We lease commercial office space in one building in West Des Moines, Iowa, for our principal offices under an operating lease that expires on November 30, 2026. We also lease our office in Pell City, Alabama, pursuant to an operating lease that expires on December 31, 2015. We are fully utilizing these facilities and believe both locations to be sufficient to house our operations for the foreseeable future.
In addition to net income, we have consistently utilized operating income, operating income per common share and operating income per common share-assuming dilution, non-GAAP financial measures commonly used in the life insurance industry, to evaluate our financial performance. Operating income equals net income adjusted to eliminate the impact of net realized gains and losses on investments including net OTTI losses recognized in operations, fair value changes in derivatives and embedded derivatives, loss on extinguishment of debt, and changes in litigation reserves. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of operating income together with net income provides information that may enhance an investor's understanding of our underlying results and profitability. The amounts included in the reconciliation of net income to operating income are presented net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs and income taxes.
Management's discussion and analysis reviews our consolidated financial position at December 31, 2014 and 2013, and our consolidated results of operations for the three years in the period ended December 31, 2014, and where appropriate, factors that may affect future financial performance. This analysis should be read in conjunction with our audited consolidated financial statements, notes thereto and selected consolidated financial data appearing elsewhere in this report.
In 2014 and 2013, we retired $322 million aggregate principal amount of three convertible note issues. The total consideration paid to retire the convertible notes included $438 million of cash and 9.45 million shares of our common stock. In 2013, we issued $400 million of senior unsecured notes due 2021 (the "2021 Notes") and used the net proceeds from the note offering to fund a substantial portion of the convertible note retirements. At December 31, 2014, we had $22.4 million principal amount of our 3.50% Convertible Senior Notes due 2015 (the "2015 notes") outstanding. The 2015 notes mature in September 2015 and will be retired at maturity if not redeemed or repurchased prior to that date. Our holding company has sufficient cash on hand and cash resources to retire the remaining 2015 notes without accessing external sources of capital such as its bank line of credit or dividends from our primary life insurance subsidiary.
We specialize in the sale of individual annuities (primarily deferred annuities) and, to a lesser extent, we also sell life insurance policies. Under U.S. generally accepted accounting principles ("GAAP"), premium collections for deferred annuities are reported as deposit liabilities instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liabilities for policyholder account balances and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender and other charges deducted from the account balances of policyholders, net realized gains (losses) on investments and changes in fair value of derivatives. Components of expenses for products accounted for as deposit liabilities are interest sensitive and index product benefits (primarily interest credited to account balances), changes in fair value of embedded derivatives, amortization of deferred sales inducements and deferred policy acquisition costs, other operating costs and expenses and income taxes.
Results of Operations for the Three Years Ended December 31, 2014
Annuity deposits by product type collected during 2014, 2013 and 2012, were as follows:
Annuity deposits before coinsurance ceded decreased 1% during 2014 compared to 2013 and increased 7% during 2013 compared to 2012. We attribute the continuing significant sales of our products to several factors including the highly competitive rates on our products, our continued strong relationships with our national marketing organizations and independent insurance agents, the increased attractiveness of safe money products in volatile markets, lower interest rates on competing products such as bank certificates of deposit and product enhancements.
We believe our existing statutory capital and surplus and the statutory surplus we expect to generate internally through statutory earnings will support a higher level of new business growth than in previous years. However, while we have the capital resources to accept more business than was sold in 2014, our capacity is not unlimited and sales growth must be matched with available resources to maintain desired financial strength ratings from credit rating agencies. Should sales growth accelerate to levels that cannot be supported by internal capital generation, we would intend to obtain capital from external sources to facilitate such growth.
Net income, in general, has been positively impacted by the growth in the volume of business in force and the investment spread earned on this business. The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 13% to $33.4 billion for the year ended December 31, 2014 compared to $29.5 billion in 2013 and 14% for the year ended December 31, 2013 compared to $26.0 billion in 2012. Our investment spread measured in dollars was $809.5 million, $695.6 million, and $596.7 million for the years ended December 31, 2014, 2013 and 2012. As discussed above, our investment spread in 2014, 2013 and 2012 has been negatively impacted by both the extended low interest rate environment and our excess liquidity due to calls of our United States government agency securities (see Net investment income).
