(a)Book value per share is calculated as total stockholders' equity divided by the total number of shares of common stock outstanding. Shares outstanding include shares held by rabbi trusts and exclude unallocated shares held by our employee stock ownership plan-see note 10 to our audited consolidated financial statements. Page 26 of 66
Management's discussion and analysis reviews our consolidated financial position at December 31, 2008 and 2007, and our consolidated results of operations for the three years in the period ended December 31, 2008, and where appropriate, factors that may affect future financial performance. This discussion should be read in conjunction with our audited consolidated financial statements, notes thereto and selected consolidated financial data appearing elsewhere in this report.
All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the Securities and Exchange Commission ("SEC"), press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and other similar expressions, constitute forward-looking statements. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Accordingly, we cannot assure you that actual results will not differ materially from those expressed or implied by the forward-looking statements. Factors that could contribute to these differences include, among other things:
•general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the fair value of our investments, which could result in other than temporary impairments, and certain liabilities, and the lapse rate and profitability of policies;
•changes in the Federal income tax laws and regulations which may affect the relative income tax advantages of our products;
•the risk factors or uncertainties listed from time to time in our private placement memorandums or filings with the SEC.
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 charges deducted from the account balances of policyholders in connection with withdrawals, realized gains and losses on investments and changes in fair value of derivatives. Components of expenses for products accounted for as deposit liabilities are interest credited to account balances, changes in fair value of embedded derivatives, amortization of deferred policy acquisition costs and deferred sales inducements, other operating costs and expenses and income taxes.
Our profitability depends in large part upon the amount of assets under our management, investment spreads we earn on our policyholder account balances, our ability to manage our investment portfolio to maximize returns and minimize risks such as interest rate changes and defaults or impairment of assets, our ability to manage interest rates credited to policyholders and costs of the options purchased to fund the annual index credits on our index annuities, our ability to manage the costs of acquiring new business (principally commissions to agents and first year bonuses credited to policyholders) and our ability to manage our operating expenses.
Our fixed maturity securities (bonds and redeemable preferred stocks maturing more than one year after issuance) and equity securities (common and non-redeemable preferred stocks) classified as available for sale are reported at fair value. Unrealized gains and losses, if any, on these securities are
The following table presents the fair value of fixed maturity and equity securities, available for sale, by pricing source and SFAS 157 hierarchy level as of December 31, 2008:
Management's assessment of all available data when determining fair value of our investments is necessary to appropriately apply SFAS 157. The first step in our process of determining fair value of our investments is obtaining quotes for each individual investment from an independent broker. These quotes are non-binding, but they are determined based on observable market data. The process that the independent broker uses for determining fair value begins with obtaining prices from an independent pricing service. The broker then evaluates other observable market data to determine if that price should be modified for facts and circumstances that may have not been considered by the pricing service. Inputs used by both the broker and the pricing service include market information, such as yield data, and other factors relating to instruments or securities with similar characteristics.
on-going review of methodologies used by the independent broker, review of pricing statistics and trends, back testing recent trades, comparing prices to those obtained from other third party pricing services, reviewing cash flow activity in the subsequent period, monitoring credit rating upgrades and downgrades and monitoring of trading volumes. Most all of the information used by the pricing service and the independent broker can be corroborated by our procedures of investigating market data and tying that data to the facts utilized by the broker.
The evaluation of investments for other than temporary impairments involves significant judgment and estimates by management. The carrying amount of each of our investments is reviewed on an ongoing basis for changes in market interest rates and credit deterioration. If this review indicates a decline in fair value below cost or amortized cost that is other than temporary, our carrying amount in the investment is reduced to its fair value and a specific write down is taken. Such reductions in carrying amount are recognized as realized losses and charged to earnings. The fair value of the other than temporarily impaired investment becomes its new cost basis. For fixed maturities, we accrete the new cost basis to the estimated future cash flows over the expected remaining life of the security by adjusting the security's yield.
