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Edited Transcript of AEL earnings conference call or presentation 7-Nov-19 3:00pm GMT

Q3 2019 American Equity Investment Life Holding Co Earnings Call

WEST DES MOINES Nov 15, 2019 (Thomson StreetEvents) -- Edited Transcript of American Equity Investment Life Holding Co earnings conference call or presentation Thursday, November 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey David Lorenzen

American Equity Investment Life Holding Company - Executive VP & CIO

* John Michael Matovina

American Equity Investment Life Holding Company - Chairman, CEO & President

* Julie Lynne LaFollette

American Equity Investment Life Holding Company - Director of IR

* Ronald James Grensteiner

American Equity Investment Life Holding Company - President of American Equity Investment Life Insurance Company

* Ted Morris Johnson

American Equity Investment Life Holding Company - CFO & Treasurer

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Conference Call Participants

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* Alex Scott

* Erik James Bass

Autonomous Research LLP - Partner of US Life Insurance

* John Bakewell Barnidge

Sandler O'Neill + Partners, L.P., Research Division - Director of Equity Research

* John Matthew Nadel

UBS Investment Bank, Research Division - Analyst

* Pablo Augusto Serrano Singzon

JP Morgan Chase & Co, Research Division - Analyst

* Ryan Joel Krueger

Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Welcome to American Equity Investment Life Holding Company's Third Quarter 2019 Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Coordinator of Investor Relations.

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Julie Lynne LaFollette, American Equity Investment Life Holding Company - Director of IR [2]

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Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss third quarter 2018 earnings. Our earnings release and financial supplement can be found on our website at www.american-equity.com. Non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents.

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

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [3]

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Thank you, Julie. Good morning everyone and thank you for joining us this morning. As we reported last night, our third quarter financial results remain strong. Non-GAAP operating income for the quarter was $233 million or $2.54 per share. And if you exclude the impact of the revisions to our actuarial assumptions operating income would have been $109 million or $1.19 a share. And both of those are, those are new records for operating income and operating income or operating earnings per share excluding the effect of assumption reviews.

As a reminder, the three key metrics that drive our financial performance are growing our invested assets and policyholder funds under management, generating a high level of operating earnings on a growing asset base through investment spread and then minimizing impairment losses in our investment portfolio.

So for the third quarter of 2019, we delivered 1% sequential growth and 5% trailing 12-month growth in policyholder funds under management. On a trailing 12-month basis, we generated a 16.3% non-GAAP operating return on average equity excluding the impact of actuarial assumption reviews, and our investment impairment losses, net of recoveries, and after the effects of deferred acquisition costs and income taxes, were just 0.1% of average equity.

The growth in policyholder funds under management was driven by $1.2 billion of net sales in the quarter and $4.9 billion of net sales for the trailing 12 months. Net sales in the quarter were up nearly 31% year-over-year, but they were down 15% sequentially. Our policy rates were less attractive in the second half of the third quarter, following the rate reductions we made in early August that we talked about on the last call. You will hear more about the sales environment and competition from Ron a bit later.

Investment spread in the quarter increased sequentially with trendable investment spread and the benefit from non- trendable investment spread items up roughly the same amount. Trendable spread benefited from a decline in the cost of money as option costs continue to decline through our rate management. Ted will have more details on investment spread in his remarks.

Also during the quarter, Fitch Ratings upgraded their ratings on us and earlier in the year Standard & Poor's and AM Best affirmed our ratings. With the Fitch upgrade, we now have an investment grade rating for our holding company senior unsecured debt for each of the rating agencies that rate us. So I'll be back at the end of the call for some closing remarks.

Now I'll turn the call over to Ted for additional comments on third quarter financial results.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [4]

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Thank you, John. As we reported yesterday afternoon, we had non-GAAP operating income of $233 million or $2.54 per share for the third quarter of 2019 compared to non-GAAP operating income of $171 million or $1.87 per share for the third quarter of 2018. Excluding actuarial assumption revisions, operating income would have been $109 million or a $1.19 per share for the third quarter of 2019, compared to $90 million or $0.99 per share for the third quarter of 2018.

