |
8.6 |
% |
|||||||
Private equity |
255 |
4.3 |
% |
105 |
2.4 |
% |
|||||||
Real assets |
233 |
3.9 |
% |
182 |
4.2 |
% |
|||||||
Natural resources |
95 |
1.6 |
% |
163 |
3.8 |
% |
|||||||
Public equities |
43 |
0.8 |
% |
119 |
2.8 |
% |
|||||||
Investment in Apollo |
1,313 |
22.0 |
% |
— |
— |
% |
|||||||
Total investment funds – related parties |
5,278 |
88.6 |
% |
3,550 |
82.5 |
% |
|||||||
Total investment funds including related parties |
$ |
5,960 |
100.0 |
% |
$ |
4,300 |
100.0 |
% |
Overall, the total investment funds, including related party, were $6.0 billion and $4.3 billion, respectively, as of June 30, 2020 and December 31, 2019. See Note 2 – Investments to the condensed consolidated financial statements for further discussion regarding how we account for our investment funds. Our investment fund portfolio is subject to a number of market related risks including interest rate risk and equity market risk. Interest rate risk represents the potential for changes in the investment fund’s net asset values resulting from changes in the general level of interest rates. Equity market risk represents potential for changes in the investment fund’s net asset values resulting from changes in equity markets or from other external factors which influence equity markets. These risks expose us to potential volatility in our earnings period-over-period. We actively monitor our exposure to these risks. The increase in investment funds, including related party, was primarily driven by our investment in Apollo of $1.3 billion as of June 30, 2020 as well as an increase in our investment in Athora.
Funds Withheld at Interest
Funds withheld at interest represents a receivable for amounts contractually withheld by ceding companies in accordance with modco and funds withheld reinsurance agreements in which we act as the reinsurer. Generally, assets equal to statutory reserves are withheld and legally owned by the ceding company. We hold funds withheld at interest receivables, including those held with VIAC, Lincoln and Jackson. As of June 30, 2020, the majority of the ceding companies holding the assets pursuant to such reinsurance agreements had a financial strength rating of A- or better (based on an A.M. Best scale).
The funds withheld at interest is comprised of the host contract and an embedded derivative. We are subject to the investment performance on the withheld assets with the total return directly impacting the host contract and the embedded derivative. Interest accrues at a risk-free rate on the host receivable and is recorded as net investment income in the condensed consolidated statements of income (loss). The embedded derivative in our reinsurance agreements is similar to a total return swap on the income generated by the underlying assets held by the ceding companies. The change in the embedded derivative is recorded in investment related gains (losses). Although we do not legally own the underlying investments in the funds withheld at interest, in each instance the ceding company has hired Apollo to manage the withheld assets in accordance with our investment guidelines.
92
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following summarizes the underlying investment composition of the funds withheld at interest, including related parties:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Carrying Value |
Percent of Total |
Carrying Value |
Percent of Total |
|||||||||
Fixed maturity securities |
|||||||||||||
U.S. government and agencies |
$ |
15 |
— |
% |
$ |
15 |
0.1 |
% |
|||||
U.S. state, municipal and political subdivisions |
346 |
0.6 |
% |
482 |
1.7 |
% |
|||||||
Foreign governments |
182 |
0.3 |
% |
143 |
0.5 |
% |
|||||||
Corporate |
30,405 |
55.1 |
% |
14,590 |
51.4 |
% |
|||||||
CLO |
3,405 |
6.2 |
% |
2,586 |
9.1 |
% |
|||||||
ABS |
2,781 |
5.0 |
% |
2,510 |
8.8 |
% |
|||||||
CMBS |
2,157 |
3.9 |
% |
756 |
2.7 |
% |
|||||||
RMBS |
2,095 |
3.8 |
% |
1,482 |
5.2 |
% |
|||||||
Equity securities |
68 |
0.1 |
% |
74 |
0.3 |
% |
|||||||
Mortgage loans |
5,966 |
10.8 |
% |
4,357 |
15.3 |
% |
|||||||
Investment funds |
916 |
1.7 |
% |
807 |
2.8 |
% |
|||||||
Derivative assets |
161 |
0.3 |
% |
224 |
0.8 |
% |
|||||||
Short-term investments |
1,012 |
1.8 |
% |
157 |
0.6 |
% |
|||||||
Cash and cash equivalents |
6,736 |
12.2 |
% |
239 |
0.8 |
% |
|||||||
Other assets and liabilities |
(1,005 |
) |
(1.8 |
)% |
(21 |
) |
(0.1 |
)% |
|||||
Total funds withheld at interest including related party |
$ |
55,240 |
100.0 |
% |
$ |
28,401 |
100.0 |
% |
As of June 30, 2020 and December 31, 2019, we held $55.2 billion and $28.4 billion, respectively, of funds withheld at interest receivables, including related party. Approximately 95.6% and 94.4% of the fixed maturity securities within the funds withheld at interest are investment grade by NAIC designation as of June 30, 2020 and December 31, 2019, respectively. The increase in funds withheld at interest receivables, including related party, was primarily driven by a $28.8 billion increase in assets as a result of the Jackson reinsurance transaction, partially offset by unrealized losses on fixed maturity securities due to credit spreads widening and run off in the underlying blocks of business.
Derivative Instruments
We hold derivative instruments for economic hedging purposes to reduce our exposure to cash flow variability of assets and liabilities, equity market risk, interest rate risk, credit risk and foreign exchange risk. The types of derivatives we may use include interest rate swaps, foreign currency swaps and forward contracts, total return swaps, credit default swaps, variance swaps, futures and fixed indexed options.
A discussion regarding our derivative instruments and how such instruments are used to manage risk is included in Note 3 – Derivative Instruments to the condensed consolidated financial statements.
As part of our risk management strategies, management continually evaluates our derivative instrument holdings and the effectiveness of such holdings in addressing risks identified in our operations.
93
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Net Invested Assets
The following summarizes our net invested assets:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Net Invested Asset Value1
|
Percent of Total |
Net Invested Asset Value1
|
Percent of Total |
|||||||||
Corporate |
$ |
63,171 |
46.0 |
% |
$ |
55,077 |
46.9 |
% |
|||||
CLO |
11,984 |
8.7 |
% |
10,223 |
8.7 |
% |
|||||||
Credit |
75,155 |
54.7 |
% |
65,300 |
55.6 |
% |
|||||||
RMBS |
8,665 |
6.3 |
% |
8,394 |
7.1 |
% |
|||||||
CML |
15,664 |
11.4 |
% |
14,038 |
12.0 |
% |
|||||||
RML |
4,755 |
3.5 |
% |
4,490 |
3.8 |
% |
|||||||
CMBS |
3,417 |
2.5 |
% |
2,930 |
2.5 |
% |
|||||||
Real estate |
32,501 |
23.7 |
% |
29,852 |
25.4 |
% |
|||||||
ABS |
10,507 |
7.6 |
% |
10,317 |
8.8 |
% |
|||||||
Alternative investments |
6,082 |
4.4 |
% |
5,586 |
4.8 |
% |
|||||||
State, municipal, political subdivisions and foreign government |
1,750 |
1.3 |
% |
2,260 |
1.9 |
% |
|||||||
Equity securities |
392 |
0.3 |
% |
365 |
0.3 |
% |
|||||||
Short-term investments |
699 |
0.5 |
% |
624 |
0.5 |
% |
|||||||
U.S. government and agencies |
85 |
0.1 |
% |
49 |
— |
% |
|||||||
Other investments |
19,515 |
14.2 |
% |
19,201 |
16.3 |
% |
|||||||
Cash and equivalents |
7,541 |
5.5 |
% |
1,958 |
1.7 |
% |
|||||||
Policy loans and other |
1,244 |
0.9 |
% |
1,175 |
1.0 |
% |
|||||||
Net invested assets excluding investment in Apollo |
135,956 |
99.0 |
% |
117,486 |
100.0 |
% |
|||||||
Investment in Apollo |
1,313 |
1.0 |
% |
— |
— |
% |
|||||||
Net invested assets |
$ |
137,269 |
100.0 |
% |
$ |
117,486 |
100.0 |
% |
|||||
1 See Key Operating and Non-GAAP Measures for the definition of net invested assets.
|
Our net invested assets were $137.3 billion and $117.5 billion as of June 30, 2020 and December 31, 2019, respectively. As of June 30, 2020, our net invested assets were mainly comprised of 46.0% of corporate securities, 25.1% of structured securities, 14.9% of mortgage loans and 4.4% of alternative investments. Corporate securities included $16.6 billion of private placements, which represented 12.1% of our net invested assets. The increase in net invested assets as of June 30, 2020 from December 31, 2019 was primarily driven by a $10.2 billion increase in assets, net of the ACRA noncontrolling interest, as a result of the Jackson reinsurance transaction, our investment in Apollo of $1.3 billion, growth in deposits over liability outflows and reinvestment of earnings.
In managing our business we utilize net invested assets as presented in the above table. Net invested assets do not correspond to total investments, including related parties, on our condensed consolidated balance sheets, as discussed previously in Key Operating and Non-GAAP Measures. Net invested assets represent the investments that directly back our net reserve liabilities and surplus assets. We believe this view of our portfolio provides a view of the assets for which we have economic exposure. We adjust the presentation for funds withheld and modco transactions to include or exclude the underlying investments based upon the contractual transfer of economic exposure to such underlying investments. We also adjust for VIEs in order to show the net investment in the funds, which are included in the alternative investments line above as well as adjust for the allowance for credit losses. Net invested assets includes our proportionate share of ACRA investments, based on our economic ownership, but excludes the proportionate share of investments associated with the noncontrolling interest.
Net invested assets is utilized by management to evaluate our investment portfolio. Net invested assets, excluding our strategic investment in Apollo, is used in the computation of net investment earned rate, which allows us to analyze the profitability of our investment portfolio. Net invested assets is also used in our risk management processes for asset purchases, product design and underwriting, stress scenarios, liquidity, and ALM.
94
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Net Alternative Investments
The following summarizes our alternative investments:
June 30, 2020 |
December 31, 2019 |
||||||||||||
(In millions, except percentages) |
Net Invested Asset Value |
Percent of Total |
Net Invested Asset Value |
Percent of Total |
|||||||||
Retirement Services |
|||||||||||||
Differentiated investments |
|||||||||||||
AmeriHome |
$ |
730 |
12.0 |
% |
$ |
595 |
10.7 |
% |
|||||
MidCap |
594 |
9.8 |
% |
547 |
9.8 |
% |
|||||||
Catalina |
295 |
4.9 |
% |
271 |
4.9 |
% |
|||||||
Venerable |
118 |
1.9 |
% |
99 |
1.8 |
% |
|||||||
Other |
309 |
5.1 |
% |
208 |
3.7 |
% |
|||||||
Total differentiated investments |
2,046 |
33.7 |
% |
1,720 |
30.9 |
% |
|||||||
Real estate |
1,260 |
20.7 |
% |
1,430 |
25.6 |
% |
|||||||
Credit |
911 |
15.0 |
% |
968 |
17.3 |
% |
|||||||
Private equity |
550 |
9.0 |
% |
378 |
6.8 |
% |
|||||||
Real assets |
411 |
6.8 |
% |
349 |
6.2 |
% |
|||||||
Natural resources |
45 |
0.7 |
% |
51 |
0.9 |
% |
|||||||
Other |
— |
— |
% |
58 |
1.0 |
% |
|||||||
Total Retirement Services alternative investments |
5,223 |
85.9 |
% |
4,954 |
88.7 |
% |
|||||||
Corporate and Other |
|||||||||||||
Athora |
501 |
8.2 |
% |
140 |
2.5 |
% |
|||||||
Credit |
89 |
1.5 |
% |
128 |
2.3 |
% |
|||||||
Natural resources |
226 |
3.7 |
% |
245 |
4.4 |
% |
|||||||
Public equities1
|
43 |
0.7 |
% |
119 |
2.1 |
% |
|||||||
Total Corporate and Other alternative investments |
859 |
14.1 |
% |
632 |
11.3 |
% |
|||||||
Net alternative investments |
$ |
6,082 |
100.0 |
% |
$ |
5,586 |
100.0 |
% |
|||||
1 As of June 30, 2020 and December 31, 2019, public equities is exclusively comprised of an investment in OneMain Holdings, Inc. (ticker: OMF).
|
Net alternative investments were $6.1 billion and $5.6 billion as of June 30, 2020 and December 31, 2019, respectively, representing 4.4% and 4.8% of our net invested assets portfolio as of June 30, 2020 and December 31, 2019, respectively.
Net alternative investments do not correspond to the total investment funds, including related parties and VIEs, on our condensed consolidated balance sheets. As discussed above in the net invested assets section, we adjust the GAAP presentation for funds withheld, modco and VIEs. The investment in Apollo is excluded from our alternative investments, while we include CLO equity tranche securities in alternative investments due to their underlying characteristics and equity-like features.
Through our relationship with Apollo, we have indirectly invested in companies that meet the key characteristics we look for in net alternative investments. Two of our largest alternative investments are in asset originators, MidCap and AmeriHome, both of which, from time to time, provide us with access to assets for our investment portfolio.