Net income for 2014 was negatively impacted and net income for 2013 and 2012 was positively impacted by a revision of assumptions used in determining liabilities for lifetime income benefit riders. These revisions were consistent with unlocking for deferred policy acquisition costs and deferred sales inducements. The impact of these revisions on net income was as follows:
In 2014, we retired $138 million aggregate principal amount of two issues of convertible notes. The loss on retirement was $12.5 million ($11.5 million after income taxes). In connection with the retirement of the 2015 notes, we entered into early termination agreements for a corresponding amount of the related 2015 notes hedges and the 2015 warrants. The impact of these partial unwinds decreased the change in fair value of derivatives and net income for the year ended December 31, 2014 by $6.3 million and $3.7 million, respectively (see Note 5 to our audited consolidated financial statements).
In addition to net income, we have consistently utilized operating income, a non-GAAP financial measure commonly used in the life insurance industry, to evaluate our financial performance. Operating income equals net income adjusted to eliminate the impact of net realized gains and losses on investments including net OTTI losses recognized in operations, fair value changes in derivatives and embedded derivatives, loss on extinguishment of debt, and changes in litigation reserves. Because these items fluctuate from year to year in a manner unrelated to core operations, we believe measures excluding their impact are useful in analyzing operating trends. We believe the combined presentation and evaluation of operating income together with net income provides information that may enhance an investor's understanding of our underlying results and profitability.
Premiums and other considerations decreased 28% to $32.6 million in 2014 and 41% to $45.3 million in 2013 from $76.7 million in 2012. These revenues are comprised of life insurance premiums and premiums from life contingent single premium immediate annuities including life contingent supplemental contracts issued upon annuitization of deferred annuities. Life insurance premiums have remained consistent throughout the periods presented while premiums from life contingent single premium immediate annuities ($21.8 million, $34.8 million and $63.8 million in 2014, 2013 and 2012, respectively) have decreased over the periods, because we have adjusted the rates offered on these products to be less competitive in the low interest rate environment.
Net investment income increased 11% to $1.5 billion in 2014 and 8% to $1.4 billion in 2013 from $1.3 billion in 2012. The increases were principally attributable to the growth in our annuity business and corresponding increases in our invested assets. Average invested assets excluding derivative instruments (on an amortized cost basis) increased 13% to $31.3 billion in 2014 and 14% to $27.8 billion in 2013 compared to $24.4 billion in 2012. The average yield earned on average invested assets was 4.90%, 4.98% and 5.28% for 2014, 2013 and 2012, respectively.
The differences between the change in fair value of derivatives between years for call options are primarily due to the performance of the indices upon which our call options are based. A substantial portion of our call options are based upon the S&P 500 Index with the remainder based upon other equity and bond market indices. The range of index appreciation (after applicable caps, participation rates and asset fees) for options expiring during these years is as follows:
Net OTTI losses recognized in operations decreased to $2.6 million in 2014 and decreased to $6.2 million in 2013 from $14.9 million in 2012. The impairments recognized in 2014, 2013 and 2012 were primarily on residential mortgage backed securities and were principally due to changes of assumptions regarding loss severity of a number of securities we hold which affected our ongoing analysis of expected cash flow projections. See Financial Condition-Investments and Note 3 to our audited consolidated financial statements for additional discussion of write downs of securities for other than temporary impairments.
Change in fair value of embedded derivatives includes changes in the fair value of our fixed index annuity embedded derivatives and changes in the fair value of the embedded derivative related to the conversion option of our 2015 notes and, in 2014, our 2029 notes (see Notes 5 and 9 to our audited consolidated financial statements). The components of change in fair value of embedded derivatives are as follows:
Interest expense on notes payable decreased 6% to $36.4 million in 2014 and increased 36% to $38.9 million in 2013 from $28.5 million in 2012. The decrease in 2014 is attributable to the extinguishment of $322 million aggregate principal amount of our convertible senior notes in 2014 and 2013, which was partially offset by interest expense on the $400 million of 6.625% senior unsecured notes we issued in July 2013. The increase in 2013 was attributable to interest expense on the senior unsecured notes issued in July 2013 which was partially offset by lower interest expense on our convertible senior notes due to the extinguishment of $184 million principal amount of these notes during 2013. See Note 9 to our audited consolidated financial statements.