In addition, where our intent was to retain the investment to allow for recovery, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions
We offer a variety of index annuities with crediting strategies linked to the S&P 500 Index and other equity and bond market indices. We purchase call options on the applicable indices as an investment to provide the income needed to fund the annual index credits on the index products. New one-year options are purchased at the outset of each contract year. We purchase call options weekly and daily based upon new and renewing index account values during the applicable week or day, and the purchases are made by category according to the particular products and indices applicable to the new or renewing account values. Any proceeds received at the expiration of the one-year option term fund the related index credits to the policyholders. If there is no gain in an index, the policyholder receives a zero index credit on the policy, and we incur no costs beyond the option cost, except in cases where the minimum guaranteed value of a contract exceeds its index value.
•We must mark to market the call options purchased to fund the annual index credits on our index annuities based upon quoted market prices from related counterparties and the associated credit worthiness of each counterparty. We record the change in fair value of these options as a component of our revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions.
•Under SFAS 133, the contractual obligations for future annual index credits are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. Policy liabilities for index annuities are equal to the sum of the "host" (or guaranteed) component and the embedded derivative component for each index annuity policy. The host value is established at inception of the contract and accreted over the policy's life at a constant rate of interest. We estimate the fair value of the embedded derivative component at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for non-performance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values. Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases in the fair values of the call options purchased to fund the annual index credits and changes in the interest rates used to discount the excess of the projected policy contract values over the projected minimum guaranteed contract values. The amounts reported in the consolidated statements of operations as "Interest credited to account balances" represent amounts credited to policy liabilities pursuant to SFAS 97 which include
For annuity products, these costs are being amortized generally in proportion to expected gross profits from interest margins and, to a lesser extent, from surrender charges. Current and future period gross profits/margins for index annuities also include the impact of amounts recorded for the change in fair value of derivatives and the change in fair value of embedded derivatives. Current period amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of realized investment gains and losses) to be realized from a group of products are revised. Our estimates of future gross profits/margins are based on actuarial assumptions related to the underlying policies terms, lives of the policies, yield on investments supporting the liabilities and level of expenses necessary to maintain the polices over their entire lives. Revisions are made based on historical results and our best estimates of future experience.
costs and deferred sales inducements at December 31, 2008 would increase by $41.8 million. Correspondingly, a reasonably likely 10% decrease in estimated gross profits for all future years would result in a $46.6 million decrease in the combined December 31, 2008 balances.
Results of Operations for the Three Years Ended December 31, 2008
Net income decreased 28% to $20.8 million in 2008 and 62% to $29.0 million in 2007, from $75.5 million in 2006. Net income for 2008 includes the impact of the adoption of Statement of Financial Accounting Standards ("SFAS") No. 157, Fair Value Measurements ("SFAS 157") as discussed below.
Realized gains and losses on investments fluctuate from year to year based upon changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments. We recognized significant other than temporary impairments on fixed income and equity securities during 2008. The amounts disclosed above are net of the related reductions in amortization of deferred sales inducements and deferred policy acquisition costs and income taxes. Income tax benefits related to realized gains (losses) on investments have been reduced by $34.5 million in 2008 for the establishment of a deferred tax valuation allowance related to the other than temporary impairments and capital loss carryforwards.
Changes in the amounts attributable to the application of SFAS 133 to our contingent convertible senior notes are discussed below under change in fair value of embedded derivatives and interest expense on notes payable.
Actual amounts credited to policyholder account balances may be less than the index appreciation due to contractual features in the index annuity policies (caps, participation rates, and asset fees) which allow us to manage the cost of the options purchased to fund the annual index credits. The change in fair value of derivatives is also influenced by the aggregate costs of options purchased. The aggregate cost of options has increased primarily due to an increased amount of index annuities in force. The aggregate cost of options is also influenced by the amount of policyholder funds allocated to the various indices and market volatility which affects option pricing. Costs for options purchased during the year ended December 31, 2008 decreased compared to 2007 due to adjustments to caps, participation rates, and asset fees. During the year ended December 31, 2007, the cost of options increased compared to 2006 due to market volatility. See Critical Accounting Policies-Derivative Instruments-Index Products.
Gain on retirement of debt of $13.7 million in 2008 resulted from the purchase of $78.1 million of principal amount of our convertible senior notes at a discount. See Financial Condition-Liabilities for a description of our convertible senior notes.