MidCap
Our equity investment in MidCap is held indirectly through CoInvest VII, of which MidCap constitutes substantially all of the fund’s investments. MidCap is a commercial finance company that provides various financial products to middle-market businesses in multiple industries, primarily located in the U.S. MidCap primarily originates and invests in commercial and industrial loans, including senior secured corporate loans, working capital loans collateralized mainly by accounts receivable and inventory, senior secured loans collateralized by portfolios of commercial and consumer loans and related products and secured loans to highly capitalized pharmaceutical and medical device companies, and commercial real estate loans, including multifamily independent-living properties, assisted living, skilled nursing and medical office properties, warehouse, office building, hotel and other commercial use properties and multifamily properties. MidCap originates and acquires loans using borrowings under financing arrangements that it has in place with numerous financial institutions. MidCap’s earnings are primarily driven by the difference between the interest earned on its loan portfolio and the interest accrued under its outstanding borrowings. As a result, MidCap is primarily exposed to the credit risk of its loan counterparties and prepayment risk. Additionally, financial results are influenced by related levels of middle-market business investment and interest rates.
95
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our alternative investment in MidCap had a carrying value of $594 million and $547 million as of June 30, 2020 and December 31, 2019, respectively. As of June 30, 2020 and December 31, 2019, this alternative investment is comprised of our investment in CoInvest VII, which is substantially comprised of its investment in MidCap, of $517 million and $547 million, respectively, and redeemable preferred stock of $77 million and $0 million, respectively. Our investment in CoInvest VII largely reflects any contributions to and distributions from CoInvest VII and the fair value of MidCap. CoInvest VII returned a net investment earned rate of 6.95% and 15.55% for the three months ended June 30, 2020 and 2019, respectively, and (4.68)% and 12.53% for the six months ended June 30, 2020 and 2019, respectively. Alternative investment income (loss) from CoInvest VII was $10 million and $21 million for the three months ended June 30, 2020 and 2019, respectively, and $(11) million and $35 million for the six months ended June 30, 2020 and 2019, respectively. The decrease in alternative investment income for the three months ended June 30, 2020 compared to 2019 was mainly due to lower origination volumes due to the current interest rate environment. The decrease in alternative investment income for the six months ended June 30, 2020 compared to 2019 was mainly due to a decrease in valuation in the first quarter reflecting an increase in loan loss assumptions and lower origination volumes due to the current interest rate environment. The redeemable preferred stock returned a net investment earned rate of 112.01% and 0.00% for the three months ended June 30, 2020 and 2019, respectively, and 84.05% and 0.00% for the six months ended June 30, 2020 and 2019, respectively. Alternative investment income from the redeemable preferred stock was $11 million for both the three and six months ended June 30, 2020 and $0 million for both the three and six months ended June 30, 2019. The increase in alternative investment income from the redeemable preferred stock was primarily driven by favorable profit interests.
AmeriHome
Our equity investment in AmeriHome is held indirectly through A-A Mortgage, of which AmeriHome is currently the fund’s only investment. AmeriHome is a mortgage origination platform and an aggregator of mortgage servicing rights. AmeriHome acquires mortgage loans from retail originators and re-sells the loans to the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Government National Mortgage Association and other investors. AmeriHome retains the mortgage servicing rights on the loans that it sells and employs a subservicer to perform servicing operations, including payment collection. AmeriHome’s earnings are primarily driven by two sources: gains or losses on the sale of mortgage loans and the difference between the fee that it charges for mortgage servicing and the fee charged by the subservicer. As a result, AmeriHome’s financial results are influenced by interest rates and related housing demand. AmeriHome is primarily exposed to credit risk related to the accuracy of the representations and warranties in the loans that AmeriHome acquires and prepayment risk, which prematurely terminates fees related to mortgage servicing.
Our alternative investment in A-A Mortgage had a carrying value of $730 million and $595 million as of June 30, 2020 and December 31, 2019, respectively. Our investment in A-A Mortgage represents our proportionate share of its net asset value, which largely reflects any contributions to and distributions from A-A Mortgage and the fair value of AmeriHome. A-A Mortgage returned a net investment earned rate of 63.57% and 13.71% for the three months ended June 30, 2020 and 2019, respectively, and 41.04% and 13.90% for the six months ended June 30, 2020 and 2019, respectively. Alternative investment income from A-A Mortgage was $109 million and $19 million for the three months ended June 30, 2020 and 2019, respectively, and $135 million and $39 million for the six months ended June 30, 2020 and 2019, respectively. The increase in alternative investment income for both the three and six months ended June 30, 2020 compared to 2019 was mainly due to an increase in valuation driven by strong earnings reflecting increased origination volumes and increased gains on sales to secondary markets.
Public Equities
We indirectly hold public equity positions through our equity investments in a few alternative investments. Although the net invested asset value of these securities is minor, such securities have resulted in volatility in our statements of income (loss) in recent periods. As of June 30, 2020 and December 31, 2019, we indirectly held public equity positions of $43 million and $119 million, respectively. As of June 30, 2020 and December 31, 2019, we held approximately 2.8 million shares of OneMain with a market value of $43 million and $119 million, respectively. The decrease in market value is driven by the decline in share price, partially offset by dividend received in 2020.
96
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Non-GAAP Measure Reconciliations
The reconciliations to the nearest GAAP measure for adjusted operating income (loss) available to common shareholders is included in the Consolidated Results of Operations section.
The reconciliation of total AHL shareholders’ equity to total adjusted AHL common shareholders’ equity, which is included in adjusted book value per common share, adjusted debt to capital ratio and adjusted operating ROE, is as follows:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Total AHL shareholders’ equity |
$ |
14,711 |
$ |
13,391 |
|||
Less: Preferred stock |
1,755 |
1,172 |
|||||
Total AHL common shareholders’ equity |
12,956 |
12,219 |
|||||
Less: AOCI |
2,184 |
2,281 |
|||||
Less: Accumulated change in fair value of reinsurance assets |
615 |
493 |
|||||
Total adjusted AHL common shareholders’ equity |
$ |
10,157 |
$ |
9,445 |
|||
Segment adjusted AHL common shareholders’ equity |
|||||||
Retirement Services |
$ |
6,957 |
$ |
7,443 |
|||
Corporate and Other |
3,200 |
2,002 |
|||||
Total adjusted AHL common shareholders’ equity |
$ |
10,157 |
$ |
9,445 |
The reconciliation of average AHL shareholders’ equity to average adjusted AHL common shareholders’ equity, which is included in adjusted operating ROE is as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
Average AHL shareholders’ equity |
$ |
12,326 |
$ |
11,241 |
$ |
14,051 |
$ |
10,321 |
|||||||
Less: Average preferred stock |
1,464 |
420 |
1,464 |
420 |
|||||||||||
Less: Average AOCI |
505 |
1,233 |
2,233 |
644 |
|||||||||||
Less: Average accumulated change in fair value of reinsurance assets |
230 |
474 |
554 |
282 |
|||||||||||
Average adjusted AHL common shareholders’ equity |
$ |
10,127 |
$ |
9,114 |
$ |
9,800 |
$ |
8,975 |
|||||||
Segment average adjusted AHL common shareholders’ equity |
|||||||||||||||
Retirement Services |
$ |
7,480 |
$ |
7,952 |
$ |
7,199 |
$ |
7,755 |
|||||||
Corporate and Other |
2,647 |
1,162 |
2,601 |
1,220 |
|||||||||||
Average adjusted AHL common shareholders’ equity |
$ |
10,127 |
$ |
9,114 |
$ |
9,800 |
$ |
8,975 |
97
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The reconciliation of net investment income to net investment earnings and earned rate is as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||||||||||||||
2020 |
2019 |
2020 |
2019 |
||||||||||||||||||||||||
(In millions, except percentages) |
Dollar |
Rate |
Dollar |
Rate |
Dollar |
Rate |
Dollar |
Rate |
|||||||||||||||||||
GAAP net investment income |
$ |
1,336 |
4.22 |
% |
$ |
1,182 |
4.10 |
% |
$ |
2,081 |
3.39 |
% |
$ |
2,264 |
3.98 |
% |
|||||||||||
Change in fair value of reinsurance assets |
218 |
0.69 |
% |
161 |
0.56 |
% |
488 |
0.79 |
% |
293 |
0.52 |
% |
|||||||||||||||
Alternative income gain (loss) |
56 |
0.18 |
% |
12 |
0.04 |
% |
(45 |
) |
(0.08 |
)% |
7 |
0.01 |
% |
||||||||||||||
ACRA noncontrolling interest |
(81 |
) |
(0.26 |
)% |
— |
— |
% |
(153 |
) |
(0.25 |
)% |
— |
— |
% |
|||||||||||||
Apollo investment (income) loss |
(481 |
) |
(1.52 |
)% |
— |
— |
% |
(184 |
) |
(0.30 |
)% |
— |
— |
% |
|||||||||||||
Held for trading amortization and other |
(8 |
) |
(0.02 |
)% |
(10 |
) |
(0.03 |
)% |
4 |
0.01 |
% |
(16 |
) |
(0.03 |
)% |
||||||||||||
Total adjustments to arrive at net investment earnings/earned rate |
(296 |
) |
(0.93 |
)% |
163 |
0.57 |
% |
110 |
0.17 |
% |
284 |
0.50 |
% |
||||||||||||||
Total net investment earnings/earned rate |
$ |
1,040 |
3.29 |
% |
$ |
1,345 |
4.67 |
% |
$ |
2,191 |
3.56 |
% |
$ |
2,548 |
4.48 |
% |
|||||||||||
Retirement Services |
$ |
1,075 |
3.44 |
% |
$ |
1,321 |
4.63 |
% |
$ |
2,259 |
3.73 |
% |
$ |
2,492 |
4.42 |
% |
|||||||||||
Corporate and Other |
(35 |
) |
(8.91 |
)% |
24 |
8.39 |
% |
(68 |
) |
(7.94 |
)% |
56 |
10.05 |
% |
|||||||||||||
Total net investment earnings/earned rate |
$ |
1,040 |
3.29 |
% |
$ |
1,345 |
4.67 |
% |
$ |
2,191 |
3.56 |
% |
$ |
2,548 |
4.48 |
% |
|||||||||||
Retirement Services average net invested assets |
$ |
124,943 |
$ |
114,059 |
$ |
121,213 |
$ |
112,711 |
|||||||||||||||||||
Corporate and Other average net invested assets ex. Apollo investment |
1,567 |
1,162 |
1,712 |
1,113 |
|||||||||||||||||||||||
Consolidated average net invested assets ex. Apollo investment |
$ |
126,510 |
$ |
115,221 |
$ |
122,925 |
$ |
113,824 |
The reconciliation of interest sensitive contract benefits to Retirement Services’ cost of crediting, and the respective rates, is as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||||||||||||||
2020 |
2019 |
2020 |
2019 |
||||||||||||||||||||||||
(In millions, except percentages) |
Dollar |
Rate |
Dollar |
Rate |
Dollar |
Rate |
Dollar |
Rate |
|||||||||||||||||||
GAAP interest sensitive contract benefits |
$ |
2,076 |
6.65 |
% |
$ |
1,094 |
3.84 |
% |
$ |
757 |
1.25 |
% |
$ |
2,610 |
4.63 |
% |
|||||||||||
Interest credited other than deferred annuities and institutional products |
75 |
0.24 |
% |
50 |
0.18 |
% |
138 |
0.22 |
% |
105 |
0.19 |
% |
|||||||||||||||
FIA option costs |
271 |
0.86 |
% |
280 |
0.98 |
% |
537 |
0.88 |
% |
558 |
0.99 |
% |
|||||||||||||||
Product charges (strategy fees) |
(34 |
) |
(0.11 |
)% |
(29 |
) |
(0.10 |
)% |
(66 |
) |
(0.11 |
)% |
(57 |
) |
(0.10 |
)% |
|||||||||||
Reinsurance embedded derivative impacts |
15 |
0.05 |
% |
14 |
0.05 |
% |
29 |
0.05 |
% |
29 |
0.05 |
% |
|||||||||||||||
Change in fair value of embedded derivatives – FIAs |
(1,734 |
) |
(5.55 |
)% |
(868 |
) |
(3.05 |
)% |
(230 |
) |
(0.38 |
)% |
(2,179 |
) |
(3.86 |
)% |
|||||||||||
Negative VOBA amortization |
5 |
0.02 |
% |
7 |
0.02 |
% |
12 |
0.02 |
% |
19 |
0.03 |
% |
|||||||||||||||
ACRA noncontrolling interest |
(113 |
) |
(0.37 |
)% |
— |
— |
% |
(75 |
) |
(0.12 |
)% |
— |
— |
% |
|||||||||||||
Other changes in interest sensitive contract liabilities |
(1 |
) |
0.00 |
% |
(1 |
) |
0.00 |
% |
(2 |
) |
— |
% |
(3 |
) |
(0.01 |
)% |
|||||||||||
Total adjustments to arrive at cost of crediting |
(1,516 |
) |
(4.86 |
)% |
(547 |
) |
(1.92 |
)% |
343 |
0.56 |
% |
(1,528 |
) |
(2.71 |
)% |
||||||||||||
Retirement Services cost of crediting |
$ |
560 |
1.79 |
% |
$ |
547 |
1.92 |
% |
$ |
1,100 |
1.81 |
% |
$ |
1,082 |
1.92 |
% |
|||||||||||
Retirement Services cost of crediting on deferred annuities |
$ |
451 |
1.94 |
% |
$ |
448 |
1.98 |
% |
$ |
873 |
1.92 |
% |
$ |
892 |
1.98 |
% |
|||||||||||
Retirement Services cost of crediting on institutional products |
109 |
2.87 |
% |
99 |
3.76 |
% |
227 |
3.08 |
% |
190 |
3.73 |
% |
|||||||||||||||
Retirement Services cost of crediting |
$ |
560 |
1.79 |
% |
$ |
547 |
1.92 |
% |
$ |
1,100 |
1.81 |
% |
$ |
1,082 |
1.92 |
% |
|||||||||||
Retirement Services average net invested assets |
$ |
124,943 |
$ |
114,059 |
$ |
121,213 |
$ |
112,711 |
|||||||||||||||||||
Average account value on deferred annuities |
92,814 |
90,675 |
90,654 |
