Good morning, ladies and gentlemen, and welcome to Brighthouse Financial's conference call. My name is Shannon, and I will be your coordinator today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference call. In fairness to all participants, please limit yourself to one question and one follow-up. As a reminder, the conference is being recorded for replay purposes. I would now like to turn the presentation over to Dana Amante, Head of Investor Relations. Ms. Amante, you may proceed.
Thank you, and good morning. Welcome to Brighthouse Financial's conference call to discuss its long-term Statutory Free Cash Flow projections. Material for today's call was released this morning and can be found on the Investor Relations section of our website. Today, you will hear from Eric Steigerwalt, our President and Chief Executive Officer, and Ed Spehar, our Chief Financial Officer. Following our prepared remarks, we will open the call up for a question-and-answer period. Before we begin, I would like to note that our discussion during this call may include forward-looking statements within the meaning of the federal securities laws. Brighthouse Financial's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties described from time to time in Brighthouse Financial's filings with the SEC.
Information discussed on today's call speaks only as of today, September 20th, 2023. The company undertakes no obligation to update any information discussed on today's call. Now I'll turn the call over to our CEO, Eric Steigerwalt.
Thank you, Dana, and good morning, everyone. A thank you to everyone for joining us. I would like to kick off the call today as I am extremely pleased with the statutory free cash flow projections we published this morning, which demonstrate the significant progress we have made toward our goal of generating more predictable free cash flows in a broad range of market scenarios. As you have heard us say many times, our financial management strategy is based on a multi-year, multi-scenario framework, and the convergence that can be seen in these free cash flow projections across multiple scenarios reflects the steady execution of our strategy since Brighthouse became an independent, publicly traded company in 2017.
Reflecting our unwavering focus on our financial and risk management, we have continued to look for opportunities to optimize our balance sheet with the goal of creating more consistent and predictable cash flows across various market scenarios. For example, over the past several years, we have taken steps to optimize our statutory balance sheet and fundamentally lower the company's risk profile. At the end of 2019, we revised our VA hedging strategy and repositioned our equity hedge portfolio. More recently, in the rising interest rate environment of 2022, we took the opportunity to add a substantial amount of long-dated interest rate protection to materially reduce risk associated with low interest rates.
As our Statutory Free Cash Flow projections show, the additional low interest rate protection that we added last year has created more consistent Statutory Free Cash Flows across scenarios with a significant positive impact on our expected cash flow under the adverse scenario, which assumes an equity and interest rate shock along with a credit cycle. Ed will provide more details on that in a moment. Our focus on prudent financial management is one of the key priorities that make up the foundation of our strategy. We continue to manage the company under a multi-year, multi-scenario framework in order to protect and support our fantastic distribution franchise. We remain very pleased with the strong franchise that we have built, including our expansive distribution footprint and our complementary and competitive product offerings.
Since we launched as an independent company, we have significantly expanded our presence in the annuity space, more than doubling total annuity sales, largely driven by our flagship Shield Level Annuities. We have also reestablished our presence in the life insurance space as we execute our focused life insurance strategy, and we have launched several new products, as well as rolled out product enhancements, which have further strengthened our overall product portfolio. In addition, in 2021, we entered the institutional spread margin business , and furthermore, we remain very excited about our expanded relationship with BlackRock to deliver BlackRock's LifePath Paycheck, providing us with a fantastic opportunity to deliver our products through the worksite channel.
As one of the top annuity providers in the United States, we continue to leverage the depth and breadth of our expertise, along with our distribution relationships, to competitively position ourselves in the markets that we choose to compete in. We remain focused on offering a diversified portfolio of complementary products to further drive the addition of high-quality new business to our in-force book. The combination of growth in sales of the less capital-intensive products we offer today, and the outflows of higher capital-intensive business, which represent approximately 30% of total outflows on a regular basis, has resulted in a significant ongoing shift in our business mix, as shown on slide 4 of our presentation. Shield and fixed annuities collectively have grown from 15% of our total annuity account value at year-end 2016, to approximately 40% at June 30th, 2023.