Interest credited to account balances decreased 63% to $205.1 million in 2008 and increased 39% to $560.2 million in 2007 from $404.3 million in 2006. The components of interest credited to account balances are summarized as follows:
Amortization of deferred sales inducements increased 162% to $30.7 million in 2008 and decreased 53% to $11.7 million in 2007 from $24.8 million in 2006. Amortization of deferred sales inducements was increased by $1.3 million in 2008 and decreased by $0.6 million during 2006 due to the impact of unlocking discussed above. In general, amortization of deferred sales inducements has been increasing each year due to growth in our annuity business and the deferral of sales inducements incurred with respect to sales of premium and interest bonus annuity products. Bonus products represented 92%, 86% and 77% of our total annuity deposits during 2008, 2007 and 2006, respectively. The anticipated increase in amortization from these factors has been affected by amortization associated with the application of SFAS 133 to our index annuity business and amortization associated with net realized losses on investments.
The conversion option embedded within our contingent convertible senior notes was required to be bifurcated and recorded at fair value in accordance with SFAS 133 beginning December 15, 2005 due to an insufficient number of authorized shares. See notes 1 and 7 to our audited consolidated financial statements. Effective June 8, 2006, the conversion option was no longer required to be bifurcated and recorded at fair value upon shareholder approval of an increase of authorized shares. The change in the fair value of the conversion option embedded within these notes for the year ended December 31, 2006 coincides with the changes in the per share price of our common stock during the period of time during 2006 that the conversion option was required to be bifurcated.
Interest expense on notes payable decreased 5% to $15.4 million in 2008 and 20% to $16.2 million in 2007 from $20.4 million in 2006. The decrease in 2008 was attributable to our purchase of $78.1 million principal amount of our 5.25% contingent convertible notes during 2008, offset in part by interest on borrowings under our revolving line of credit, which had a weighted average interest rate of 4.14% for the year ended December 31, 2008. The line of credit borrowings were used to fund the purchase of our common stock and our contingent convertible notes. The decrease in 2007 was primarily due to a decrease in the amortization of the discount on our contingent convertible notes to $1.1 million from $4.7 million in 2006. This discount was created in the fourth quarter of 2005 when the conversion option embedded in our contingent convertible senior notes was bifurcated from the host instrument, and adjusted when the derivative was unbifurcated from the host instrument on June 8, 2006. See note 8 to our audited consolidated financial statements.
Interest expense on subordinated debentures decreased 14% to $19.4 million in 2008 and increased 5% to $22.5 million in 2007 from $21.4 million in 2006. The decrease for 2008 was primarily due to decreases in the weighted average interest rates on the outstanding subordinated debentures. The increase for 2007 was primarily due to the issuance of additional subordinated debentures of $41.2 million during 2006, offset by decreases in the weighted average interest rates on the outstanding subordinated debentures. The weighted average interest rate on the outstanding subordinated
debentures were 7.15%, 8.32% and 8.35% for 2008, 2007 and 2006, respectively. The weighted average interest rates have decreased because substantially all of the subordinated debentures issued during 2004 - 2006 have a floating rate of interest based upon the three month London Interbank Offered Rate plus an applicable margin. See Financial Condition-Liabilities.
Interest expense on amounts due under repurchase agreements decreased 48% to $8.2 million in 2008 and 52% to $15.9 million in 2007 from $32.9 million in 2006. The decrease in 2008 was principally due to a decrease in the weighted average interest rates on amounts borrowed, offset by an increase in the borrowings outstanding. The decrease in 2007 was principally due to a decrease in the borrowings outstanding, offset by an increase in the weighted average interest rates on amounts borrowed. Weighted average interest rates were 2.28%, 5.27% and 5.24% for 2008, 2007 and 2006, respectively, and average borrowings outstanding were $359.9 million, $301.9 million and $628.0 million during 2008, 2007 and 2006, respectively.