90,261 |
|||||||||||||||||||||||
Average net institutional reserve liabilities |
15,233 |
10,470 |
14,742 |
10,140 |
98
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The reconciliation of GAAP benefits and expenses to other liability costs is as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
GAAP benefits and expenses |
$ |
3,317 |
$ |
2,673 |
$ |
3,150 |
$ |
6,928 |
|||||||
Premiums |
(355 |
) |
(787 |
) |
(1,495 |
) |
(2,787 |
) |
|||||||
Product charges |
(141 |
) |
(132 |
) |
(281 |
) |
(257 |
) |
|||||||
Other revenues |
(18 |
) |
(9 |
) |
(16 |
) |
(21 |
) |
|||||||
Cost of crediting |
(275 |
) |
(253 |
) |
(534 |
) |
(495 |
) |
|||||||
Change in fair value of embedded derivatives – FIA, net of offsets |
(1,445 |
) |
(817 |
) |
11 |
(2,077 |
) |
||||||||
DAC, DSI and VOBA amortization related to investment gains and losses |
(323 |
) |
(181 |
) |
102 |
(354 |
) |
||||||||
Rider reserves related to investment gains and losses |
(46 |
) |
(24 |
) |
30 |
(52 |
) |
||||||||
Policy and other operating expenses, excluding policy acquisition expenses |
(145 |
) |
(117 |
) |
(262 |
) |
(220 |
) |
|||||||
AmerUs closed block fair value liability |
(100 |
) |
(59 |
) |
(55 |
) |
(112 |
) |
|||||||
ACRA noncontrolling interest |
(241 |
) |
— |
(76 |
) |
— |
|||||||||
Other |
(13 |
) |
1 |
(17 |
) |
2 |
|||||||||
Total adjustments to arrive at other liability costs |
(3,102 |
) |
(2,378 |
) |
(2,593 |
) |
(6,373 |
) |
|||||||
Other liability costs |
$ |
215 |
$ |
295 |
$ |
557 |
$ |
555 |
|||||||
Retirement Services |
$ |
215 |
$ |
295 |
$ |
557 |
$ |
555 |
|||||||
Corporate and Other |
— |
— |
— |
— |
|||||||||||
Consolidated other liability costs |
$ |
215 |
$ |
295 |
$ |
557 |
$ |
555 |
The reconciliation of policy and other operating expenses to operating expenses is as follows:
Three months ended June 30, |
Six months ended June 30, |
||||||||||||||
(In millions) |
2020 |
2019 |
2020 |
2019 |
|||||||||||
GAAP policy and other operating expenses |
$ |
218 |
$ |
185 |
$ |
406 |
$ |
350 |
|||||||
Interest expense |
(29 |
) |
(15 |
) |
(49 |
) |
(32 |
) |
|||||||
Policy acquisition expenses, net of deferrals |
(73 |
) |
(69 |
) |
(144 |
) |
(131 |
) |
|||||||
Integration, restructuring and other non-operating expenses |
(9 |
) |
(11 |
) |
(13 |
) |
(12 |
) |
|||||||
Stock compensation expenses |
— |
(3 |
) |
(10 |
) |
(6 |
) |
||||||||
ACRA noncontrolling interest |
(19 |
) |
— |
(23 |
) |
— |
|||||||||
Total adjustments to arrive at operating expenses |
(130 |
) |
(98 |
) |
(239 |
) |
(181 |
) |
|||||||
Operating expenses |
$ |
88 |
$ |
87 |
$ |
167 |
$ |
169 |
|||||||
Retirement Services |
$ |
71 |
$ |
68 |
$ |
139 |
$ |
130 |
|||||||
Corporate and Other |
17 |
19 |
28 |
39 |
|||||||||||
Consolidated operating expenses |
$ |
88 |
$ |
87 |
$ |
167 |
$ |
169 |
99
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The reconciliation of total investments, including related parties, to net invested assets is as follows:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Total investments, including related parties |
$ |
163,039 |
$ |
130,550 |
|||
Derivative assets |
(2,379 |
) |
(2,888 |
) |
|||
Cash and cash equivalents (including restricted cash) |
7,521 |
4,639 |
|||||
Accrued investment income |
836 |
807 |
|||||
Payables for collateral on derivatives |
(2,117 |
) |
(2,743 |
) |
|||
Reinsurance funds withheld and modified coinsurance |
(203 |
) |
(1,440 |
) |
|||
VIE and VOE assets, liabilities and noncontrolling interest |
(18 |
) |
25 |
||||
Unrealized (gains) losses |
(3,782 |
) |
(4,095 |
) |
|||
Ceded policy loans |
(225 |
) |
(235 |
) |
|||
Net investment receivables (payables) |
(1,281 |
) |
(57 |
) |
|||
Allowance for credit losses |
574 |
— |
|||||
Total adjustments to arrive at gross invested assets |
(1,074 |
) |
(5,987 |
) |
|||
Gross invested assets |
161,965 |
124,563 |
|||||
ACRA noncontrolling interest |
(24,696 |
) |
(7,077 |
) |
|||
Net invested assets |
$ |
137,269 |
$ |
117,486 |
The reconciliation of total investment funds, including related parties, to net alternative investments within net invested assets is as follows:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Investment funds, including related parties |
$ |
5,960 |
$ |
4,300 |
|||
Nonredeemable preferred stock included in equity securities |
— |
78 |
|||||
CLO and ABS equities included in trading securities |
504 |
405 |
|||||
Investment in Apollo |
(1,313 |
) |
— |
||||
Investment funds within funds withheld at interest |
916 |
807 |
|||||
Royalties and other assets included in other investments |
85 |
67 |
|||||
Unrealized (gains) losses and other adjustments |
8 |
8 |
|||||
ACRA noncontrolling interest |
(78 |
) |
(79 |
) |
|||
Total adjustments to arrive at alternative investments |
122 |
1,286 |
|||||
Net alternative investments |
$ |
6,082 |
$ |
5,586 |
The reconciliation of total liabilities to net reserve liabilities is as follows:
(In millions) |
June 30, 2020 |
December 31, 2019 |
|||||
Total liabilities |
$ |
167,602 |
$ |
132,734 |
|||
Short-term debt |
— |
(475 |
) |
||||
Long-term debt |
(1,486 |
) |
(992 |
) |
|||
Derivative liabilities |
(118 |
) |
(97 |
) |
|||
Payables for collateral on derivatives and securities to repurchase |
(3,118 |
) |
(3,255 |
) |
|||
Funds withheld liability |
(427 |
) |
(408 |
) |
|||
Other liabilities |
(1,486 |
) |
(1,181 |
) |
|||
Reinsurance ceded receivables |
(5,310 |
) |
(4,863 |
) |
|||
Policy loans ceded |
(225 |
) |
(235 |
) |
|||
ACRA noncontrolling interest |
(24,094 |
) |
(6,574 |
) |
|||
Other |
(5 |
) |
(2 |
) |
|||
Total adjustments to arrive at net reserve liabilities |
(36,269 |
) |
(18,082 |
) |
|||
Net reserve liabilities |
$ |
131,333 |
$ |
114,652 |
100
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources
There are two forms of liquidity relevant to our business, funding liquidity and balance sheet liquidity. Funding liquidity relates to the ability to fund operations. Balance sheet liquidity relates to our ability to liquidate or rebalance our balance sheet without incurring significant costs from fees, bid-offer spreads, or market impact. We manage our liquidity position by matching projected cash demands with adequate sources of cash and other liquid assets. Our principal sources of liquidity, in the ordinary course of business, are operating cash flows and holdings of cash, cash equivalents and other readily marketable assets.
Our investment portfolio is structured to ensure a strong liquidity position over time in order to permit timely payment of policy and contract benefits without requiring asset sales at inopportune times or at depressed prices. In general, liquid assets include cash and cash equivalents, highly rated corporate bonds, unaffiliated preferred stock and unaffiliated public common stock, all of which generally have liquid markets with a large number of buyers. The carrying value of these assets, excluding modified coinsurance and funds withheld portfolios, as of June 30, 2020 was $62.9 billion. Assets included in modified coinsurance and funds withheld portfolios are available to fund the benefits for the associated obligations but are restricted from other uses. The carrying value of the underlying assets in these modified coinsurance and funds withheld portfolios that are liquid as of June 30, 2020 was $38.0 billion. Although our investment portfolio does contain assets that are generally considered illiquid for liquidity monitoring purposes (primarily mortgage loans, policy loans, real estate, investment funds, and affiliated common stock), there is some ability to raise cash from these assets if needed. In periods of economic downturn, such as the one brought about by the spread of COVID-19, we may maintain higher cash balances than required to manage our liquidity risk and to take advantage of market dislocations as they arise. We have access to additional liquidity through our $1.25 billion credit agreement, which was undrawn as of June 30, 2020 and had a remaining term of more than four years, subject to up to two one-year extensions. Our registration statement on Form S-3 ASR (Shelf Registration Statement) provides us access to the capital markets, subject to market conditions and other factors. We are also party to agreements with several different financial institutions, pursuant to which we may engage in secured repurchase transactions to obtain short-term liquidity, to the extent available. In addition, through our membership in the FHLB, we are eligible to borrow under variable rate short-term federal funds arrangements to provide additional liquidity.
We proactively manage our liquidity position to meet cash needs while minimizing adverse impacts on investment returns. We analyze our cash-flow liquidity over the upcoming 12 months by modeling potential demands on liquidity under a variety of scenarios, taking into account the provisions of our policies and contracts in force, our cash flow position, and the volume of cash and readily marketable securities in our portfolio. We also monitor our liquidity profile under more severe scenarios.
We perform a number of stress tests and analyses to assess our ability to meet our cash flow requirements, as well as the ability of our reinsurance and insurance subsidiaries to meet their collateral obligations. Among these analyses, we manage to the following ALM limits:
• |
our projected net cumulative cash flows, including both new business and target levels of new investments under a “plan scenario” and a “moderately severe scenario” event, are non-negative over a rolling 12-month horizon; |
• |
we hold enough cash, cash equivalents and other discounted liquid limit assets to cover 12 months of AHL’s and Athene USA’s projected obligations, including debt servicing costs: |
▪ |
minimum of 50% of expenses and 100% of debt servicing to be held in cash and cash equivalents at AHL operating accounts |
▪ |
minimum of 50% of any required AHL – Athene USA inter-company loan commitments to be held in cash and cash equivalents by AHL |
▪ |
dividends from ALRe sufficient to support the ongoing operations of AHL must be available under moderate and substantial stress scenarios |
▪ |
for purposes of administering this test, liquid limit assets are discounted by 25% and include public corporate bonds rated A- or above, liquid ABS (defined as prime auto, auto floorplan, Tier 1 subprime auto, auto lease, prime credit cards, equipment lease or utility stranded assets); RMBS with weighted average lives less than three years rated A- or above and CMBS with weighted average lives less than three years rated AAA- or above |
• |
we seek to maintain sufficient capital and surplus at ALRe to meet the following collateral and capital maintenance calls under a substantial stress event, such as the failure of a major financial institution (Lehman event): |
▪ |
collateral calls from modco and third-party reinsurance contracts |
▪ |
AARe capital maintenance calls arising from AARe collateral calls from modco reinsurance contracts; and |
▪ |
U.S. regulated entity capital maintenance calls from nonmodco activity. |
Insurance Subsidiaries’ Liquidity
Operations
The primary cash flow sources for our insurance subsidiaries include retirement services product inflows (premiums), investment income, principal repayments on our investments, net transfers from separate accounts and financial product deposits. Uses of cash include investment purchases, payments to policyholders for surrenders, withdrawals and payout benefits, interest and principal payments on funding agreements, PRT obligations, policy acquisition costs and general operating costs.
101
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our policyholder obligations are generally long-term in nature. However, one liquidity risk is an extraordinary level of early policyholder withdrawals. We include provisions within our annuity policies, such as surrender charges and MVAs, which are intended to protect us from early withdrawals. As of June 30, 2020 and December 31, 2019, approximately 75% and 78%, respectively, of our deferred annuity liabilities were subject to penalty upon surrender. In addition, as of June 30, 2020 and December 31, 2019, approximately 58% and 64%, respectively, of policies contained MVAs that may also have the effect of limiting early withdrawals if interest rates increase, but may encourage early withdrawals by effectively subsidizing a portion of surrender charges when interest rates decrease. Our funding agreements, group annuities and payout annuities are generally non-surrenderable.
Membership in Federal Home Loan Bank
Through our membership in the FHLB, we are eligible to borrow under variable rate short-term federal funds arrangements to provide additional liquidity. The borrowings must be secured by eligible collateral such as mortgage loans, eligible CMBS or RMBS, government or agency securities and guaranteed loans. As of June 30, 2020 and December 31, 2019, we had $0 million and $475 million, respectively, of outstanding borrowings under these arrangements.
We have issued funding agreements to the FHLB in exchange for cash advances. These funding agreements were issued in an investment spread strategy, consistent with other investment spread operations. As of June 30, 2020 and December 31, 2019, we had funding agreements outstanding with the FHLB in the aggregate principal amount of $2.1 billion and $1.2 billion, respectively.