Third quarter 2019 operating income included a net benefit of $124 million or $1.35 per share from revisions to actuarial assumptions. Third quarter 2018 operating income included a net benefit of $81 million or $0.88 per share from revisions to actuarial assumptions. On a pre-tax basis, the third quarter 2019 revisions reduced amortization of deferred policy acquisition costs and deferred sales inducements by $473 million and increased the liability for future payments under lifetime income benefit riders by $315 million for a net increase and pre-tax operating income of $158 million. Going forward, the impact from our revisions to actuarial assumptions on future results is expected to be a small benefit to near-term earnings.

The most significant assumption changes were to lapse and utilization assumptions. We have credible lapse and utilization data based upon a comprehensive experience study spanning over 10 years on our products with lifetime income benefit riders, and have experienced lapsation on these policies lower than previously estimated. Lower lapse assumptions should result in more policyholders being eligible to turn on their lifetime income benefit than previously anticipated, and therefore the need for a greater lifetime income benefit reserve amount.

On the other hand, lower lapsation assumptions results in policies remaining in force over a longer period of time, leading to a greater level of expected gross profits than previously estimated. This higher level of estimated future gross profits means that we had amortized the deferred acquisition cost and deferred sales inducement assets faster than what our current revised assumptions indicate was necessary.

Our experience study has also indicated that the ultimate utilization of certain lifetime income benefit riders is expected to be less than our prior assumptions and the timing of utilization of lifetime income benefit riders is later than in our prior assumptions. We have reduced our ultimate utilization assumptions for fee riders from 75% to 60% and for no fee riders from 37.5% to 30% for policies issued in 2014 and prior years. The net effect of utilization assumption revisions partially offsets the negative effects on the lifetime income benefit reserve from the change in lapsation assumptions.

We are assuming a 3.8% long-term US treasury rate with a mean reversion period of 20 years. Our long-term assumption for aggregate spread is unchanged at 2.6%, which translates to an ultimate discount rate of 2.9%.

Investment spread for the third quarter was 275 basis points, up from 263 basis points in the second quarter as a result of a 4 basis point decline in the cost of money and an 8 basis point increase in the average yield on invested assets. Trendable spread in the third quarter was 260 basis points compared to 254 basis points in the second quarter of this year.

Average yield on invested assets was 4.59% in the third quarter of 2019, compared to 4.51% in the second quarter of 2019. This increase was attributable to an increase in the benefit from non-trendable investment income items from 5 basis points in the second quarter to 13 basis points in the third quarter of this year. Included in non-trendable items this quarter were 11 basis points from prepayment fees and bond call income and 2 basis points from accelerated residential mortgage-backed security paydowns and other miscellaneous items.

The impact from the decline in short-term yield on the $4.8 billion of floating rate instruments in our investment portfolio negatively affected our average yield by 2 basis points.

The average yield on fixed income securities purchased and commercial mortgage loans funded in the third quarter was 3.3% compared to 4.52% for the first half of the year. During the quarter, we purchased $1.9 billion of fixed income securities at a rate of 3.21% and originated $180 million of commercial mortgage loans at a rate of 4.33%. The decline in new money yields reflected the general decline in available yields and lower allocations to both asset-backed and structured securities, as well as greater purchases of lower yielding US treasuries and agencies and municipal securities.

The average yield on fixed income securities purchased and commercial mortgage loans funded in October was 3.59%. Our expectation in the near-term is for new money yields to continue to range from 150 basis points to 200 basis points over the 10-year treasury yield. Longer term, we're looking to develop and expand relationships with third parties that can source more higher yielding private asset-backed and infrastructure securities for our portfolio.

The aggregate cost of money for annuity liabilities was 184 basis points, down four basis points from the second quarter of 2019. The benefit from over hedging of the index-linked interest obligations was two basis points in the third quarter compared to 4 basis points in the second quarter. We estimate that the trend of cost of money declined by 6 basis points in the third quarter.

Option costs decreased in the third quarter reflecting reductions in caps and participation rates on new business from the June and August new money rate changes, renewal rate changes initiated in both October of last year and in August of this year and higher volatility. The trend of declining option costs, which began in December 2018, could extend further as we reduced new money rates last month and will begin reducing renewal rates on $29.7 billion of policyholder funds under management, in January 2020. We expect this latest renewal rate reduction to produce annual savings in the cost of money of 11 basis points on the $29.7 billion and 6 basis points on our entire in-force when fully implemented over the next 12 months to 15 months.

Should the yields available to us decrease or the cost of money rise, we continue to have flexibility to reduce our crediting rates if necessary and could decrease our cost of money by roughly 59 basis points, if we reduce current rates to guaranteed minimums. This is up slightly from 58 basis points at the end of the second quarter.