As discussed above, the application of SFAS 133 to our index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our index annuity contracts. The gross profit adjustments resulting from the application of SFAS 133 to our index annuity business increased amortization by $44.2 million, and decreased amortization by $52.3 million, and $6.7 million in 2008, 2007 and 2006, respectively. The gross profit adjustments from net realized gains (losses) decreased amortization by $61.6 million and $0.9 million for 2008 and 2007, respectively, and increased amortization by $0.5 million in 2006. Excluding the amortization amounts attributable to the application of SFAS 133 and realized gains and losses on investments, amortization would have been $144.2 million, $109.5 million and $101.1 million for 2008, 2007 and 2006, respectively.
Other operating costs and expenses increased 9% to $52.6 million in 2008 and 19% to $48.2 million in 2007 from $40.4 million in 2006. The increase in 2008 was principally attributable to an increase of $4.3 million in salaries and benefits and $1.0 million in general overhead, offset by decreases in legal fees of $0.8 million. The increase in 2007 was principally attributable to increases in legal fees related to the defense of ongoing litigation amounting to $6.0 million and $1.2 million in costs related to the development of an electronic document database.
Insurance statutes regulate the type of investments that our life subsidiaries are permitted to make and limit the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and our business and investment strategy, we generally seek to invest in United States government and government-sponsored agency securities and debt securities rated investment grade by established nationally recognized rating organizations or in securities of comparable investment quality, if not rated and commercial mortgage loans on real estate.
We have experienced credit deterioration in our fixed maturity portfolio which primarily occurred during the fourth quarter of 2008 on mortgage-backed securities and financial sector securities due to the global financial crisis.
mortgage-backed and asset-backed securities provide for periodic payments throughout their lives, and are shown below as a separate line item.
At December 31, 2008 and 2007, the amortized cost and estimated fair value of fixed maturity securities and equity securities that were in an unrealized loss position were as follows:
The following table sets forth the composition by credit quality (NAIC designation and the equivalent ratings of a nationally recognized securities rating organization) of fixed maturity securities with gross unrealized losses:
Mortgage and asset-backed securities: At December 31, 2008, we had no exposure to subprime mortgage-backed securities. Substantially all of the securities we own are in the highest rated tranche of the pool in which they are structured and are not subordinated to any other tranche. Our "Alt-A" mortgage-backed securities are comprised of 34 securities with a total amortized cost basis of $542.9 million and a fair value of $458.6 million. Unrealized losses in residential mortgage-backed securities have increased as mortgage spreads have widened as Fannie Mae and Freddie Mac slipped into government receivership in 2008 due to increased capital concerns. Despite government efforts, increased foreclosures and bankruptcies as well as further imbalances in supply and demand for mortgage-backed securities has caused additional spread widening in the fourth quarter.
Equity securities: The unrealized loss on equity securities, which includes exposure to REITS, investment banks and finance companies, is due to the instability in the financial markets and a further deterioration in the economy. A deepening recession due to tight credit markets and a difficult housing market have raised concerns in regard to earnings and dividend stability in many companies which directly affect the values of these securities.
At December 31, 2008 and 2007, the amortized cost and estimated fair value of fixed maturity securities and equity securities in an unrealized loss position and the number of months in an unrealized loss position were as follows:
At December 31, 2008 and 2007, the amortized cost and estimated fair value of fixed maturity securities (excluding United States Government and United States Government sponsored agency securities) and equity securities that had unrealized losses greater than 20% and the number of months in an unrealized loss position greater than 20% were as follows:
Our analysis of these securities that we have determined are temporarily impaired and their credit performance at December 31, 2008 is as follows:
Finance and Insurance: The decline in value of these corporate bonds and preferred stocks is due to the dramatic widening in credit spreads as the result of diminished liquidity, mortgage related issues and instability in the financial credit markets related to the on going financial crisis and the concerns over the global recession despite government action to calm the markets.
performance, decreased its outstanding debt through the sale of assets and has improved its access to liquidity through new credit facilities. Based upon these indicators we have concluded that an other than temporary impairment on this security was not needed.
Real Estate: The decline in value of these preferred stocks is the result of uncertainties in the real estate industry and credit markets due to the financial crisis rather than deterioration in the operations of these companies. We have concluded that other than temporary impairments on these securities were not needed due to their strong liquidity position and business fundamentals which will allow them to operate and recover to amortized cost from the current economic cycle.