The maximum FHLB indebtedness by a member is determined by the amount of collateral pledged, and cannot exceed a specified percentage of the member’s total statutory assets dependent on the internal credit rating assigned to the member by the FHLB. As of June 30, 2020, the total maximum borrowings under the FHLB facilities were limited to $28.9 billion. However, our ability to borrow under the facilities is constrained by the availability of assets that qualify as eligible collateral under the facilities and certain other limitations. Considering these limitations, we estimate that as of June 30, 2020 we had the ability to draw up to a total of approximately $3.4 billion, inclusive of borrowings then outstanding. This estimate is based on our internal analysis and assumptions, and may not accurately measure collateral which is ultimately acceptable to the FHLB. Drawing such amounts would have an adverse impact on AADE’s and/or AAIA’s RBC ratio, which may further restrict our ability or willingness to draw up to our estimated capacity.
Securities Repurchase Agreements
We engage in repurchase transactions whereby we sell fixed income securities to third parties, primarily major brokerage firms or commercial banks, with a concurrent agreement to repurchase such securities at a determined future date. We require that, at all times during the term of the repurchase agreements, we maintain sufficient cash or other liquid assets sufficient to allow us to fund substantially all of the repurchase price. Proceeds received from the sale of securities pursuant to these arrangements are generally invested in short-term investments, with the offsetting obligation to repurchase the security included within payables for collateral on derivatives and securities to repurchase on the condensed consolidated balance sheets. As per the terms of the repurchase agreements, we monitor the market value of the securities sold and may be required to deliver additional collateral (which may be in the form of cash or additional securities) to the extent that the value of the securities sold decreases prior to the repurchase date.
As of June 30, 2020, the fair value of securities and collateral held by counterparties and payables for repurchase agreements was $1.8 billion and $1.6 billion, respectively.
On May 1, 2020, we signed a $1.0 billion committed repurchase facility with BNP Paribas. The facility has an initial commitment period of 12 months and automatically renews for successive 12-month periods until terminated by either party. During the commitment period, we may sell and BNP Paribas is required to purchase eligible investment grade corporate bonds pursuant to repurchase transactions at pre-agreed discounts in exchange for a 41 basis points per annum commitment fee. As of June 30, 2020, we had no outstanding payables.
102
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cash Flows
Our cash flows were as follows:
Six months ended June 30, |
|||||||
(In millions) |
2020 |
2019 |
|||||
Net income (loss) |
$ |
(285 |
) |
$ |
1,428 |
||
Non-cash revenues and expenses |
1,687 |
155 |
|||||
Net cash provided by operating activities |
1,402 |
1,583 |
|||||
Sales, maturities and repayments of investments |
9,377 |
7,776 |
|||||
Purchases of investments |
(14,386 |
) |
(12,425 |
) |
|||
Other investing activities |
273 |
631 |
|||||
Net cash used in investing activities |
(4,736 |
) |
(4,018 |
) |
|||
Issuance of common stock |
350 |
— |
|||||
Net proceeds and repayments of debt |
424 |
— |
|||||
Deposits on investment-type policies and contracts |
8,398 |
5,972 |
|||||
Withdrawals on investment-type policies and contracts |
(3,871 |
) |
(3,275 |
) |
|||
Net capital contributions and distributions to/from noncontrolling interests |
194 |
— |
|||||
Net change in cash collateral posted for derivative transactions and securities to repurchase |
461 |
1,214 |
|||||
Issuance of preferred stock, net of expenses |
583 |
839 |
|||||
Preferred stock dividends |
(37 |
) |
— |
||||
Repurchase of common stock |
(328 |
) |
(427 |
) |
|||
Other financing activities |
60 |
(54 |
) |
||||
Net cash provided by financing activities |
6,234 |
4,269 |
|||||
Effect of exchange rate changes on cash and cash equivalents |
(21 |
) |
— |
||||
Net increase in cash and cash equivalents1
|
$ |
2,879 |
$ |
1,834 |
|||
1 Includes cash and cash equivalents and restricted cash.
|
Cash flows from operating activities
The primary cash inflows from operating activities include net investment income, annuity considerations and insurance premiums. The primary cash outflows from operating activities are comprised of benefit payments and operating expenses. Our operating activities generated cash flows totaling $1.4 billion and $1.6 billion for the six months ended June 30, 2020 and 2019, respectively. The decrease in cash provided by operating activities was primarily driven by lower cash received from PRT transactions as well as a decrease in net investment income.
Cash flows from investing activities
The primary cash inflows from investing activities are the sales, maturities and repayments of investments. The primary cash outflows from investing activities are the purchases and acquisitions of new investments. Our investing activities used cash flows totaling $4.7 billion and $4.0 billion for the six months ended June 30, 2020 and 2019, respectively. The increase in cash used in investing activities was primarily attributed to an increase in purchases of investments attributed to deploying the deposits received, redeployment of the investment portfolio associated with the Jackson reinsurance transaction, as well as managing our liquidity risk to capitalize on growth opportunities as they may arise.
Cash flows from financing activities
The primary cash inflows from financing activities are deposits on our investment-type policies, changes of cash collateral posted for derivative transactions, capital contributions and proceeds from borrowing activities. The primary cash outflows from financing activities are withdrawals on our investment-type policies, changes of cash collateral posted for derivative transactions, repayments of outstanding borrowings, repurchases of common stock and payment of preferred stock dividends. Our financing activities provided cash flows totaling $6.2 billion and $4.3 billion for the six months ended June 30, 2020 and 2019, respectively. The increase in cash provided by financing activities was primarily attributed to higher investment-type deposits from retail, flow reinsurance and funding agreement deposits as well as proceeds of $499 million of long-term debt, the issuance of stock in connection with the strategic transaction with Apollo and net capital contributions from noncontrolling interests, partially offset by the change in cash collateral posted for derivative transactions driven by unfavorable equity market performance in 2020, the repayment of short-term debt, lower preferred stock issuances than prior year and the payment of preferred stock dividends.
103
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Holding Company Liquidity
Dividends from Subsidiaries
AHL is a holding company whose primary liquidity needs include the cash-flow requirements relating to its corporate activities, including its day-to-day operations, debt servicing, preferred stock dividend payments and strategic transactions, such as acquisitions. The primary source of AHL’s cash flow is dividends from its subsidiaries, which are expected to be adequate to fund cash flow requirements based on current estimates of future obligations.
The ability of AHL’s insurance subsidiaries to pay dividends is limited by applicable laws and regulations of the jurisdictions where the subsidiaries are domiciled, as well as agreements entered into with regulators. These laws and regulations require, among other things, the insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay.
Subject to these limitations and prior notification to the appropriate regulatory agency, the U.S. insurance subsidiaries are permitted to pay ordinary dividends based on calculations specified under insurance laws of the relevant state of domicile. Any distributions above the amount permitted by statute in any twelve month period are considered to be extraordinary dividends, and require the approval of the appropriate regulator prior to payment. AHL does not currently plan on having the U.S. subsidiaries pay any dividends to ALRe.
Dividends from ALRe are projected to be the primary source of AHL’s liquidity. Under the Bermuda Insurance Act, ALRe is prohibited from paying a dividend in an amount exceeding 25% of the prior year’s statutory capital and surplus, unless at least two members of ALRe’s board of directors and its principal representative in Bermuda sign and submit to the Bermuda Monetary Authority (BMA) an affidavit attesting that a dividend in excess of this amount would not cause ALRe to fail to meet its relevant margins. In certain instances, ALRe would also be required to provide prior notice to the BMA in advance of the payment of dividends. In the event that such an affidavit is submitted to the BMA in accordance with the Bermuda Insurance Act, and further subject to ALRe meeting its relevant margins, ALRe is permitted to distribute up to the sum of 100% of statutory surplus and an amount less than 15% of its total statutory capital. Distributions in excess of this amount require the approval of the BMA.
The maximum distribution permitted by law or contract is not necessarily indicative of our actual ability to pay such distributions, which may be further restricted by business and other considerations, such as the impact of such distributions on surplus, which could affect our ratings or competitive position and the amount of premiums that can be written. Specifically, the level of capital needed to maintain desired financial strength ratings from rating agencies, including S&P, A.M. Best and Fitch, is of particular concern when determining the amount of capital available for distributions. AHL believes its insurance subsidiaries have sufficient statutory capital and surplus, combined with additional capital available to be provided by AHL, to meet their financial strength ratings objectives. Finally, state insurance laws and regulations require that the statutory surplus of our insurance subsidiaries following any dividend or distribution must be reasonable in relation to their outstanding liabilities and adequate for the insurance subsidiaries’ financial needs.
Other Sources of Funding
If needed, we may seek to secure additional funding at the holding company level by means other than dividends from subsidiaries, such as by drawing on our undrawn $1.25 billion credit agreement or by pursuing future issuances of debt or equity securities to third-party investors. Certain other sources of liquidity potentially available at the holding company level are discussed below.
Shelf Registration – Under our Shelf Registration Statement, subject to market conditions, we have the ability to issue, in indeterminate amounts, debt securities, preference shares, depositary shares, Class A common shares, warrants and units.
Debt – On January 12, 2018, we issued $1.0 billion in aggregate principal amount of 4.125% Senior Notes due January 2028 (2028 Notes). On April 3, 2020, we issued $500 million in aggregate principal amount of 6.150% senior unsecured notes due 2030 (2030 Notes).
Preferred Stock – On June 10, 2019, we issued 34,500 6.35% Fixed-to-Floating Rate Perpetual Non-Cumulative Preference Shares, Series A, par value of $1.00 per share with a liquidation preference of $25,000 per share, for aggregate proceeds of $839 million, net of the underwriters’ discount and estimated expenses.
On September 19, 2019, we issued 13,800 5.625% Fixed Rate Perpetual Non-Cumulative Preference shares, Series B, par value of $1.00 per share with a liquidation preference of $25,000 per share, for aggregate proceeds of $333 million, net of the underwriters’ discount and estimated expenses.
On June 11, 2020, we issued 24,000 6.375% Fixed Rate Reset Perpetual Non-Cumulative Preference shares, Series C, par value of $1.00 per share with a liquidation preference of $25,000 per share, for aggregate proceeds of $583 million, net of underwriters’ discount and estimated expenses. See Note 10 – Equity to the condensed consolidated financial statements for further information.
Intercompany Note – AHL has an unsecured revolving note payable with ALRe, which permits AHL to borrow up to $1 billion with a fixed interest rate of 1.25% and a maturity date of March 31, 2024. As of June 30, 2020 and December 31, 2019, the revolving note payable had an outstanding balance of $153 million and $38 million, respectively.
104
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In light of the spread of COVID-19 and the resulting impact on economic conditions and the financial markets, additional funding of the type described above may not be available on terms favorable to us or at all. As a result of the economic consequences of the spread of COVID-19, we have observed an increase in our cost of debt. At the time of issuance, our 2028 Notes had a yield to maturity of 4.14% and a spread to benchmark treasury of T + 160 basis points. At the time of issuance, our 2030 Notes had a yield to maturity of 6.18% and a spread to benchmark treasury of T + 550 basis points. In addition, certain covenants in our credit agreement prohibit us from maintaining debt in excess of specified thresholds. Specifically, our credit agreement prohibits us from permitting the Consolidated Debt to Capitalization Ratio (as such term is defined in the credit agreement) to exceed 35% as of the end of any quarter.
Capital Resources
As of December 31, 2019 and 2018, our U.S. insurance companies’ TAC, as defined by the NAIC, was $2.4 billion and $2.2 billion, respectively, and our U.S. RBC ratio was 429% and 421%, respectively. Each U.S. domestic insurance subsidiary’s state of domicile imposes minimum RBC requirements that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of TAC to its authorized control level RBC (ACL). Our TAC was significantly in excess of all regulatory standards as of December 31, 2019 and 2018, respectively.
Bermuda capital for ALRe was $11.0 billion and $9.7 billion as of December 31, 2019 and 2018, respectively. ALRe adheres to BMA regulatory capital requirements to maintain statutory capital and surplus to meet the minimum margin of solvency and maintain minimum economic balance sheet (EBS) capital and surplus to meet the enhanced capital requirement. Under the EBS framework, ALRe’s assets are recorded at market value and its insurance reserves are determined by reference to nine prescribed scenarios, with the scenario resulting in the highest reserve balance being ultimately required to be selected. ALRe’s EBS capital and surplus was $14.1 billion and $12.0 billion, resulting in a BSCR ratio of 310% and 340% as of December 31, 2019 and 2018, respectively. An insurer must have a BSCR ratio of 100% or greater to be considered solvent by the BMA. As of December 31, 2019 and 2018, ALRe held the appropriate capital to adhere to these regulatory standards.
As of December 31, 2019 and 2018, our ALRe RBC was 443% and 405%, respectively. We believe that we have a strong capital position in light of our risks and that we are well positioned to meet policyholder and other obligations. We also believe that our strong capital position, as well as our excess capital position and access to uncalled capital commitments at ACRA, may provide us the opportunity to take advantage of market dislocations as they arise. We exclude our interests in the AOG units and other subsidiary holding companies from our capital base for purposes of calculating ALRe RBC, but do reflect such interests within our excess capital calculations, net of risk charges.
In evaluating the amount of capital needed to support our Retirement Services segment, we utilize internal economic capital models as well as capital models of our three rating agencies, S&P, A.M. Best and Fitch, to review capital levels. Generally, the RBC ratios we calculate for our U.S. and for our Bermuda subsidiaries (under U.S. methodologies for our U.S. insurance subsidiaries and our ALRe RBC ratio methodology for our Bermuda insurance subsidiaries) enable us to determine capital needed to support our Retirement Services segment consistent with levels determined by such rating agencies and our economic capital models.