By year-end 2027, we expect less capital-intensive annuities, including Shield, fixed annuities, and newer, less capital-intensive VA, to represent approximately 82% of our total annuity account value, with higher capital-intensive VAs representing only 18%. In addition, we expect our focus on driving our statutory expense ratio down over time to further enhance our ability to offer competitively priced solutions, which in turn should enable us to continue to diversify our business mix in future years. To wrap up, we believe our long-term statutory free cash flow projections reflect our focused financial and risk management approach, which, along with our growth strategy, are the cornerstones of generating more predictable cash flows, even through challenging markets, and delivering on our commitment of returning capital to shareholders over time.
With that, I'll turn the call over to Ed to discuss our hedging strategy and our long-term statutory free cash flow projections.
Thank you, Eric, and good morning, everyone. I'm excited to speak to you today about the long-term statutory free cash flowprojections that we published this morning. As you can see from the cumulative five and 10-year projections shown on Slide 5, we expect meaningful long-term statutory free cash flow that are more predictable across various market scenarios. This is a significant improvement compared with the expectations that we provided in March 2022, and demonstrates the continued execution of our strategy, which includes prudent management of balance sheet risk and the dilution of legacy liabilities with profitable new business. As Eric mentioned earlier, we have taken actions over the past several years to materially reduce the company's risk profile, including adding a substantial amount of long-dated, low-interest rate protection when rates returned to what we considered to be a more normal level in 2022.
Prior to the increase in interest rates in 2022, we were positioned to benefit from higher rates as we were unwilling to fully hedge rate risk when interest rates were at abnormally low levels. While we have always had meaningful out-of-the-money protection for low rates, we saw the opportunity last year to materially increase protection at an attractive cost. This management action contributed to lower projected statutory free cash flows in the normal scenario, for which we project approximately $2 billion of free cash flow over a five year period and between $6 billion and $8 billion over 10 years. However, importantly, additional hedges provide a significant benefit to projected statutory free cash flow in the adverse scenario, driving an expectation of approximately $1 billion of free cash flow for the 5-year period and between $2 billion and $4 billion over the 10-year period.
Prior to the increase in our long-dated, low-interest rate protection, we projected no free cash flow under the adverse scenario, and we saw degradation in our capital position over the long term. The increase in interest rates since year-end 2021 is also a meaningful contributor to our long-term statutory free cash flow projection in the moderate scenario, which is approximately $1.5 billion over five years and between $5 billion-$7 billion over ten years. I would note that the interest rate assumption reflected in the moderate scenario assumes rates follow the forward curve as of June 30th, 2023, which had the ten-year Treasury yield at 4.36% in ten years.
In contrast, the normal scenario assumes the 10-year U.S. Treasury yield mean reverts to 3.75% over 10 years, which is aligned with the long-term interest rate assumption update we expect to use in our upcoming annual actuarial review. This is the first time since we have been a public company, that the forward curve is anticipating a higher 10-year Treasury yield over the next 10 years than our long-term assumption for rates. The other factor impacting the updated statutory free cash flow projections is the transition to our in-house modeling platform. As we discussed previously, we completed all our major systems conversions by year-end 2022, including the transition to our Brighthouse Financial actuarial platform.... Our projections process now leverages this platform, which allows for more granular inputs and assumptions and the elimination of third-party modeling services.
I am particularly pleased with the convergence of projected statutory free cash flow across the normal, moderate, and adverse scenarios. The combination of additional rate hedges, the increase in interest rates, and the continued shift in our business mix has contributed to a meaningful improvement in statutory free cash flow predictability when compared with the projections that we shared publicly in March 2022, which were based on year-end 2021. As you can see on slide six, our projections based on year-end 2021 had free cash flow under the moderate scenario at only approximately 10% of the free cash flow expectation under the normal scenario, with 0 expected under the adverse scenario.