Operating expenses increased 3% sequentially in the quarter. The sequential increase in operating expenses reflected a $700,000 increase in legal, consulting and recruitment from fees and $700,000 in additional risk charges for excess regulatory reserves ceded to an unaffiliated churn as a result of an increase in the excess regulatory reserve ceded.

Our estimated risk-based capital ratio at September 30th 2019 is 366 compared to 369 at June 30th and 360 at December 31st 2018. We had a modest increase in adjusted capital and surplus that did not keep pace with the increase in required capital necessary from growth in our business.

Our RBC ratio continues to be negatively impacted by lower statutory net income in 2019 attributable to lower option expiration proceeds and lower index credits. Net index credits were 0.8% of account value in the first nine months of 2019, compared to 1.4% in the fourth quarter of last year and 3.6% to 5.4% in each of the first three quarters of 2018. Assuming current equity market levels, we expect option expiration proceeds and credits to rebound in the fourth quarter. Although low option expiration proceeds and related index credits can affect statutory capital and surplus and risk-based capital in the short run, over the long run market movements tend to even out and we expect the policies to perform in line with pricing expectations.

Now I'll turn the call over to Ron to discuss sales, marketing and competition.

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Ronald James Grensteiner, American Equity Investment Life Holding Company - President of American Equity Investment Life Insurance Company [5]

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Thank you, Ted, and good morning everyone. As we reported yesterday. Third quarter gross and net sales were $1.3 billion and $1.2 billion respectively, representing increases of 25% and 31% from third quarter 2018 sales. On a sequential basis, gross and net sales decreased 13% and 15% respectively. In addition to the gain in gross sales the year-over-year increase in net sales reflects a reduction in the co-insurance percentage for Eagle Life's reinsured fixed-indexed annuity products from 50% to 20% and increased sales of Eagle Life's fixed-indexed annuities that are not reinsured. Eagle Life's sales product mix in the third quarter was more heavily weighted towards multi-year guaranteed annuity products, which have a co-insurance percentage of 80% resulting in a larger sequential decline in net sales relative to gross sales.

In the independent agent channel, gross sales decreased 13% sequentially driven by reductions we made to crediting rates and guaranteed income in mid-June and early August as available yields in the market continued to fall. The sales environment and the independent agent channel remained competitive during the quarter. Most competitors lower crediting rates and guaranteed income throughout the quarter, although a few continue to hold guaranteed income steady.

Combined sales for AssetShield and the Choice series, our primary accumulation products for independent agents, were 39% of American Equity Life's fixed-indexed annuity sales in the third quarter compared to 46% in the second quarter of 2019.

IncomeShield accounted for 48% of sales in the third quarter compared to 40% of sales in the second quarter of 2019. IncomeShield 10 was the largest or with was the best selling guaranteed lifetime income product in the independent agent channel in the first half of the year. Despite the changes to guaranteed income we made in August IncomeShield 10 sales were still up 8% sequentially.

In light of the decline and available yields we implemented further reductions to crediting rates and guaranteed income on October 16th. We lowered annual participation rates on AssetShield 10 with the market value adjustment to 25% from 40% previously. This rate was 54% in January, indicating how much yields have deteriorated over the course of the year. Participation rates on the volatility controlled Dividend Aristocrats Excess Return one-year and two-year strategies are now at 100% and 110%, well below the levels at the start of the year

For guaranteed income, we reduced pay off factors for the lifetime income benefit rider is available on our guaranteed income products. The reductions and factors reduced guaranteed income on our best-selling IncomeShield products by roughly 12% following reductions of approximately 6.5% to 7% back in August. While more conservative when compared to the highest levels of income in the marketplace. We're still higher than several key competitors.

While absolutely necessary, we believe our reduction in participation rates from the 50% level, likely, had an outsized effect on our distribution - producing a relatively greater drop in sales of our accumulation products this quarter. Offering half or more of the S&P 500 appreciation with no downside risk was a very appealing offering even against hybrid volatility-controlled indexes with high participation rates.