Repurchase of Securities
Share Repurchase Program
In December 2018, our board of directors established a share repurchase program with an initial authorization for the repurchase of up to $250 million of our Class A shares. In 2019, our board of directors approved four additional authorizations under our share repurchase program for the purchase of up to an additional $1.3 billion of our Class A common shares, in the aggregate, for a total authorization of $1.6 billion. Pursuant to our share repurchase program, we repurchased 10.4 million Class A common shares for $319 million during the six months ended June 30, 2020. As of August 5, 2020, we have repurchased, in the aggregate, 32.8 million Class A common shares for $1.2 billion since inception of our share repurchase program and have $321 million of repurchase authorization remaining. In connection with our strategic initiative to increase available liquidity in response to the spread of COVID-19, during March 2020, management temporarily halted share repurchases under our program. Management has determined it is appropriate to recommence share repurchases under our program. The timing and amount of share repurchases, if any, will be determined by management in accordance with the authority delegated by our board of directors.
Repurchase of Other Securities
We may from time to time seek to retire or purchase our other outstanding debt or equity securities through cash purchases and/or exchanges for other securities, purchases in the open market, privately negotiated transactions or otherwise. Any such repurchases will be dependent upon several factors, including our liquidity requirements, contractual restrictions, general market conditions and applicable regulatory, legal and accounting factors. Whether or not we repurchase any of our other securities and the size and timing of any such repurchases will be determined at our discretion.
105
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Balance Sheet and Other Arrangements
Balance Sheet Arrangements
Contractual Obligations
The following table summarizes estimated future payments on our contractual obligations as of June 30, 2020:
Payments Due by Period |
|||||||||||||||||||
(In millions) |
Total |
2020 |
2021-2022 |
2023-2024 |
2025 and thereafter |
||||||||||||||
Interest sensitive contract liabilities |
$ |
135,537 |
$ |
12,068 |
$ |
28,963 |
$ |
24,019 |
$ |
70,487 |
|||||||||
Future policy benefits |
24,596 |
499 |
1,020 |
1,055 |
22,022 |
||||||||||||||
Other policy claims and benefits |
124 |
124 |
— |
— |
— |
||||||||||||||
Dividends payable to policyholders |
112 |
5 |
10 |
9 |
88 |
||||||||||||||
Long-term debt1
|
2,138 |
36 |
144 |
144 |
1,814 |
||||||||||||||
Securities to repurchase2
|
1,672 |
1,016 |
26 |
26 |
604 |
||||||||||||||
Total |
$ |
164,179 |
$ |
13,748 |
$ |
30,163 |
$ |
25,253 |
$ |
95,015 |
|||||||||
1 The obligations for long-term debt payments include contractual maturities of principal and estimated future interest payments based on the terms of the debt agreements, as described in Note 8 – Debt to the condensed consolidated financial statements.
| |||||||||||||||||||
2 The obligations for securities to repurchase payments include contractual maturities of principal and estimated future interest payments based on the terms of the agreements.
|
We also have other obligations related to collateral on derivatives, investment fund commitments and funds withheld liabilities which have not been included in the above table as the timing and amount of each of the return on the collateral, the fulfillment of the commitments and the funds withheld liabilities are uncertain. See Note 12 – Commitments and Contingencies to the condensed consolidated financial statements for further discussion on the investment fund commitments.
Other
In the normal course of business, we invest in various investment funds which are considered VIEs, and we consolidate a VIE when we are considered the primary beneficiary of the entity. For further discussion of our involvement with VIEs, see Note 4 – Variable Interest Entities to the condensed consolidated financial statements.
Off Balance Sheet Arrangements
None.
106
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Estimates and Judgments
The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Amounts based on such estimates involve numerous assumptions subject to varying and potentially significant degrees of judgment and uncertainty, particularly related to the future performance of the underlying business, and will likely change in the future as additional information becomes available. Critical estimates and assumptions are evaluated on an ongoing basis based on historical developments, market conditions, industry trends and other information that is reasonable under the circumstances. There can be no assurance that actual results will conform to estimates and assumptions and that reported results of operations will not be materially affected by the need to make future accounting adjustments to reflect periodic changes in these estimates and assumptions, particularly as more information about the extent to which COVID-19 and the resulting impact on economic conditions and the financial markets become known. Critical accounting estimates are impacted significantly by our methods, judgments and assumptions used in the preparation of the consolidated financial statements and should be read in conjunction with our significant accounting policies described in Note 1 – Business, Basis of Presentation and Significant Accounting Policies to the consolidated financial statements of our 2019 Annual Report. The most critical accounting estimates and judgments include those used in determining:
• |
fair value of investments; |
• |
credit loss allowances; |
• |
future policy benefit reserves; |
• |
derivatives valuation, including embedded derivatives; |
• |
deferred acquisition costs, deferred sales inducements and value of business acquired; |
• |
consolidation of VIEs; and |
• |
valuation allowances on deferred tax assets. |
Except as described below, the above critical accounting estimates and judgments are discussed in detail in Part II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates and Judgments of our 2019 Annual Report. Due to the adoption of CECL in the first quarter 2020 and the significance of the Jackson National reinsurance transaction in the second quarter 2020, the following updates and replaces the substantively similar information provided in the 2019 Annual Report.
See Note 1 – Business, Basis of Presentation and Significant Accounting Policies to the condensed consolidated financial statements for adoption of new and future accounting pronouncements.
Investments
Credit Loss Allowances
Establishing allowances for expected credit losses is a quantitative and qualitative process, which is subject to risks and uncertainties and involves significant estimates and judgments by management. Changes in the estimates and judgments used in such analysis can have a significant impact on our consolidated results of operations.
The allowance for expected credit losses on assets held at amortized cost and off-balance sheet credit exposures is established utilizing quantitative modeling. Key inputs into the model include data pertaining to the characteristics of the assets, historical losses and current market conditions. Additionally, the model incorporates management’s expectations around future economic conditions and macroeconomic forecasts over a reasonable and supportable forecast period, after which the model reverts to historical averages. For residential mortgage loans, key loan characteristics impacting the estimate include among others: time to maturity, delinquency status, original credit scores and loan-to-value ratios. Key macroeconomic variables include unemployment rates and the housing price index. For commercial mortgage loans, key loan characteristics impacting the estimate include among others: time to maturity, delinquency status, loan-to-value ratios and debt service coverage ratios. Key macroeconomic variables include unemployment rates, rent growth, capitalization rates, and the housing price index. These inputs, the reasonable and supportable forecast period, and reversion to historical average technique are subject to a formal governance and review process by management. Additionally, management considers qualitative adjustments to the model output to the extent that any relevant information regarding the collectability of the asset is available and not already considered in the quantitative model. If we determine that a financial asset has become collateral dependent, which we determine to occur when foreclosure is probable, the allowance is measured as the difference between amortized cost and the fair value of the collateral, less any expected costs to sell.
We evaluate AFS securities with a fair value that has declined below amortized cost to determine how the decline in fair value should be recognized. If we determine, based on the facts and circumstances related to the specific security, that we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, any existing allowance for credit losses is reversed and the amortized cost of the security is written down to fair value. If neither of these conditions exist, we evaluate whether the decline in fair value has resulted from a credit loss or other factors.
For non-structured AFS securities, we qualitatively consider relevant facts and circumstances in evaluating whether a decline below fair value is credit-related. Relevant facts and circumstances include but are not limited to: (1) the extent to which the fair value is less than amortized cost; (2) changes in agency credit ratings, (3) adverse conditions related to the security’s industry or geographical area, (4) failure to make scheduled payments, and (5) other known changes in the financial condition of the issuer or quality of any underlying collateral or credit enhancements.
107
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
For structured AFS securities meeting the definition of beneficial interests, the qualitative assessment is bypassed, and any securities having experienced a decline in fair value below amortized cost is subject solely to a quantitative analysis.
If upon completion of this analysis it is determined that a potential credit loss exists, an allowance for expected credit losses is established equal to the amount by which the present value of expected cash flows is less than amortized cost, limited by the amount by which fair value is less than amortized cost. A non-structured security’s cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using security-specific facts and circumstances including timing, security interests and loss severity. A structured security’s cash flow estimates are based on security-specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayments and structural support, including subordination and guarantees. The expected cash flows are discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete a structured security. For securities with a contractual interest rate that varies based on changes in an independent factor, such as an index or rate, the effective interest rate is calculated based on the factor as it changes over the life of the security. Inherently under the discounted cash flow model, both the timing and amount of cash flows affect the measurement of the allowance for expected credit losses.
Future Policy Benefits—Liabilities for Guaranteed Living Withdrawal Benefits and Guaranteed Minimum Death Benefits
As of June 30, 2020, the GLWB and GMDB liability balance, including the impacts of shadow adjustments, totaled $4.5 billion. The increase (decrease) to the GLWB and GMDB liability balance, including the impacts of shadow adjustments from hypothetical changes in projected assessments, changes in the discount rate and annual equity growth is summarized as follows:
(In millions) |
June 30, 2020 |
||
+10% assessments |
$ |
(147 |
) |
–10% assessments |
164 |
||
+100 bps discount rate |
143 |
||
–100 bps discount rate |
(167 |
) |
|
1% higher annual equity growth |
(46 |
) |
|
1% lower annual equity growth |
44 |
Derivatives—Valuation of Embedded Derivatives on FIAs
As of June 30, 2020, we had embedded derivative liabilities classified as Level 3 in the fair value hierarchy of $11.1 billion. The increase (decrease) to the embedded derivatives on FIA products from hypothetical changes in discount rates is summarized as follows:
(In millions) |
June 30, 2020 |
||
+100 bps discount rate |
$ |
(921 |
) |
–100 bps discount rate |
944 |
Deferred Acquisition Costs, Deferred Sales Inducements, and Value of Business Acquired—As of June 30, 2020, DAC, DSI and VOBA totaled $5.5 billion. The increases (decreases) to DAC, DSI and VOBA from hypothetical changes in estimated future gross profits and the embedded derivative discount rate are summarized as follows:
June 30, 2020 |
|||||||||||||||
(In millions) |
DAC |
DSI |
VOBA |
Total |
|||||||||||
+10% estimated future gross profits |
$ |
127 |
$ |
30 |
$ |
54 |
$ |
211 |
|||||||
–10% estimated future gross profits |
(147 |
) |
(35 |
) |
(59 |
) |
(241 |
) |
|||||||
+100 bps discount rate |
(151 |
) |
(55 |
) |
(39 |
) |
(245 |
) |
|||||||
–100 bps discount rate |
161 |
58 |
37 |
256 |
Item 3. Quantitative and Qualitative Disclosures About Market Risks
We regularly analyze our exposure to market risks, which reflect potential losses in value due to credit and counterparty risk, interest rate risk, currency risk, commodity price risk and equity price risk. As a result of that analysis, we have determined that we are primarily exposed to credit risk, interest rate risk and equity price risk. A description of our market risk exposures, including strategies used to manage our exposure to market risk, may be found under Part II—Item 7A. Quantitative and Qualitative Disclosures About Market Risk of the 2019 Annual Report.
108
There have been no material changes to our market risk exposures from those previously disclosed in the 2019 Annual Report, except as described below. The following updates and replaces the information provided in the 2019 Annual Report:
Sensitivities
Interest Rate Risk
We assess interest rate exposures for financial assets and financial liabilities using hypothetical stress tests and exposure analyses. Assuming all other factors are constant, if there was an immediate parallel increase in interest rates of 25 basis points from levels as of June 30, 2020, we estimate a net decrease to our point-in-time pre-tax income from changes in the fair value of these financial instruments of $491 million. The net change in fair value for these financial instruments would directly impact the current period gross profits and assessments used in the calculations of DAC, DSI, and VOBA amortization and changes to rider reserves, resulting in an offsetting increase to our pre-tax income of $68 million. If there were a similar parallel increase in interest rates from levels as of December 31, 2019, we estimate a net decrease to our point-in-time pre-tax income from changes in the fair value of these financial instruments of $179 million with an offsetting increase to pre-tax income of $53 million from DAC, DSI, and VOBA amortization and changes in rider reserves. The increased sensitivity to point-in-time pre-tax income from changes in the fair value of financial instruments in the estimated outcome as of June 30, 2020, when compared to December 31, 2019, was driven by the June 2020 Jackson reinsurance transaction, which substantially increased our exposure to reinsurance unrealized gains and losses that are included in our pre-tax income. The financial instruments included in the sensitivity analysis are carried at fair value and changes in fair value are recognized in earnings. These financial instruments include derivative instruments, embedded derivatives and certain fixed maturity securities. The sensitivity analysis excludes those financial instruments carried at fair value for which changes in fair value are recognized in equity, such as AFS fixed maturity securities.
Assuming a 25 basis points increase in interest rates persists for a 12-month period, the estimated impact to adjusted operating income is expected to be relatively unchanged from the sensitivities shown in Part II-Item 7A. Quantitative and Qualitative Disclosures About Market Risk of the 2019 Annual Report, as there were minimal floating rate assets added as a part of the Jackson reinsurance transaction. The models used to estimate the impact of a 25 basis point change in market interest rates incorporate numerous assumptions, require significant estimates and assume an immediate change in interest rates without any discretionary management action to counteract such a change. Consequently, potential changes in our valuations indicated by these simulations will likely be different from the actual changes experienced under any given interest rate scenarios and these differences may be material. Because we actively manage our assets and liabilities, the net exposure to interest rates can vary over time. However, any such decreases in the fair value of fixed maturity securities, unless related to credit concerns of the issuer requiring recognition of an OTTI, would generally be realized only if we were required to sell such securities at losses to meet liquidity needs.