Today, our projections based on June 30th, 2023, have our free cash flow under the moderate scenario at approximately 75% of the expectation under the normal scenario, and our projections under the adverse scenario at approximately 50% of the expectation under the normal scenario. Also, and importantly, the RBC ratio at the end of the five and 10-year periods in all scenarios is expected to be within our target range. In summary, we continue to optimize our balance sheet to support the growth of our franchise through a broad range of market scenarios. The evolution of our business mix, combined with financial management actions, continues to significantly lower the risk profile of our company and is helping to drive more predictable projected statutory free cash flow, which we believe will support subsidiary dividends across a variety of scenarios.
Finally, I would like to close with our expectation that we plan to take at least $300 million of dividends to the holding company in 2023. I will now turn the call over to the operator for your questions.
Thank you. To ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. As a reminder, we ask that you please limit yourself to one question and one follow-up. Our first question comes from the line of Tracy Benguigui with Barclays. Your line is now open.
Thank you. It's great seeing multiyear free cash flow scenarios, but in order to measure progress on a more real-time basis, is it fair to assume the closest proxy to distributable earnings is normalized stat earnings? Since you previously mentioned debt interest expense could be serviced from non-regulated sources of cash. And, and if I'm thinking about this the right way, could you bridge for us why Brighthouse only recognized a modest $200 million of normalized stat earnings since 2020? Thank you.
Sorry, Tracy, could you repeat that? The last part you said $200 million of normalized stat earnings in 2020?
No, since 2020, including the -$100 million in the first half of this year.
Yeah. I guess I would say that it's fair to assume that over time, you will see norm stat earnings be a proxy for what—for statutory free cash flow. That's what we see in our long-term projections. That will not hold for any short period of time, but over the long term, you do see, particularly, I think, when you look at the normal and moderate scenarios, norm stat earnings being a pretty good proxy for free cash flow.
Okay, great. And I just want to make sure I'm thinking about this the right way. The VA and Shield five-year distributable earnings is a reasonable proxy for the total company distributable earnings in the first five years, and then the less market-sensitive business can be recognized in later years. So if I compare that, that last year, what you have here, the $2.6 billion, I think last year's slide was $2.7 billion, to this year's $2 billion. I'm thinking it's - if I'm thinking that through, this is a better interest rate scenario than last year. Last year, you had a 1.52% interest rate assumption, be given the 10-year treasury rate at year-end 2021.
I think now you're looking at 3.81% as of June 30th, and you also have a higher reversion to the mean assumption in 10 years. So could you unpack why the base case is comparably less comparable? I think you mentioned something about the interest rate hedging, but I'm just trying to balance that with some of the other more favorable assumptions.
Sure. There's a couple things I would say. First of all, if you think about markets, in prior years, we have talked about the equity market being an effective offset to rates, meaning strong equities were offsetting a more challenging rate environment. If you look at the change this year, it's the opposite, where we have separate account returns that are about 15%, or separate account balances that are about 15% lower than what we would have projected, given the equity market performance, primarily. That is offset by the fact that rates are up substantially from where we were last year. As we said, we took advantage of those higher rates to buy a substantial amount of interest rate protection. There is a cost for that protection when you look at our normal and moderate scenarios.
We think that that is a very attractive cost today, to produce an adverse scenario outcome that is materially better than what we've had in the past. So showing free cash flow in the $ billions for the adverse scenario, when in the past we had nothing, and as I said in my prepared remarks, we actually saw a deterioration in RBC ratios as you went out over time. We consider it to be a very attractive trade-off to give up some upside in the normal and moderate scenarios from the hedging costs to protect the adverse scenario. The other comment I would make is, given how much we're hedging now for rates, we would not see the benefit from interest rates going up that we saw in these projections relative to the last projections.