Interest expense on subordinated debentures was unchanged at $12.1 million in 2014 and decreased 10% to $12.1 million in 2013 from $13.5 million in 2012. The 2013 decrease was primarily due to the redemption of $22 million principal amount of our 8% Convertible Junior Subordinated Debentures in July 2012 (see Note 10 to our audited consolidated financial statements). $169.6 million principal amount of the subordinated debentures have interest based upon the three month London Interbank Offered Rate plus an applicable margin, which carried a weighted average interest rate of 4.09%, 4.07% and 4.35% for 2014, 2013 and 2012, respectively. See Financial Condition-Liabilities.
Amortization of deferred policy acquisition costs decreased 55% to $163.6 million in 2014 and increased 122% to $365.5 million in 2013 from $164.9 million in 2012. In general, amortization of deferred policy acquisition costs has been increasing each year due to the growth in our annuity business and the deferral of policy acquisition costs incurred with respect to sales of annuity products. The increase in amortization from these factors has been affected by amortization associated with fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business, amortization associated with net realized gains (losses) on investments and net OTTI losses recognized in operations and the amortization associated with litigation reserves. As discussed above, fair value accounting for derivatives and embedded derivatives utilized in our fixed index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our fixed index annuity contracts.
In 2013, other operating costs and expenses, net of changes in litigation liabilities and guaranty fund assessments, were primarily affected by increases in salaries and benefits, increased risk charges for the 2013 Hannover Transaction as well as the fluctuation in legal expense for the cost of defense of on-going litigation. Other operating costs and expenses excluding litigation expense and guaranty fund assessments discussed previously increased 7% to $82.4 million in 2013 from $77.1 million in 2012.
Income tax expense decreased in 2014 and increased in 2013 primarily because of the changes in income before income taxes. The effective income tax rates were 35.7%, 34.9% and 32.8% for 2014, 2013 and 2012, respectively.
Income tax expense and the resulting effective tax rate are based upon two components of income before income taxes ("pretax income") that are taxed at different tax rates. Life insurance income is generally taxed at an effective rate of approximately 35.4% reflecting the absence of state income taxes for substantially all of the states that the life insurance subsidiaries do business in. The income (loss) for the parent company and other non-life insurance subsidiaries is generally taxed at an effective tax rate of 41.5% reflecting the combined federal / state income tax rates. The effective tax rates resulting from the combination of the income tax provisions for the life / non-life sources of income (loss) vary from year to year based primarily on the relative size of pretax income (loss) from the two sources. The effective income tax rate increased in 2014 and 2013, because a portion of the parent company's loss on extinguishment of debt was not deductible resulting in an effective tax rate on the parent company's pretax loss that was less than 41.5%. The increases in the effective income tax rates were partially offset by tax favored investment income that lowered the effective income tax rate for the life subgroup.
Our fixed maturity security portfolio is managed to minimize risks such as interest rate changes and defaults or impairments while earning a sufficient and stable return on our investments. Historically, we have had a high percentage of our fixed maturity securities in U.S. Government sponsored agency securities (for the most part Federal Home Loan Mortgage Corporation and Federal National Mortgage Association). While U.S. Government sponsored agency securities are of high credit quality, we experienced several periods during the last three years where we held excess cash and other short-term investments due to lags in the reinvestment of proceeds from these securities called for redemption during those years. These calls resulted from the low interest rate and tight agency spread environment. Since 2007, when we had almost 80% of our fixed maturity portfolio invested in callable agencies, we have reallocated a significant portion of our fixed maturities from the callable agency securities to other highly rated, long-term securities. The largest portion of our fixed maturity securities are now in investment grade (NAIC designation 1 or 2) publicly traded or privately placed corporate securities.