Public Equity Risk
Assuming all other factors are constant, we estimate that a decline in public equity market prices of 10% would be relatively unchanged from the sensitivities shown in Part II—Item 7A. Quantitative and Qualitative Disclosures About Market Risk of the 2019 Annual Report.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures as such term is defined under Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and our management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We have carried out an evaluation, as of the end of the period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at attaining the level of reasonable assurance noted above.
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting as defined in Exchange Act Rule 13a-15(f) during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
109
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to litigation arising in the ordinary course of our business, including litigation principally relating to our FIA business. We cannot assure you that our insurance coverage will be adequate to cover all liabilities arising out of such claims. The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. There is significant judgment required in assessing both the probability of an adverse outcome and the determination as to whether an exposure can be reasonably estimated. In management’s opinion, the ultimate disposition of any current legal proceeding or claim brought against us will not have a material effect on our financial condition, results of operations or cash flows. Litigation is, however, inherently uncertain and an adverse outcome from such litigation could have a material effect on the operating results of a particular reporting period.
From time to time, in the ordinary course of business and like others in the insurance and financial services industries, we receive requests for information from government agencies in connection with such agencies’ regulatory or investigatory authority. Such requests can include financial or market conduct examinations, subpoenas or demand letters for documents to assist the government in audits or investigations. We and each of our U.S. insurance subsidiaries review such requests and notices and take appropriate action. We have been subject to certain requests for information and investigations in the past and could be subject to them in the future.
For a description of certain legal proceedings affecting us, see Note 12 – Commitments and Contingencies – Litigation, Claims and Assessments to the condensed consolidated financial statements.
Item 1A. Risk Factors
The following should be read in conjunction with, and supplement and amend, the factors that may affect our business or operations described in Part I–Item 1A. Risk Factors of our 2019 Annual Report. Other than as described in this Item 1A, there have been no material changes to our risk factors from the risk factors previously disclosed in our 2019 Annual Report.
Certain metrics discussed in this section are based on management view and therefore may not correspond to amounts disclosed in our condensed consolidated financial statements or the notes thereto. For example, investment figures cited represent our invested assets, which include assets held by cedants that correspond to liabilities ceded to us. We believe that these metrics provide the most comprehensive view of our risk exposures. See Part 1–Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations–Key Operating and Non-GAAP Measures–Net Invested Assets for further discussion.
The following updates and supplements the risk factors described in our 2019 Annual Report:
Major public health issues, and specifically the pandemic caused by the spread of COVID-19, could have an adverse impact on our financial condition, results of operations, liquidity, cash flows and other aspects of our business.
We are closely monitoring developments related to the COVID-19 pandemic to assess its impact on our business. While still evolving, the COVID-19 pandemic has caused significant economic and financial turmoil both in the U.S. and around the world. At this time, it is not possible to estimate how long it will take to halt the spread of the virus or the longer term-effects that the COVID-19 pandemic could have on our business. The extent to which the COVID-19 pandemic impacts our business, results of operations, financial condition, liquidity or prospects will depend on future developments which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the COVID-19 pandemic and the actions taken to contain or address its impact, and may cause us to revisit or revise estimates of future earnings or other guidance we have previously provided to the markets. In particular, certain projected financial information previously provided to our shareholders in connection with our recent share issuance transaction with Apollo may as a result of the impact from the COVID-19 pandemic materially differ from our actual results, and should not be relied upon.
While we have implemented risk management and contingency plans and taken preventive measures and other precautions, no predictions of specific scenarios can be made with respect to the COVID-19 pandemic and such measures may not adequately predict the impact on our business from such events. Currently, we are in the process of executing our employee repopulation plan. While we have taken measures to reduce the risk of transmission among employees, including implementing social distancing measures and face covering and contact tracing protocols, our efforts may prove ineffective. Should our efforts prove ineffective or should the virus continue to spread in the communities in which we operate, we may deem it appropriate to extend or re-implement remote work arrangements. An extended period of remote work arrangements could strain our business continuity plans, introduce operational risk, including but not limited to cybersecurity risks, and impair our ability to manage our business. We also outsource certain critical business activities to third parties. As a result, we rely upon the successful implementation and execution of the business continuity and repopulation planning of such entities in the current environment. While we closely monitor the business continuity activities of these third parties, successful implementation and execution of their business continuity and repopulation strategies are largely outside our control. If one or more of the third parties to whom we outsource certain critical business activities experience operational failures as a result of the impacts from the spread of COVID-19, or claim that they cannot perform due to a force majeure, it may have a material adverse effect on our business, financial condition, results of operations, liquidity and cash flows.
110
With one exception, each of the Non-U.S. Companies (as defined below) currently intends to operate in a manner that will not cause it to be subject to current U.S. federal income taxation on its net income, and certain of them intend to be UK tax resident by reason of having their central management and control exercised in the UK. However, our directors and personnel reside in various jurisdictions and often must travel to carry out their duties in accordance with such intended tax positions. Travel restrictions imposed as a result of the COVID-19 pandemic have limited, and may continue to limit, such travel. While we have implemented contingency plans to mitigate the impact of such travel restrictions, no assurances can be provided that we will not become subject to greater tax liabilities than anticipated due to restrictions on the ability of our directors and personnel to carry out their activities from the intended jurisdictions.
Increased economic uncertainty and increased unemployment resulting from the economic impacts of the spread of COVID-19 may also result in policyholders seeking sources of liquidity and withdrawing at rates greater than we previously expected. If policyholder lapse and surrender rates significantly exceed our expectations, it could have a material adverse effect on our business, financial condition, results of operations, liquidity and cash flows. Measures undertaken to combat the spread of COVID-19, including social distancing practices and stay at home orders, as well as increased economic uncertainty, have resulted in a difficult sales environment for the origination of new policies. These factors have had a significant impact on the IMO channel, which benefits from a high degree of customer interaction. Should these conditions persist or worsen, we may see further declines in our retail sales and/or flow reinsurance volumes. In addition, such events or conditions could result in a decrease in economic activity in large geographic areas, adversely affecting our business within such geographic areas and/or adversely affecting the general economic climate.
The effects of the spread of COVID-19 on economic conditions and the financial markets may trigger or exacerbate the market risk discussed elsewhere in this report and in our 2019 Annual Report. Specifically, our investment portfolio (and, namely, the valuations of invested assets we hold) has been, and may continue to be, adversely affected. Moreover, changes in interest rates, reduced liquidity or a continued slowdown in the U.S. or in global economic conditions may also adversely affect the values of and cash flows generated by these assets. Within our investment portfolio, there is exposure to certain segments of the economy that have been disproportionately affected by the spread of COVID-19, including but not limited to, aviation, real estate (including CMLs, triple net lease investments, RMLs, CMBS, RMBS and related servicer investments), retail, hospitality, energy and financial services. These investments are subject to increased credit or valuation risk, which could ultimately result in increased investment losses. Our investments in mortgages and mortgage-backed securities have been and could further be negatively affected by delays or failures of borrowers to make payments of principal and interest when due and delays and moratoriums on foreclosures and enforcement actions with respect to delinquent or defaulted mortgages imposed by governmental authorities. Further, extreme market volatility may leave us unable to react to market events in a prudent manner consistent with our historical investment practices in dealing with more orderly markets. Market dislocations, decreases in observable market activity or unavailability of information, in each case, arising from the spread of COVID-19, may restrict our access to key inputs used to derive certain estimates and assumptions made in connection with financial reporting or otherwise, including estimates and changes in long term macro-economic assumptions relating to accounting for the allowance for credit losses. Restricted access to such inputs may make our financial statement balances and estimates and assumptions used to run our business subject to greater variability and subjectivity.
While governmental and non-governmental organizations are engaging in efforts to combat the spread and severity of the COVID-19 pandemic and related public health issues, these measures may not be effective. We also cannot predict how legal and regulatory responses to concerns about the COVID-19 pandemic and related public health issues will impact our business. Such events or conditions could result in additional regulation or restrictions affecting the conduct of our business in the future.
As a financial services company, we are exposed to liquidity risk, which is the risk that we are unable to meet near-term obligations as they come due.
Liquidity risk is a manifestation of events that are driven by other risk types (e.g. market, policyholder behavior, operational). A liquidity shortfall may arise in the event of insufficient funding sources or an immediate and significant need for cash or collateral. In addition, it is possible that expected liquidity sources, such as our credit agreement, may be unavailable or inadequate to satisfy the liquidity demands described below. In particular, the spread of COVID-19 has introduced tremendous volatility into the financial markets and may restrict the liquidity sources available to us and further may result in an increase of our liquidity demands.
We have four primary sources of liquidity exposure and associated drivers that trigger material liquidity demand. Those sources are:
• |
Collateral market exposure: Abrupt changes to interest rate, equity, and/or currency markets, such as that experienced during the six months ended June 30, 2020, have and may further increase collateral requirements to counterparties and may create liquidity risk. As of June 30, 2020, we had collateral with a value of $3.8 billion pledged to third-parties.
|
• |
Asset liability mismatch: There are liquidity risks associated with liabilities coming due prior to the matching asset cash flows. Structural maturities mismatch can occur in activities such as securities lending, where the liabilities are effectively overnight open transactions or otherwise short-term in nature and may be used to fund longer-term assets. We also face potential liquidity risks from unexpected cash demands due to severe mortality, policyholder withdrawals or lapse events. If such events were to occur, we may face unexpectedly high levels of claim payments to policyholders. |
• |
Funding availability: We have availed ourselves of the financial markets for funding (such as through the issuance of senior notes, securities lending and repurchase arrangements and other forms of borrowing in the capital markets). These sources might not be available during times of stress, or may only be available on unfavorable terms, which can result in a decrease in our profitability and a significant reduction in our financial flexibility. |
111
• |
Funding commitments: We are contractually obligated to fund capital calls of or otherwise make investments in certain entities. These obligations may become due at any time upon counterparty request. Substantial economic stress, such as that brought about by COVID-19, may accelerate the timing and increase the frequency of capital calls. To the extent that a significant amount of such obligations becomes due at any given time, it may give rise to liquidity risk. As of June 30, 2020, we had commitments to make investments in the amount of $5.1 billion, excluding commitments of third-party cedants to investees associated with assets backing obligations reinsured to us.
|
If a material liquidity demand is triggered and we are unable to satisfy the demand with the sources of liquidity readily available to us, it may have a material adverse impact on our business, financial condition, results of operations, liquidity and cash flows.
See Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations–Liquidity and Capital Resources for a discussion of our liquidity and sources and uses of liquidity, including information about legal and regulatory limits on the ability of our subsidiaries to pay dividends.
The following updates and replaces the final paragraph of the similarly named risk factor in our 2019 Annual Report:
Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR after 2021 may adversely affect the value of our investment portfolio, our ability to achieve our hedging objectives and our ability to issue funding agreements bearing a floating rate of interest.
To manage the uncertainty surrounding the discontinuation of LIBOR, we have established a six-phase plan. Our plan is subject to change as we gain additional information. We have created an Executive Steering Committee composed of senior executives to coordinate and oversee execution of our plan. To the extent that management effort and attention is focused on other matters, such as responding to the risk posed by COVID-19, successfully completing all of the phases of our plan prior to the discontinuation of LIBOR could become more difficult. Although we expect that we will be successful at completing all the phases of our plan prior to the discontinuation of LIBOR, we can provide no assurance at this time. Failure to complete all phases of our plan prior to the discontinuation of LIBOR may have a material adverse effect on our business, financial position, results of operations and cash flows. See Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations–Industry Trends and Competition-Discontinuation of LIBOR for further discussion.
Our most significant LIBOR exposure area as it relates to legacy contracts is our portfolio of floating rate investments tied to LIBOR. As of June 30, 2020, $19.7 billion or 73% of the notional value of our contracts tied to LIBOR extending beyond 2021 were contracts relating to investments within our investment portfolio. As our asset manager, Apollo manages the relationship with relevant market participants, including investees and trustees; negotiates and maintains the relevant investment documentation; and inputs key information, such as interest rates, into systems integrated with our financial reporting system. We are therefore reliant upon Apollo to complete important functions in the LIBOR transition process as it relates to our investment portfolio, including negotiating for relevant fallbacks, where appropriate, and inputting the appropriate replacement interest rates into the applicable information systems in advance of LIBOR’s transition. Should Apollo fail to timely complete all of its responsibilities prior to the discontinuation of LIBOR, it could have an adverse impact on our results of operations and ability to timely report accurate financial information.
The following updates and replaces, in their entirety, the similarly named risk factors in our 2019 Annual Report:
Our investment portfolio may be subject to concentration risk, particularly with respect to single issuers, including MidCap, AmeriHome, Athora and PK AirFinance; industries, including financial services; and asset classes, including real estate.
Concentration risk arises from exposure to significant asset defaults of a single issuer, industry or class of securities, based on economic conditions, geography or as a result of adverse regulatory or court decisions. When an investor’s assets are concentrated and that particular asset or class of assets experiences significant defaults, the default of such assets could threaten the investor’s financial condition, results of operations and cash flows. Our most significant potential exposures to concentration risk of single issuers are our investments in MidCap, a provider of revolving and term debt facilities to middle market companies in North America and Europe; A-A Mortgage and its indirect investment in AmeriHome, a mortgage lender and mortgage servicer; Athora, an insurance holding company focused on the European life insurance market; and PK AirFinance, a provider and arranger of loans principally to airlines and aircraft leasing companies secured by commercial aircraft.