The way that we manage rate risk now is we're thinking about gains and losses in our hedging position, in our hedging portfolio, relative to the benefits that we would get over the next five years in the statutory framework, the mean reversion point changes. So we're looking at it holistically, what happens with our hedge portfolio and the offsetting impacts in those mean reversion point changes over 5 years. Because we were positioned to benefit from rising rates, you know, you're seeing us capturing the benefit of those mean reversion point changes, and that's the reason you see such a favorable impact in the moderate scenario from interest rates.
Rachel, if I could just sneak one more in. Are you still assuming VA peak funding in 2024? And if so, why wouldn't we see higher cash flows in the first five years compared to the subsequent five years?
Yeah. So when you look at our projections here, you see significant cash flows as you go out over time, which is driven by the aging of the VA block and the decline in the amount of capital that we have to hold relative to tail scenarios. So if you think about the framework for VA, the primary driver of how much capital you're going to hold is driven by the average of the 2% worst scenarios for markets. And when you look at our projections, that is coming down. That is the primary driver of the release of capital. The idea of reserves peaking, the importance of that concept is really reserves peaking occurs when you have with aging, essentially is occurring in line with your peaking of your total asset requirement for the tail scenarios.
They're both coming down, but they're converging, right? There's a convergence of 70 and 98. CTE 70, the average of the 30% worst scenarios for reserves. I know you like this technical stuff, so I'll throw some out at you. And CTE 98, which is the average of the 2%. Reserves coming down is because you're paying claims, not because you're freeing up capital. The importance of reserves is really when they converge with the tail scenarios in 98, you have less uncertainty about your outcomes. And less uncertainty about your outcomes may mean you'd be comfortable holding less of a buffer in terms of capital relative to your targets, so meaning your RBC ratio. I think what's important here is we don't assume any benefit in the out years from a lower RBC ratio.
The only benefit you're getting in these cash flows in the out years is the peaking of the capital requirement for this aging block of business. We do not assume that we are going to run at a lower RBC ratio than the 400%-450% that we've talked about.
What year is that peak?
Yeah, we're. It's not 2024. It's further out.
Thank you.
Thank you. Our next question comes from the line of Eric Bass with Autonomous Research. Your line is now open.
Hi, thank you. Maybe as a follow-up on the last question or discussion, just about how you see free cash flow building over time. Would you expect it to be roughly linear near term, starting from the, I guess, $300 million dividend base this year? And then is there a step function increase at some point in years five through 10? Or is it just that the trajectory starts to steepen as kind of new business earns in and that tail risk drops off?
Hey, Eric, I appreciate the question, but, you know, we're going to stick to giving you these cumulative free cash flows, which I think is the best way to go when you're talking about long-term projections. I mean, this is obviously a significant amount of information to disclose, in our opinion, on the fundamentals of this company. So we're going to stick with cumulative five and 10-year stuff, and then we'll let you guys figure out how you want to model that.
Got it, fair. And I guess, how does the reduction in volatility affect your view on capital return and the level of holding company liquidity you want to hold going forward? And it's related to that, does it change your view at all on a common dividend as your free cash flow is now looks much more predictable, especially in adverse scenarios?
Hey, Eric, it's Eric. Look, every year, we talk about the potential of a common dividend with the board. I'm sure that's not surprising to any of you. So far, we have stuck with returning capital through share buybacks. I would say at this point, it's still our preferred way of returning capital to shareholders. But, you know, we have a board meeting coming up in November, and I can assure you that we will discuss not only share repurchases, but the potential of a common dividend. So at some point, it may make sense to pay a common dividend. So far, obviously, we have not done that, but we'll see what happens in the next couple of years. Ed, you want to add anything?
No, I think that covers it.
Got it. No change in philosophy on kind of HoldCo liquidity at this point?
Are you jumping in or I-
Yeah. I don't think we have any reason to change HoldCo liquidity, because first of all, we haven't given you a specific number, right? We've said that we think that the amount of liquidity you want to have at the holding company is going to vary, based on a number of factors. It's not just going to be fixed charge coverage, which, by the way, for us, as you know, is covered primarily by non-dividend flows from the holding company.