More recently, we have seen competitors raise participation rates, possibly betting on a continuation of the recent back up in interest rates. Even after these increases, however, our Dividend Aristocrats Excess Return strategy still illustrates competitively. Our objective is to highlight this strategy by placing more marketing and educational emphasis on its features and strong performance. It's a slow process but we seem to be making headway as roughly 42% of new money into AssetShield 10 is currently being allocated to Dividend Aristocrats compared to 16% in May, which is the last month our S&P 500 participation rate for AssetShield 10 was at least 50%. To put this into perspective the allocation to the S&P 500 participation rate strategy in AssetShield 10 has fallen to 37% from 61% in May.

Turning to pending, pending business at American Equity Life averaged 2,685 applications during the third quarter compared to 3,156 applications in the second quarter and 2,905 when we reported second-quarter earnings. Pending this morning stands at 2,169 applications.

Gross FIA sales at Eagle Life decreased 28% sequentially. Eagle Life had distinguished itself in the bank and broker-dealer channels with its emphasis on offering attractive participation rates on S&P 500 annual point to point strategies.

Given the decline in interest rates, we made reductions to participation rates during August and October similar to those made on accumulation products at American Equity Life. While our S&P 500 participation rates are not attractive to distribution at this time, we're placing additional emphasis on the Dividend Aristocrats strategies at Eagle Life too. Our two latest product introductions at Eagle Life, the Eagle Select Focus 5 and Focus 7 have been gaining traction with distribution and both include the Dividend Aristocrats participation rate strategies.

Eagle Life will also be rolling out a new guaranteed income product the Eagle Select Income Focus, to banks and broker-dealers later this month. This is a significant initiative for Eagle Life to capture some guaranteed income market share in these channels. Last year's guaranteed income sales were $5.8 billion and guaranteed income sales continue to grow this year. While guaranteed lifetime income has been a focus at American Equity Life, this has not been the case at Eagle Life. The standard no-fee guaranteed lifetime income rider, pioneered by American Equity Life in the independent agent channel, will be unique in the bank and broker-dealer channels. To maximize guaranteed lifetime income, policyholders may instead choose a fee-based rider, which will be very competitive with those offered by the leader in these channels.

We continue to put significant emphasis on account acquisition. On our second quarter call, we mentioned that we expected to bring on at least two meaningful accounts by year-end. We have a selling agreement finalized with one, a large independent broker-dealer, and we expect to see sales early next year once the onboarding process is complete. We remain hopeful that we will secure a selling agreement with the other meaningful independent broker-dealer by the year-end.

Pending applications today at Eagle Life stand at 127 compared to 285 applications when we reported second-quarter earnings and 300 applications, a year ago.

And with that, I'll turn the call back over to John for closing remarks.

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [6]

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Thank you, Ted and Ron. We certainly are pleased with our third quarter results, which included record operating income on both a reported basis and after adjusting for the impact of unlocking. Our investment spread continues to benefit from active crediting rate management. Our trendable spread has increased each quarter of this year and third quarter 2019 trendable spread at 2.6% was 12 basis points higher than the fourth quarter 2018 level of 2.48%. Improvement in our investment spread has more than offset the mid single-digit growth rate in policyholder funds under management, And putting that altogether, we estimate that we've increased our trendable operating earnings per share by 22% over the last 12 months to $1.09 per share in the third quarter of this year compared to $0.89 per share in the prior year third quarter.

In addition to spread management, key initiatives for the remainder of 2019 and 2020 will be to continue to increase our footprint in the bank and broker-dealer channels, introduce new annuity products that will complement our current product lineup, and boost our new money yield to enhance our competitive position in the rates in terms we can offer on our products.

As we've said in past calls, our long-term outlook remains quite favorable due to the growing number of Americans who will need help with their retirement security. While no single investment adequately addresses all retirement risks, annuities can play an important role in addressing guaranteed lifetime income, no matter what the market does, while also addressing sequence of return risk during retirement. We believe favorable demographics, product evolution and historical favorable results signal significant market share growth potential for fixed-indexed annuities.

So on behalf of the entire American Equity team, which now numbers a little more than 600. Thank you for your time and attention this morning.

We will now turn the call back over to the operator for questions.

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Questions and Answers

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Operator [1]

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Thank you, sir. (Operator Instructions) Our first question comes from Ryan Krueger from KBW. Please go ahead.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [2]

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Hi, thanks, good morning. First question on the $1.09 of trendable to EPS that you cited in the third quarter. I guess do you view that as a good starting point going forward. And does it incorporate the benefit from the near-term earnings that you cited from the assumption review?