As of June 30, 2020, our exposure, including loaned amounts, to MidCap was $923 million, which represented 0.7% of our net invested assets and 6.3% of total Athene Holding Ltd. shareholders’ equity. As of June 30, 2020, our exposure to A-A Mortgage was $730 million, which represented 0.5% of our net invested assets and 5.0% of total Athene Holding Ltd. shareholders’ equity. As of June 30, 2020, our exposure to Athora was $501 million, which represented 0.4% of our net invested assets and 3.4% of total Athene Holding Ltd. shareholders’ equity. As of June 30, 2020, our exposure to securitizations of loans originated by PK AirFinance, net of amounts attributable to noncontrolling interest, was $1.2 billion, which represented 0.9% of our net invested assets and 8.2% of total Athene Holding Ltd. shareholders’ equity.
112
Given our significant exposure to these issuers, we are subject to the idiosyncratic risk inherent in their business. For example:
• |
AmeriHome relies upon a subservicer to perform servicing operations on the loans for which it has mortgage servicing rights. If the subservicer were to experience financial distress or fail to provide adequate or timely services, AmeriHome may have difficulty finding another subservicer to perform servicing operations and may experience a significant decline in its financial performance. Such risks may be heightened in the current economic environment. In addition, mortgage servicers are obligated to advance certain amounts not paid by borrowers, including amounts arising from the forbearance of certain payments as mandated by the CARES Act. AmeriHome may require significant liquidity in order to make these advances and adequate sources of liquidity could be unavailable to AmeriHome to satisfy these obligations. |
• |
As a life insurer, Athora is subject to credit risk with respect to its investment portfolio and mortality risk with respect to its product liabilities, each of which may be exacerbated by unforeseen events, including but not limited to the spread of the COVID-19 pandemic. Further, Athora has significant European operations, which expose it to volatile economic conditions and risks relating to European member countries and withdrawals thereof, such as the UK. In addition, Athora is subject to multiple legal and regulatory regimes that may hinder or prevent it from achieving its business objectives. |
• |
Our investment in the PK AirFinance securitization of loans is subject to risks to the aircraft and airline industries generally, and specifically in connection with the decrease in air travel as a result of the spread of COVID-19, which has resulted in delinquent loan payments and has likely resulted in a reduction in aircraft valuations. While our investment is supported by significant equity subordination provided by borrowers, if borrowers default on their loans, PK AirFinance may pursue foreclosure and re-market the related aircraft or may restructure the defaulted loans. To the extent that the proceeds from any such restructuring or re-marketing were not sufficient to satisfy the corresponding principal balance in the securitization, significant losses on our investment could be recognized, beginning with the equity tranche of the securitization that we hold. |
To the extent that we suffer a significant loss on our investment in MidCap, A-A Mortgage, Athora or the securities issued by PK AirFinance, our financial condition, results of operations and cash flows could be adversely affected.
MidCap, AmeriHome and PK AirFinance are nonbank lenders focused on providing financing to individuals or entities. As a result, through these investments, we have significant exposure to credit risk, which has increased as a result of the economic conditions brought about by the spread of COVID-19. As a result of the current economic environment, certain of our investees in this sector have experienced a decrease in origination volumes and may experience increased credit and/or liquidity risk as borrowers defer loan payments or default on their obligations. To the extent that the current downturn causes a deterioration in the creditworthiness of the counterparties of such investees or adversely affects the securitization market for the loans originated by these entities, we may suffer significant losses on our investments in these entities and our financial condition, results of operations and cash flows could be adversely affected. In addition to the concentration risk arising from our investments in single issuers within the nonbank lending sector of the financial services industry, we have significant exposure to the financial services industry more broadly as a result of the composition of investments in our investment portfolio. As of June 30, 2020, 13% of our net invested assets were invested in issuers within the financial services industry, excluding CLOs. The current economic downturn or any further macroeconomic, regulatory or other changes having an adverse impact on the financial services industry more broadly, could have a material and adverse effect on our business, financial condition, results of operations and cash flows.
As of June 30, 2020, 24% of our net invested assets were invested in real estate-related assets. Any significant decline in the value of real estate generally or the occurrence of any of the risks described above with respect to our real estate-related investments could materially and adversely affect our financial condition and results of operations.
The BEAT may significantly increase our tax liability.
The Tax Act introduced a new tax called the BEAT. The BEAT operates as a minimum tax and is generally calculated as a percentage (10% in 2019 – 2025, and 12.5% in 2026 and thereafter) of the “modified taxable income” of an “applicable taxpayer.” Modified taxable income is calculated by adding back to a taxpayer’s regular taxable income the amount of certain “base erosion tax benefits” with respect to certain payments made to foreign affiliates of the taxpayer, as well as the “base erosion percentage” of any net operating loss deductions. The BEAT applies for a taxable year only to the extent it exceeds a taxpayer’s regular corporate income tax liability for such year (determined without regard to certain tax credits).
Certain of our reinsurance agreements require our U.S. subsidiaries (including any non-U.S. subsidiaries subject to U.S. federal income taxation) to pay or accrue substantial amounts to our non-U.S. reinsurance subsidiaries that would be characterized as “base erosion payments” with respect to which there are “base erosion tax benefits.” However, in certain types of reinsurance transactions, it is not clear whether any amounts paid or accrued by non-U.S. reinsurance entities would be netted against amounts paid or accrued to such entities for purposes of calculating the “base erosion payments” and “base erosion tax benefits.”
In light of the possibility of material additional tax cost to our U.S. subsidiaries and the lack of clear guidance regarding the appropriate method by which to compute the BEAT, we have undertaken certain actions intended to mitigate the potential effect of the BEAT on our results of operations. Such actions may have adverse consequences to our business, such as subjecting income in respect of our affiliate reinsurance to a layer of withholding tax of up to 30%, which would not have been payable under our prior structure. There can be no assurances that our efforts to mitigate the BEAT will be successful, and our consideration of any further actions may be expensive and time consuming. In addition, we have been, and may continue to be, required to take action before the uncertainty regarding the BEAT is resolved, and accordingly any action we take may, in hindsight, prove to have been unnecessary, ineffective or counterproductive.
113
The application of the BEAT to our reinsurance arrangements could be affected by further legislative action (including possibly a “technical corrections” bill), administrative guidance or court decisions, any of which could have retroactive effect. In addition, tax authorities may disagree with our BEAT calculations, or the interpretations on which those calculations are based, and assess additional taxes, interest and penalties, and the uncertainty regarding the correct interpretation of the BEAT may make such disagreements more likely. We will establish our tax provision in accordance with GAAP.
However, there can be no assurance that this provision will accurately reflect the amount of federal income tax that we ultimately pay, as that amount could differ materially from the estimate. There may be material adverse consequences to our business if tax authorities successfully challenge our BEAT calculations, in light of the uncertainties described above.
In addition, we have made estimates regarding the effective tax rate we expect to experience, which take into account the impacts of federal income tax and the BEAT. The determination of each such figure, or range of figures, involves numerous estimates and assumptions, including estimates and assumptions regarding our BEAT calculations. Such estimates and assumptions may prove incorrect. To the extent that actual experience differs from the estimates and assumptions inherent in our projections, our future effective tax rate may deviate materially from the estimates provided and our financial condition and results of operations may be materially less favorable than are implied by the projections provided.
AHL or its non-U.S. subsidiaries may be subject to U.S. federal income taxation in an amount greater than expected.
AHL and certain of its subsidiaries are treated as foreign corporations under the Internal Revenue Code (such subsidiaries, the Non-U.S. Subsidiaries, and together with AHL, the Non-U.S. Companies). Any Non-U.S. Company that is considered to be engaged in a trade or business in the U.S. generally will be subject to U.S. federal income taxation on a net basis on its income that is effectively connected with such U.S. trade or business (including branch profits tax on the portion of its earnings and profits that is attributable to such income), unless otherwise provided under an applicable income tax treaty. In addition, a Non-U.S. Company generally will be subject to U.S. federal income taxation on a gross basis on certain U.S.-source income, and certain premiums earned on insurance with respect to U.S. risks, that are not effectively connected with a U.S. trade or business, unless otherwise provided under an applicable income tax treaty.
With one exception, each of the Non-U.S. Companies currently intends to operate in a manner that will not cause it to be treated as being engaged in a trade or business within the U.S. However, the enactment of the BEAT, the reduction of the federal income tax rate applicable to corporations included in the Tax Act and other factors may cause some or all of the Non-U.S. Companies to conduct business differently. Moreover, there is considerable uncertainty as to when a foreign corporation is engaged in a trade or business within the United States, as the law is unclear and the determination is highly factual and must be made annually, and therefore there can be no assurance that the IRS will not successfully contend that a Non-U.S. Company that does not intend to be treated as engaged in a trade or business in the U.S. is nonetheless so engaged. If any such Non-U.S. Company is treated as engaged in a trade or business in the U.S., it may incur greater tax costs than expected on any income not exempt from taxation under an applicable income tax treaty, which could have a material adverse effect on our financial condition, results of operations and cash flows.
AHL is a UK tax resident and expects to qualify for the benefits of the income tax treaty between the U.S. and the UK (UK Treaty) because its Class A common shares are listed and regularly traded on the NYSE. In addition, certain of the Non-U.S. Subsidiaries are UK tax residents (together with AHL, the UK Resident Companies) and expect to qualify for the benefits of the UK Treaty by reason of being subsidiaries of AHL or by reason of satisfying an ownership and base erosion test. Accordingly, our UK Resident Companies are expected to qualify for certain exemptions from, or reduced rates of, the U.S. taxes described above that are provided for by the UK Treaty. However, there can be no assurances that our UK Resident Companies will continue to qualify for treaty benefits or satisfy all of the requirements for the tax exemptions and reductions they intend to claim. If any of our UK Resident Companies fails to qualify for such benefits or satisfy such requirements, it may incur greater tax costs than expected, which could have a material adverse effect on our financial condition, results of operations and cash flows.
U.S. persons who own our equity securities may be subject to U.S. federal income taxation at ordinary income rates on our undistributed earnings and profits.
For any taxable year in which a Non-U.S. Company is treated as a controlled foreign corporation (CFC), a “10% U.S. Shareholder” of the Non-U.S. Company that held our equity securities directly or indirectly through non-U.S. entities as of the last day in such taxable year that the Non-U.S. Company was a CFC would generally be required to include in gross income as ordinary income its pro rata share of the Non-U.S. Company’s income, regardless of whether that income was actually distributed to such U.S. person (with certain adjustments). A “10% U.S. Shareholder” of an entity treated as a foreign corporation for U.S. federal income tax purposes is a U.S. person who owns (directly, indirectly through non-U.S. entities or constructively) 10% or more of the total value of all classes of shares of the corporation or 10% or more of the total combined voting power of all classes of voting shares of the corporation. Any U.S. person that owns (or is treated as owning) 10% or more of the value of AHL should consult with their tax advisor regarding their investment in AHL.
In general, a non-U.S. corporation is a CFC if 10% U.S. Shareholders, in the aggregate, own (or are treated as owning) stock of the non-U.S. corporation possessing more than 50% of the voting power or value of such corporation’s stock. However, this threshold is lowered to 25% for purposes of taking into account the insurance income of a non-U.S. corporation. Further, special rules apply for purposes of taking into account any related person insurance income (RPII) of a non-U.S. corporation, as described below.
114
In addition, if a U.S. person disposes of shares in a non-U.S. corporation and the U.S. person owned (directly, indirectly through non-U.S. entities or constructively) 10% or more of the total combined voting power of the voting stock of the corporation at any time when the corporation was a CFC during the five-year period ending on the date of disposition, any gain from the disposition will generally be treated as a dividend to the extent of the U.S. person’s share of the corporation’s undistributed earnings and profits that were accumulated during the period or periods that the U.S. person owned the shares while the corporation was a CFC (with certain adjustments). Also, a U.S. person may be required to comply with specified reporting requirements, regardless of the number of shares owned.
We do not believe that AHL is a CFC. However, we believe that all of the Non-U.S. Subsidiaries are CFCs, except that we believe ALRe is a CFC only for purposes of taking into account certain insurance income. Specifically, the Tax Act eliminated the prohibition on “downward attribution” from non-U.S. persons to U.S. persons under former Section 958(b)(4) of the Code for purposes of determining constructive stock ownership under the CFC rules. As a result, our U.S. subsidiaries are deemed to own all of the stock of the Non-U.S. Subsidiaries (other than ALRe) for CFC purposes. Further, we believe that 10% U.S. Shareholders of ALRe collectively own more than 25%, but less than 50%, of the vote and value of ALRe by reason of downward attribution from certain of our direct or indirect shareholders. The legislative history under the Tax Act indicates that this change in law was not intended to cause a foreign corporation to be treated as a CFC with respect to a 10% U.S. Shareholder that is not related to the U.S. persons receiving such downward attribution. However, it is not clear whether a court would interpret the change made by the Tax Act in a manner consistent with such indicated intent. Moreover, no assurances can be provided that any of the Non-U.S. Companies would not be a CFC, even without regard to the downward attribution of stock from non-U.S. persons to U.S. persons, as such classification depends upon the identity and relationships of the beneficial owners of our equity securities, over which we have limited knowledge and control. Accordingly, any U.S. person that owns (or is treated as owning) 10% or more of the voting power or value of AHL should consult with their tax advisor regarding their investment in AHL.