Telecommunication and Media: The decline in fair value of these preferred stocks is related to ineffective accounting controls and decreasing advertising revenue. We have determined that these securities were not other than temporarily impaired due to the strong fundamentals exhibited by each company which should allow for the recovery to amortized cost for these securities.
The securities on the watch list are current with respect to payments of principal and interest. We have the intent and ability to hold these securities for a period of time sufficient to allow for a recovery in fair value and there were no other than temporary impairments on these securities at December 31, 2008.
Insurance: We recognized an other than temporary impairment during 2008 of $5.9 million on a bond issued by a reinsurance company due to its exposure to subprime and Alt-A mortgage-backed securities and $4.8 million on a mono-line insurance company due to rating agency downgrades and severity of the decline in price persisting for a period longer than we considered temporary.
We recognized an other than temporary impairment during 2008 of $4.0 million on preferred stock issued by AIG due to its significant decline in market value and credit quality following its bailout by the U.S. Government. We also recognized other than temporary impairments during 2008 totaling $3.1 million on two preferred stocks issued by two mono-line insurance companies due to the severity in decline in price and recovery in value in the near term was not probable.
Media: We have recorded other than temporary impairments totaling $9.3 million on one bond in the media industry. We recorded an other than temporary impairment on this bond of $3.9 million during 2007 subsequent to the completion of a leveraged buyout of the company resulting in increased leverage in combination with declining circulation and advertising revenues. We recorded additional other than temporary impairments on this bond of $5.4 million during 2008 due to weaker operational performance related to additional large declines in advertising revenues and the company filing for bankruptcy protection.
Real Estate: We recognized other than temporary impairments totaling $23.2 million on 14 perpetual preferred securities during 2008. The other than temporary impairments on these securities were due to significant decline in value of the securities, downgrades by rating agencies below investment grade and the inability to forecast recovery in the near term.
Our mortgage loans on real estate are reported at cost, adjusted for amortization of premiums and accrual of discounts. The average loan to value ratio for the overall portfolio was 58.6% and the average loan size was $2.6 million at December 31, 2008. The loan to value ratio is calculated using the underwriting and appraisal at the time the loan was issued. We have the contractual ability to pursue full personal recourse on 13.2% of the loans and partial personal recourse on 37.2% of the loans, and master leases provide us recourse against the principals of the borrowing entity on 11.8% of the loans.
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the measurement of an estimated loss for each individual loan identified and an analysis of the mortgage loan portfolio for the need for a general loan allowance for probable losses on all other loans. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral. The amount of the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience, delinquencies, credit concentrations, underwriting standards and national and local economic conditions. Based upon this process and analysis, we have determined that no specific loan loss allowance on any individual loans, and no general loan loss allowance, was necessary. At December 31, 2008, we have one loan with a principal balance of $3.2 million that was in default which we have started foreclosure proceedings on. We have not recorded a specific loan loss reserve for this loan based upon a current appraisal of the underlying property compared to the principal balance of the loan.
In the normal course of business, we commit to fund commercial mortgage loans up to 90 days in advance. At December 31, 2008, we had commitments to fund commercial mortgage loans totaling $41.4 million, with fixed interest rates ranging from 6.50% to 7.25%.
Our commercial mortgage loan portfolio consists of mortgage loans collateralized by the related properties and diversified as to property type, location, and loan size. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and other criteria to reduce the risk of default. The commercial mortgage loan portfolio is summarized by geographic region and property type as follows:
2006, respectively. The weighted average interest rate on amounts due under repurchase agreements was 2.28%, 5.27% and 5.24% for the years ended December 31, 2008, 2007 and 2006, respectively.
The notes are convertible at the holders' option prior to the maturity date into cash and shares of our common stock under certain conditions. The conversion price per share is $14.24 which represents a conversion rate of 70.2 shares of our common stock per $1,000 in principal amount of notes. Upon conversion, we will deliver to the holder cash equal to the aggregate principal amount of the notes to be converted and shares of our common stock for the amount by which the conversion value exceeds the aggregate principal amount of the notes to be converted (commonly referred to as "net share settlement"). See note 8 to the audited consolidated financial statements for additional details concerning the conversion features of the notes and the dilutive effect of the notes in our diluted earnings per share calculation.