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [3]

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First of all, we don't give guidance going forward. On the $1.09 for that doesn't take into [account] (corrected by the company after the call) any future benefit that you were referring to. The $1.09 was merely our reported number adjusted for unlocking and backing out the six points of non-trendable investment spread and applying an estimated DAC and tax effect to it.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [4]

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Got it. I guess just maybe put in a different way. If I back out all the DAC amortization and other assumption impacts, it looked like the K factor was in like the 49.5% range. Is that, was there anything unusual in that or, because that's a bit lower than it had been previously or do you feel like that's a fairly decent indication now.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [5]

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It's a little bit lower because of higher AGP versus EGP for the quarter. There was some of that impact.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [6]

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Okay. And then just the last one. Seems like you were highlighting that your products are generally still pretty competitive despite some of the action taken by your peers but the pending count is down quite a bit. So just hoping for some more color there. And if you think that's partially just representative of the overall market coming down?

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Ronald James Grensteiner, American Equity Investment Life Holding Company - President of American Equity Investment Life Insurance Company [7]

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Well, this is Ron and every time rates are reduced there is kind of a pause or a slowdown in sales and going forward, I think we have to accept that this could potentially be the norm within this low rate environment and you just have to keep going, you can't stop just because rates are low. Does it mean that there is no longer need for guaranteed income or principal protection and those types of things? No, we just keep on going forward and accept that this might be the new norm.

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Ryan Joel Krueger, Keefe, Bruyette, & Woods, Inc., Research Division - MD of Equity Research [8]

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Got it. Thank you.

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Operator [9]

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Thank you. Our next question comes from Pablo Singzon from JP Morgan. Please go ahead.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [10]

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Hi, the first question is for Ted. So the assumption review impacts are positive for operating earnings, but negative on GAAP income. Can you just discuss the difference there?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [11]

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I mean the difference there is going to be the impact of applying fair value accounting or FAS 133 to that, to those calculations.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [12]

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Got it. So this is just I guess lower risk free rates increase the liability and therefore have a negative impact on GAAP income right that's sort of --some of it.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [13]

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I mean, certainly that's going to be part of it. I think there is other factors too.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [14]

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Okay. And then the second question is for John. So it seems like AEL has been more active than its competitors in managing down the cost of money on in-force policies, at least in the recent past. Is there anything different about your current [actions] (corrected by the company after the call) for reditions versus your historical approach and have your actions had any impact whether on your distribution relationships or your policyholders.

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [15]

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I wouldn't say our pace of activity crediting rate management has changed within the last several years, we have cycles that we look at things with the policies have now been, there is some pretty large groups of policies that get looked at once a year and sometimes it's not right on top of each other. You know, like every 12 months, maybe it maybe there is a three month lag. But, and the one thing we continue to do is remain committed to not adjusting renewal rates for the first three years on policies. So, when policies hit their fourth year we then do an evaluation as to whether a rate adjustment is appropriate or not. The second part of your question was that we had any push back from agents or policyholders and we have not.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [16]

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Okay, perfect. I'm going to re-queue. Thank you.

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Operator [17]

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Thank you. Our next question comes from Alex Scott from Goldman Sachs. Please go ahead.

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Alex Scott, [18]

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Hi, thanks for taking the question. So I just wanted to talk about the review a little bit and I guess the assumption that 260 of spread, will remain constant. But I think back over your results over the last several years. I mean, they've been fairly resilient. But I mean low interest rates have impacted the spread over time, I think there is a time where you're earning something closer to like to [3.5%] (corrected by the company after the call) to 3% spread on some your products. Right? So I guess, just in light of how much rates have come down. I'd just be interested to hear what's different this time around that it will be flat as opposed to you're actually having some of the pressure hitting the bottom-line?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [19]

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I mean, certainly one of the big things that we've seen is, certainly the drop in option costs and certainly that drop and option costs is from what we've seen and higher volatility, and also our rate actions and we still do have quite a bit of cushion in room going into the future. Also we are pricing new business at least 260, and that's your assumption it plays out, then I would think spreads were remain flat or even go up, which I think is different than where the Street anyway is estimated your spread to go currently.