U.S. persons who own our equity securities may be subject to U.S. federal income taxation at ordinary income rates on a disproportionate share of our undistributed earnings and profits attributable to RPII.
If any of the Non-U.S. Companies is treated as recognizing RPII in a taxable year and is also treated as a CFC for such taxable year, each U.S. person that owns our equity securities directly or indirectly through non-U.S. entities as of the last day in such taxable year must generally include in gross income its pro rata share of the RPII, determined as if the RPII were distributed proportionately only to all such U.S. persons, regardless of whether that income is distributed (with certain adjustments). For this purpose, a Non-U.S. Company generally will be treated as a CFC if U.S. persons in the aggregate are treated as owning (directly or indirectly through non-U.S. entities) 25% or more of the total voting power or value of the Non-U.S. Company’s stock at any time during the taxable year. We believe that the Non-U.S. Companies are treated as CFCs for this purpose, based on the current ownership of our equity securities.
RPII generally is any income of a non-U.S. corporation attributable to insuring or reinsuring risks of a U.S. person that owns (or is treated as owning) stock of such non-U.S. corporation, or risks of a person that is “related” to such a U.S. person. For this purpose, (1) a person is “related” to another person if such person “controls,” or is “controlled” by, such other person, or if both are “controlled” by the same persons, and (2) “control” of a corporation means ownership (or deemed ownership) of stock possessing more than 50% of the total voting power or value of such corporation’s stock and “control” of a partnership, trust or estate for U.S. federal income tax purposes means ownership (or deemed ownership) of more than 50% by value of the beneficial interests in such partnership, trust or estate.
The Non-U.S. Companies that are insurance enterprises (the “Non-U.S. Insurance Companies”) may derive income that is considered RPII. We believe that an exception under the RPII rules for CFCs with de minimis RPII currently applies to such Non-U.S. Insurance Companies, such that U.S. persons are not required to include any RPII in their gross income with respect to any of the Non-U.S. Companies. However, AGM and its affiliates and related parties own a substantial number of our Class A common shares, have rights to acquire additional Class A common shares and hold proxies to vote Class A common shares owned by certain of our employees. Further, Athene and AGM may have considerable overlap in ownership. If it is determined that AGM controls Athene, or that the same persons control both Athene and AGM through owning (or being treated as owning) more than 50% of the vote or value of both Athene and AGM, substantially all of the income of the Non-U.S. Insurance Companies derived from the reinsurance of affiliates likely will constitute RPII. This would trigger the adverse RPII consequences described above to all U.S. persons that hold our equity securities directly or indirectly through non-U.S. entities and could have a material adverse effect on the value of their investment in our equity securities.
Our bye-laws currently limit to 9.9% the voting power of AHL owned by persons who, together with their affiliates, beneficially own more than 9.9% of the voting power of AHL, subject to exemptions authorized by our board of directors (the “9.9% Voting Cutback”). If the 9.9% Voting Cutback is applicable to any person, excess voting power generally will be reallocated to all other Class A common shares, including those held by AGM and its affiliates. Further, the voting power of Class A common shares that are owned (or treated as owned) by certain persons who own (or are treated as owning) any AGM stock would also be reallocated to all other Class A common shares, including those held by AGM and its affiliates. Our bye-laws limit these reallocations of voting power so that AGM, and any person or persons who control AGM, would not own (or be treated as owning) more than 49.9% of the total voting power of our stock if they do not own (and are not treated as owning) more than 50% of the total value of our stock. These rules are intended to prevent any such reallocation of voting power from causing AGM to be considered to control us or to be controlled by the same persons who control us for purposes of the RPII provisions. However, because the relevant attribution rules are complex and there is no definitive legal authority on whether these voting provisions are effective for these purposes, there can be no assurance that this will be the case.
115
Our bye-laws also generally provide that no person (nor certain direct or indirect beneficial owners or related persons to such person) who owns our equity securities may acquire any shares of AGM or otherwise make any investment that would cause such person, or any other person that is a U.S. person, to own (or be treated as owning) more than 50% of the vote or value of our equity securities. Any holder of our equity securities that violates this restriction may be required, at the discretion of our board of directors, to sell its equity securities or take any other reasonable action that our board of directors deems necessary. However, this restriction does not apply to members of the Apollo Group.
We have only a limited ability to determine whether any of the Non-U.S. Insurance Companies is treated as recognizing RPII in a taxable year, the amount of any such RPII or any U.S. person’s share of such RPII, and to obtain the information necessary to accurately make such determinations or fully enforce the voting provisions and ownership restrictions described above. We will take reasonable steps to obtain such information, but there can be no assurances that such steps will be adequate or that we will be successful in this regard. Accordingly, no assurances can be provided that the adverse RPII consequences described above will not apply to all U.S. persons that hold our equity securities directly or indirectly through non-U.S. entities.
The following updates and replaces, in its entirety, the risk factor entitled Our bye-laws contain provisions that cause a holder of Class A common shares to lose the right to vote the shares if the holder owns an equity interest in Apollo, AP Alternative Assets, L.P. (AAA) or certain other entities in our 2019 Annual Report:
Our bye-laws contain provisions that may cause a holder of Class A common shares to lose the right to vote the shares if the holder or certain connected persons own an equity interest in AGM.
Our bye-laws contain a voting restriction that can result in any “Restricted Common Shares” having no right to vote. A holder’s Class A common shares are considered “Restricted Common Shares” if and when the holder or any person who is considered to indirectly or constructively own any of the holder’s shares (other than certain members of the Apollo Group) owns (directly, indirectly or constructively) any stock of AGM. This voting restriction applies only if there is a person who (together with its affiliates) beneficially owns Class A common shares that would, absent the voting adjustments in our bye-laws, possess more than 9.9% of the total voting power of our Class A common shares and who has not received the consent of at least 70% (75% after March 31, 2021) of our board of directors to exceed such voting threshold. This voting restriction does not affect the transferability of Class A common shares and will not apply after any date identified as the “Restriction Termination Date” by at least 70% (75% after March 31, 2021) of our board of directors.
The following updates and replaces, in their entirety, the similarly named risk factors in our 2019 Annual Report:
Our bye-laws contain provisions that could discourage takeovers and business combinations that our shareholders might consider in their best interests, including provisions that prevent a holder of Class A common shares from having a significant stake in Athene.
Our bye-laws include certain provisions that could have the effect of delaying, deferring, preventing or rendering more difficult a change of control that holders of our Class A common shares might consider in their best interests. For example, our bye-laws contain voting adjustments that may reduce the votes of a holder’s Class A common shares to the extent necessary to prevent any person (together with its affiliates) from beneficially owning Class A common shares having more than 9.9% of the total voting power of our Class A common shares, unless such person has received the consent of at least 70% (75% after March 31, 2021) of our board of directors to exceed such threshold. In addition, if the votes of any Class A common shares are required to be reduced pursuant to these adjustments, the votes of all Class A common shares that are “Restricted Common Shares” generally are reduced to zero. The votes of all Class A common shares that did not suffer a reduction in votes are then increased, pro rata based on their then current voting power, in an aggregate amount equal to the aggregate reduction in votes under the voting adjustments described above, except that the increase in votes of any Class A common share is limited to the extent necessary to avoid triggering further voting reductions and to avoid creating a “RPII Control Group,” as defined in our bye-laws. Such adjustments, if implicated, would result in some Class A common shares having more than one vote per share. Therefore, a shareholder’s voting rights may increase above 5% of the aggregate voting power of our Class A common shares, even if the shareholder holds fewer than 5% of our Class A common shares, thereby possibly resulting in the shareholder becoming a reporting person subject to Schedule 13D or 13G filing requirements under the Exchange Act. These requirements could discourage any potential investment in our Class A common shares. In addition, our board of directors is classified into three classes of directors, with directors of each class serving staggered three-year terms. Any change in the number of directors is required by our bye-laws to be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class or from the removal of a director will hold such directorship for a term that coincides with the remaining term of that class. Moreover, our bye-laws require specific advance notice procedures and other protocols for holders of common shares to make shareholder proposals and nominate directors. Among other requirements, a shareholder must meet the minimum requirements for eligible shareholders to submit shareholder proposals under Rule 14a-8 of the Exchange Act, and submit specific information and make specific undertakings in relation to the shareholder proposal or director nomination.
Any or all of these provisions could prevent holders of our Class A common shares from receiving the benefit from any premium to the market price of our Class A common shares offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of any of these provisions could adversely affect the prevailing market price of our Class A common shares if they were viewed as discouraging takeover attempts in the future.
Future sales of common shares by existing shareholders could cause our share price to decline.
Sales of substantial amounts of our Class A common shares in the public market, or the perception that these sales could occur, could cause the market price of our Class A common shares to decline. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
116
We have filed registration statements on Form S-8 under the Securities Act to register the Class A common shares to be issued under our 2017 employee stock purchase plan (ESPP) and our equity compensation plans and, as a result, all Class A common shares acquired upon the purchase of shares under our ESPP and the vesting of share awards or the exercise of stock options granted under our equity compensation plans will also be freely tradeable under the Securities Act, subject to the terms of any lock-up agreements, unless purchased by our affiliates. As of June 30, 2020, 6.0 million common shares are reserved for future issuances under our ESPP and equity incentive plans, in the aggregate. In addition, we have filed a registration statement on Form S-3 under the Securities Act to register the Class A common shares to be issued upon the exercise of warrants, which were issued in exchange for a portion of our previously outstanding Class M common shares. Upon exercise, the Class A common shares will be freely tradeable under the Securities Act, subject to the terms of any lock-up agreements, unless held by our affiliates. As of June 30, 2020, 8.4 million common shares are registered for resale in connection with the exercise of warrants. The issuance of any of the foregoing shares or their subsequent sale may cause our share price to decline.
Pursuant to the shareholders agreement among us and certain members of the Apollo group that was entered into in connection with the share issuance transaction with Apollo, AGM and certain of its affiliates agreed not to directly or indirectly transfer any Class A common share prior to February 28, 2023, subject to certain exceptions (Apollo Lock-up). As of June 30, 2020, there were more than 50 million shares subject to the Apollo Lock-up. When the Apollo Lock-up ends, the market price of our common shares could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. Furthermore, Apollo has the right to require, subject to the expiration or waiver of the Apollo Lock-up, us to register Class A common shares for resale in certain circumstances pursuant to the registration rights agreements we have entered into with Apollo.
In the future, we may issue additional common shares or other equity or debt securities convertible into or exercisable or exchangeable for Class A common shares in connection with a financing, strategic investment, litigation settlement or employee arrangement or otherwise. Any of these issuances could result in substantial dilution to our existing shareholders and could cause the trading price of our Class A common shares to decline.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Securities
Purchases of common stock made by or on behalf of us or our affiliates during the three months ended June 30, 2020 are set forth below:
Period |
(a) Total number of shares purchased |
(b) Average price paid per share |
(c) Total number of shares purchased as part of publicly announced programs1
|
(d) Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs1
|
||||||
April 1 – April 30, 2020 |
— |
$ |
— |
— |
$ |
321,408,033 |
||||
May 1 – May 31, 2020 |
— |
$ |
— |
— |
$ |
321,408,033 |
||||
June 1 – June 30, 2020 |
— |
$ |
— |
— |
$ |
321,408,033 |
||||
1 Prior to October 28, 2019, we had announced approvals by our board of directors for $967 million of aggregate repurchases under our share repurchase program. Amounts authorized for repurchase under those approvals had been fully used prior to March 31, 2020. On October 28, 2019, we announced that our board of directors had approved an additional $600 million authorization for the repurchase of our Class A common shares. The remaining authorization does not have a definitive expiration date, but may be terminated at any time at the sole discretion of our board of directors. See Note 10 – Equity to the condensed consolidated financial statements for more information.
|
Purchases of depositary shares made by or on behalf of us or our affiliates during the three months ended June 30, 2020:
Period |
(a) Total number of shares purchased1
|
(b) Average price paid per share |
(c) Total number of shares purchased as part of publicly announced programs2
|
(d) Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs2
|
||||||||||
April 1 – April 30, 2020 |
— |
$ |
— |
— |
$ |
— |
||||||||
May 1 – May 31, 2020 |
— |
$ |
— |
— |
$ |
— |
||||||||
June 1 – June 30, 2020 |
80,000 |
$ |
25.00 |
— |
$ |
— |
||||||||
1 Purchases relate to certain executive officers or members of our board of directors as our affiliates.
| ||||||||||||||
2 As of June 30, 2020, our board of directors had not authorized any purchases of depositary shares in connection with a publicly announced plan or program.
|
117
EXHIBIT INDEX
Exhibit No. |
Description |
4.1 |
|
4.2 |
|
4.3 |
|
4.4 |
|
10.1 |
|
31.1 |
|
31.2 |
|
32.1 |
|
32.2 |
|
101.INS |
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
101.SCH |
XBRL Taxonomy Extension Schema. |
101.CAL |
XBRL Taxonomy Extension Calculation Linkbase. |
101.LAB |
XBRL Taxonomy Extension Label Linkbase. |
101.PRE |
XBRL Taxonomy Extension Presentation Linkbase. |
101.DEF |
XBRL Taxonomy Extension Definition Linkbase. |
104 |
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
118
SIGNATURES
Pursuant to the requirements 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.
ATHENE HOLDING LTD. |
|
Date: August 5, 2020 |
/s/ Martin P. Klein |
Martin P. Klein |
|
Executive Vice President and Chief Financial Officer |
|
(principal financial officer and duly authorized signatory) |
119