Following is a summary of subordinated debt obligations to the trusts at December 31, 2008 and 2007:
American Equity Capital Trust I issued 865,671 shares of 8% trust preferred securities, of which 2,000 shares are held by one of our subsidiaries, and we issued $26.8 million of our 8% subordinated debentures. During 2008, 2007 and 2006, 8,333 shares, 9,333 shares and 14,000 shares of these trust preferred securities converted into 30,862 shares, 34,567 shares and 51,849 shares, respectively, of our common stock. The remaining 738,338 shares of these trust preferred securities not held by a subsidiary are convertible into 2,734,528 shares of our common stock.
During the fourth quarter of 2006, we entered into four interest rate swaps to manage interest rate risk associated with the floating rate component on certain of our subordinated debentures. The terms of the interest rate swaps provide that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount totaling $80.0 million. The interest rate swaps are not effective hedges under SFAS 133. Therefore, we record the interest rate swaps at fair value with the changes in fair value and any net cash payments received or paid included in the change in fair value of derivatives in our consolidated statements of operations.
During the fourth quarter of 2006, we entered into a $150 million revolving line of credit with eight banks. The applicable interest rate will be floating at LIBOR plus 0.80% or the greater of prime rate or federal funds rate plus 0.50%, as elected by us. The amount outstanding under this revolving line of credit at December 31, 2008 and 2007 was $75.0 million and $5.0 million, respectively. See note 8 to our audited consolidated financial statements for additional details concerning the terms of the revolving line of credit.
Our life subsidiaries' primary sources of cash flow are annuity deposits, investment income, and proceeds from the sale, maturity and calls of investments. The primary uses of funds are investment purchases, payments to policyholders in connection with surrenders and withdrawals, policy acquisition costs and other operating expenses.
We believe that cash flows generated from sources above are sufficient to satisfy the current liquidity requirements of our operations, including reasonable foreseeable contingencies. During 2009, we expect American Equity Life to generate sufficient cash flows from annuity deposits to meet cash outflow requirements. However, there can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since benefit and surrender levels are influenced by such factors as the interest rate environment, our claims paying ability and our financial strength ratings. Total funds returned to policyholders were $1.3 billion, $1.3 billion and $1.6 billion for the years ended December 31, 2008, 2007 and 2006, respectively.
expect they will be adequate to fund our parent company cash flow requirements in 2009. We may also obtain cash by drawing down our $150 million revolving line of credit, which we currently have $75 million outstanding, or by issuing debt or equity securities. We do not have any significant debt maturing until the fourth quarter of 2011 and we have no material commitments for capital expenditures.
In the normal course of business, we enter into financing transactions, lease agreements, or other commitments. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations as of December 31, 2008.
(1)Amounts shown in this table are projected payments through the year 2028 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.
In May 2008, the FASB issued FASB Staff Position ("FSP") No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) ("FSP APB 14-1"). FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. Early adoption is not allowed. This FSP requires issuers of convertible debt instruments that may be settled in cash upon conversion to separately account for the liability and equity components in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. This FSP is effective for us beginning January 1, 2009 and will be applied retrospectively to all periods presented and impacts our contingent convertible senior notes (see note 8 to our audited consolidated financial statements). The cumulative effect of the change in accounting principle on periods prior to those presented shall be recognized as of the beginning of the first period presented through a reduction in the corresponding notes payable balance. An offsetting adjustment shall be made to the opening balance of retained earnings and additional paid-in capital for that period, presented separately. We believe that the impact of the adoption of FSP APB 14-1 is to increase non-cash interest expense using the effective interest method by approximately $4.3 million, $4.7 million and $0.9 million for the years ended December 31, 2008, 2007 and 2006, respectively, from the amounts currently reported as well as decrease the gain on the retirement of convertible senior notes in 2008 by approximately $3.9 million.