Finance: The decline in value of this security is due to the continued wide spreads as a result of the ongoing concerns relating to capital, asset quality and earnings stability due to the financial events of the past four years and the ongoing events in the Eurozone. While this issuer has had its financial position and profitability weakened by the credit and liquidity crisis, we have determined that this security was not other than temporarily impaired due to our evaluation of the operating performance and the credit worthiness of the issuer.
Other asset backed securities: The decline in value of this security is due to poor performance in the underlying pool of student loans. The investment is backed by a guarantee from the for-profit education services provider. We have determined that this security was not other than temporarily impaired, because the guarantee is in good standing and all required payments have been made, including hyper-amortization payments triggered by the performance of the student loan portfolio.
We do not intend to sell these securities and it is more likely than not we will not have to sell these securities before recovery of their amortized cost and, as such, there were no other than temporary impairments on these securities at December 31, 2014.
Currently, American Equity Life may pay dividends or make other distributions without the prior approval of the Iowa Insurance Commissioner, unless such payments, together with all other such payments within the preceding twelve months, exceed the greater of (1) American Equity Life's net gain from operations for the preceding calendar year, or (2) 10% of American Equity Life's statutory capital and surplus at the preceding December 31. For 2015, up to $343.3 million can be distributed as dividends by American Equity Life without prior approval of the Iowa Insurance Commissioner. In addition, dividends and surplus note payments may be made only out of statutory earned surplus, and all surplus note payments are subject to prior approval by regulatory authorities in the life subsidiary's state of domicile. American Equity Life had $1.2 billion of statutory earned surplus at December 31, 2014.
Statutory accounting practices prescribed or permitted for our life subsidiaries differ in many respects from those governing the preparation of financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. Information as to statutory capital and surplus and statutory net income for our life subsidiaries as of December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012 is included in Note 12 to our audited consolidated financial statements.
Amounts shown in this table are projected payments through the year 2034 which we are contractually obligated to pay to our annuity policyholders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency, when applicable. These assumptions are based on our historical experience.
Inflation does not have a significant effect on our consolidated balance sheet. We have minimal investments in property, equipment or inventories. To the extent that interest rates may change to reflect inflation or inflation expectations, there would be an effect on our balance sheet and operations. Lower interest rates experienced in 2014 have increased the value of our fixed maturity investments. It is likely that higher interest rates would have the opposite effect. It is not possible to calculate the effect such changes in interest rates, if any, have had on our operating results.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of December 31, 2014 and 2013.
Evaluation of Other Than Temporary Impairments and Allowance for Loan Loss
We have a policy and process to identify securities that could potentially have an impairment that is other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
For the years ended December 31, 2014 and 2013, we utilized a process of rating the mortgage loans in our portfolio based on factors such as historical operating performance, loan to value ratio and economic outlook, among others. We calculate a loss factor to apply to each rating based on historical losses we have recognized in our mortgage loan portfolio. We apply the loss factors to the total principal outstanding within each rating category to determine an appropriate estimate of the general loan loss allowance at the reporting date.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at December 31, 2014 were to increase by 100 basis points, our reserves for fixed index annuities would decrease by $377.0 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $225.0 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase our reserves for fixed index annuities by $421.9 million recorded through operations as a increase in the change in fair value of embedded derivatives and increase our combined balance for deferred policy acquisition costs and deferred sales inducements by $244.2 million recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.
Estimated future gross profits vary based on a number of sources including investment spread margins, surrender charge income, policy persistency, policy administrative expenses and realized gains and losses on investments including credit related other than temporary impairment losses. Estimated future gross profits are most sensitive to changes in investment spread margins which are the most significant component of gross profits. If estimated gross profits for all future years on business in force at December 31, 2014 were to increase by 10%, our combined balance for deferred policy acquisition costs and deferred sales inducements at December 31, 2014 would increase by $141.3 million recorded through operations as a decrease to amortization of deferred policy acquisition costs and deferred sales inducements. Correspondingly, a 10% decrease in estimated gross profits for all future years would result in a $158.6 million decrease in the combined December 31, 2014 balances recorded through operations as an increase to amortization of deferred policy acquisition costs and deferred sales inducements.