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [20]

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Well, the 260 is pricing. This is John. The pricing of new business does not influence what's sitting in the model. Today, the model is the only the policies that are there. The new business pricing I thought off hand, I don't know the spread numbers, but they probably haven't changed a lot. Now overall the, with the change in the mix of business that spread number is going to change over time. As we've called out before we have higher spread requirements for bonus products and we do for non-bonus products but I don't think the new business pricing is necessarily going to have an influence on the 260, which is just really the in-force book.

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Alex Scott, [21]

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I guess the point I was making is that, if the in-force book is earning 260 and the new business is earning 260 or something higher, if I aligned my model with your model, I think that should suggest that spreads are actually increasing over time despite rates. Do I have that right?

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [22]

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Our model that we're quoting here is just on the historical book, you are also factored into your -- is what happens for future business that goes on what we're quoting here. Giving you the assumptions is purely on the historical book of business. The forward and as we add new products on, then the mix that product mix and those spread targets and assumptions for those will affect what the aggregate gross spread which were referring to how it changes overtime.

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Alex Scott, [23]

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Got it, okay. Thank you.

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Operator [24]

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Thank you. Our next question comes from Erik Bass from Autonomous Research. Please go ahead.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [25]

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Hi, thank you. A big benefit this quarter was obviously the lower cost of money. Ted, if I'm hearing you right, it sounds like you view this as a sustainable level given the drop in option costs, so should we think of this as kind of a base level and then the actions that you're taking on renewal crediting rate actions could bring it down further. I think you said, kind of 6 basis points from the January actions going forward, is that the right way to think about it.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [26]

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All else being equal, but obviously what happens in the market going forward is going to affect what those cost of options. If there is some change in volatility, then that is going to change what we've experienced in the lower cost of options that we've seen over the past three quarters.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [27]

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Got it. That makes sense.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [28]

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But you are correct with your statement that our renewal rate crediting adjustments is going to continue to bring that cost of options down and obviously we're doing that because of the lower yields that we're seeing available out there to invest. So as some of the portfolio rolls over that's currently in there, we're going to need to probably invest at a lower rate. And so that those renewal crediting actions that we're putting in place is to offset those drops and yields.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [29]

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Got it. Thank you. And then just one question on the assumption review. I think you also mentioned you maintained the same level of assumed index credits going forward. And is that correct and is how do you think of that given some of the actions that Ron talked about on pricing in terms of bringing down participation rates?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [30]

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We maintained the spread, but not the level of what the cost of money associated or the index were the crediting too in the model. That does grade up over time. So the yield and cost of options are grading up over a 20 year mean reversion period.

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [31]

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And Ron's comments were reflective to new business not the assumption review. So clearly the new business being issued at lower rates. That will have a story on that next year at this time, so to speak.

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Erik James Bass, Autonomous Research LLP - Partner of US Life Insurance [32]

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Got it, okay. Thank you.

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Operator [33]

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Our next question comes from John Nadel from UBS. Please go ahead.

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John Matthew Nadel, UBS Investment Bank, Research Division - Analyst [34]

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Hi, good morning. I'm curious on the reduction in option costs. I'm -- I think maybe a few quarters ago, you were talking about option costs in the range of maybe 190 basis points, something like that. I think we're down in the range, currently, or at least recently more like 160 give or take. I'm just curious of that reduction in option cost, how much of that is specifically related to the actions you've taken in terms of -- in terms of the reduction to participation rate caps et cetera. And how much of that is just market effect?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [35]

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So you're right. Option cost last year averaged around 191 basis points. The most recent quarter, that was down to 165 basis points in the quarter before that was a 176. Our renewal crediting rate actions probably account for about 15 to 17 basis points of that.

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John Matthew Nadel, UBS Investment Bank, Research Division - Analyst [36]

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Got you. Okay, that's very helpful. Thank you. And then just a bigger picture question for John. Is there anything that you can offer in terms of an update around the search process timing, candidate interest in terms of your successor?

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [37]

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Well, yes, the answer is, the short answer is, no. I think you can appreciate the confidential nature of the process, so --

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John Matthew Nadel, UBS Investment Bank, Research Division - Analyst [38]

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I mean, I wasn't asking you to name names.

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John Michael Matovina, American Equity Investment Life Holding Company - Chairman, CEO & President [39]

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Well, but not -- but even anything said gets people speculating. And I mean, I will tell you the Board through its Committee has been actively engaged with the executive search firm selected by the Board to work on the assignment. And the process to identify interview and appoint a successor has been ongoing and the Board still anticipate being in a position to name a successor by the end of the year.

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John Matthew Nadel, UBS Investment Bank, Research Division - Analyst [40]

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I appreciate that. I've got -- have got just one more as it relates to sales volumes, then maybe capital. Ron, I think in your prepared remarks, or maybe in response to a question earlier indicated maybe this is the new norm in terms of sales volumes at least you have to be prepared for the possibility that it is. If it is in fact the new norm, obviously production levels are significantly below what you can fund via your statutory earnings. How long would you need to see sales volumes at a level, but below that capacity before you might look at other alternatives for deploying Capital otherwise not used to fund growth?

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Ronald James Grensteiner, American Equity Investment Life Holding Company - President of American Equity Investment Life Insurance Company [41]

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Well, let me make one clarifying comment first. So when I talk about this may be the new norm, I'm not talking about sales levels, I'm talking about the interest rate environment that we're dealing with. So, I need to make that point of clarification, before they answer the rest of the question.

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John Matthew Nadel, UBS Investment Bank, Research Division - Analyst [42]

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That's helpful. Thank you, Ron. Thank you.

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Operator [43]

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Thank you. Our next question comes from John Barnidge from Sandler O'Neill. Please go ahead.

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John Bakewell Barnidge, Sandler O'Neill + Partners, L.P., Research Division - Director of Equity Research [44]

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Thanks. Think I got disconnected earlier. And I apologize, if I'm asking a question that someone asked earlier. Surrender activity was 1.54% in the quarter on beginning period assets, does that seem like a reasonable run rate to assume?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [45]

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I mean, you know in this low rate environment and certainly absent probably increases, significant increases in rates, it seems, if you look over back over the past few quarters, that's probably a good place to start.

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John Bakewell Barnidge, Sandler O'Neill + Partners, L.P., Research Division - Director of Equity Research [46]

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Okay. And then operating expenses, does the number $38.5, I know you guys called out some things somewhat onetime in nature, but how should we be thinking of a run rate for that? Thank you.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [47]

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Certainly, I think you saw this quarter what impacted is one, if you have to factor in the increased amount of excess reserves ceded under our reinsurance agreement, you need to factor in that and what that grows too, because that's a driver of that line item. The other things that impacted the item, I mean that was another $700,000 for other miscellaneous consulting and legal, et cetera. From quarter to quarter, we typically have those items, they might go up or down. But that run rate where we're at right now is within $0.5 million or $700,000 is probably a decent run rate.

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John Bakewell Barnidge, Sandler O'Neill + Partners, L.P., Research Division - Director of Equity Research [48]

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Thank you for the answer.

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Operator [49]

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Thank you. (Operator Instructions) Our next question comes from Pablo Singzon from JP Morgan. Please go ahead.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [50]

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Hi, thanks for taking my follow-up question. So maybe for Ted or Jeff. So as you explore increasing allocations for private investments, what kind of uplift are you expecting on the investment yield side and I guess what would be the corresponding impact on capital. And also, what's your view on your potential long-term allocation there?

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Jeffrey David Lorenzen, American Equity Investment Life Holding Company - Executive VP & CIO [51]

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This is Jeff. I think the uplift is going to be hard to give guidance on because it's going to be all spread related, but we do anticipate on some of these private assets, getting spreads on the higher end or above those range targets that we provided. So there is going to be lift to the portfolio. The long-term allocations are still kind of working through those numbers. We continue to run all of our liquidity testing to make sure that we feel internally we have enough liquid assets available to meet policyholder obligations. But on the longer-term, I think private securities between private corporates and private ABS and other private assets could be 15%, 20% of the portfolio longer term. We're probably halfway there now. We have some flexibility to add some more illiquid assets to the portfolio that can get some lift but not cause us constraints in terms of our risk profile.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [52]

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Got it. And then the second question is for Ron. I'm curious if you have a view on how large the current market for guaranteed products is in the bank and also obviously as you pointed out, it's not -- it wasn't, it hasn't been the traditional market for that channel but those seems like is there an opportunity you see and as you go about expanding there maybe you could describe your strategy. Are you looking at certain distribution or will it be more broad based on you sort of cover all the bases, you have now?

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Ronald James Grensteiner, American Equity Investment Life Holding Company - President of American Equity Investment Life Insurance Company [53]

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Thank you, Pablo, it will be more broad based. As we look at the statistics and the bank channel, in particular the uptake for guaranteed income is around 20% to 25%. So that is 20% to 25% of the time when they buy fixed-indexed annuity, it has a type of guaranteed income feature attached to it. So, as the bank channel continues to grow. This year it's on pace to be somewhere in the neighborhood of $8 billion of FIA premium and now you take 20% to 25% of 8 billion, going to be a big number. So our strategy is to take our expertise that we have and guaranteed income at American Equity Life transferred over to Eagle Life and hopefully capture some of that market share. A $100 million here a couple of hundred million there can add significant success to Eagle Life's guaranteed income.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [54]

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Got it. And then my last question is for Ted. Just on the updated lapse and utilization assumptions, can you give us an update on where you are -- where you've been running historically versus your assumptions and related to that, I guess, can you talk about your approach to unlocking those I'm just more broadly, I know you referenced a study, but maybe if you could speak about specific factors that inform your decision to unlock and how you sort of balance of tension between a today and the potential for negative surprises further out in the future.

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [55]

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That is a lot Pablo. Well, let's go back over the assumptions. First of all, we did a detailed experience study that expanded over the 10 years. In addition to that, we did engage a consultant to review our study and compare our data against industry data of others in the industry and validated where our experience was that compared to the industry. Certainly, I think on a utilization that's going to differ by company depending on the product and how it was sold, et cetera. And when we look at utilization and you look at utilization for those cohorts and I said it's we reduce it for policies issued 2014 and prior and when we look at utilization across those policies, the utilization for any one year kind of ranges from 10% to 23%, with a majority of them more in the 15% or below in utilization. So very low. So it's going to take a significant increase in utilization to get up to 60% ultimate pump for those and again we left our utilization of assumptions higher for policies sold after 2014, and so we're still holding the 75% and 37.5% whether it's a fee or a no fee. And even in those older policies where I mentioned, we have one cohort at 22%, 23% utilization, that would be a cohort that has our richest benefit rider in it and that 23% is still quite low. So based upon all that data, that's how we validated our data and how we were looking at it when we were doing our assumption changes and in regards to lapses, we've been watching lapses be low for a long period of time, we've looked at that and really made the determination that was the point in time to reduce our lapse assumptions which obviously had offsetting effects on whether it was a LIBR reserve for DAC.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [56]

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Got it. And if you allow me one for Ted, I know I asked a lot. But as you look at the pre-2014 block right, it seems like if we -- if the trends sustain there, it seems like there's still some margin that you can essentially monetize at some point. I'm curious like, what is your expected duration for that overall block of policies and maybe if you could talk about an average age and we can sort of maybe apply our own math and when do you think people start dying off and so forth? But just broadly, like how much more -- how many more years do you have in that block and I guess you can sort of think about that versus your assumptions?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [57]

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I don't have that average age or the average duration of that to give you that. When you look at average ages and you look across those blocks for the weighted average age of the policyholders, some of those blocks and those other blocks, the average age is above 70. When you get closer to 2014, they might be right around 69 or that. So even the weighted average age is fairly high for those blocks. But I don't have some of that at the tip of my tongue right now to be able to give you.

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Pablo Augusto Serrano Singzon, JP Morgan Chase & Co, Research Division - Analyst [58]

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Okay, thank you.

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Operator [59]

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Thank you. Our next question comes from Alex Scott from Goldman Sachs. Please go ahead.

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Alex Scott, [60]

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Hey, thanks for taking the follow-up. Yeah, I was just wondering on the 260 spread assumption in DAC. If you can give us sensitivity at all to that. Whether it's 5 bps or something like that. And the only reason I'm asking, in our opinion , you have a relatively high DAC balance. I just want to understand if thinking through changes to that is something that I should consider if it's just not material?

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Ted Morris Johnson, American Equity Investment Life Holding Company - CFO & Treasurer [61]

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We don't have a sensitivity to give on that. Obviously, when we update and do our 10-K and when we'll have our table or our information in there that will do sensitivities on our assumptions, on the key assumptions.

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Alex Scott, [62]

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Got you. Okay, thank you.

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Operator [63]

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Thank you. I show no further questions in the queue at this time, I'd like to turn the call over to Julie LaFollette, Coordinator of Investor Relations for closing remarks.

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Julie Lynne LaFollette, American Equity Investment Life Holding Company - Director of IR [64]

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

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Operator [65]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.