It'll also be a function of, you know, upcoming debt maturities and, you know, again, I think we're still going to want to run this company with some level of conservatism, because while we're very happy with the more predictable cash flows that you see, I would not say it's predictable yet, and I don't think this is a business that is predictable. It's a lot more predictable. And so we need to be mindful of the volatility that can happen from year to year. And that's why when we talk about targets, giving multi-year numbers here is, is the best way to go, because you still have volatility from period to period.
I would just add, Eric, though, this does give us more confidence than we've ever had as a public company. While we're not going to say we're going to lower that buffer, it certainly does give us flexibility around how we think about the buffers that are built into RBC ratios and holding company cash. I agree with everything Ed said, but after six years, it's pretty confidence inspiring to see the convergence finally in these cash flows.
Yeah, and just to build on that, just Eric, as I said before, we are not factoring in these outer years any change in the buffer from an RBC ratio standpoint. And I think you could argue, given the more predictable outcomes as you get in the outer years, as reserves and capital requirements converge, you could argue to have a lower buffer. So that is one area where we have a buffer built in our target RBC ratio that, you know, is probably an element of conservatism. At the holding company, you know, look, I think, as I said, we have not given you a target. So to say lower the buffer, I mean, we don't really give you a buffer target. But I would say that we always want to have a conservative position at the holding company.
Thank you. Appreciate all the comments.
Thank you. Our next question comes from the line of Wilma Burdis with Raymond James. Your line is now open.
Hey, good morning. Traditionally, Brighthouse hasn't participated in variable annuity block sales. Do these types of deals become more attractive as the legacy block becomes a smaller portion of the book? And maybe you could also just touch on how you view the economics of these deals.
Hi, sorry, you're a little bit garbled. And could you just-
Oh.
Try to restate that?
Yeah, sure. I said, traditionally, Brighthouse hasn't participated in variable annuity block sales. Do these types of deals become more attractive as the legacy block becomes a smaller portion of the book? If you could touch on how you view the economics of those deals.
Sure. Okay. So we are obviously monitoring market developments, and we have said in the past that if something made sense for us to do, we would do it. And as we look at the market today, we still conclude that we are the best managers of these liabilities, that the economics that we see retaining these liabilities is more attractive than what we would be giving up to pass those liabilities to someone else.
Gotcha. And just maybe talk about, is now a good time to potentially add more interest rate hedging? And how do you view the current opportunities to add or change the hedging program?
I think you're asking, does it make sense to add more interest rate hedging?
Yeah, add more interest rate hedging or change the hedging program.
It's very difficult to hear you. I'm sorry. I don't know if you're- I think you said either add more interest rate hedging or change the variable annuity hedging program?
Yes. Yeah.
Yeah.
Sorry, my headphones must not be working very well.
No, I guess, our CEO's ears are much better than mine. So we feel very good about where we are with our rate protection. We have not been in a position like this, since we separated from MetLife. And the reason we haven't been is we did not feel it was prudent to hedge out interest rate risk when interest rates were at what we consider to be abnormally low levels. And so as rates went up in 2022, we took the opportunity to put on a significant amount of long-dated protection. So we're talking about multiyear low rate protection.
And as I said, we would not show the same benefit that we're showing in these numbers if rates were to go up significantly from here, because we would lose money on hedges, and then we would make it up on the changes in the mean reversion point that would occur over the next five years. So we still have leverage to up rates, but it's nowhere near the leverage that we had previously. So I don't think there's any desire here to really add more interest rate protection. And in terms of our overall approach on hedging risk, I think we feel very good about what we've done on the equity side.
We obviously de-risked that program substantially back in late 2019 and early 2020, and we continued to make improvements in terms of our understanding of actual to expected results on that side of the house. And so I don't really feel that there's any need to make material changes in our risk management strategy for VA at this point.
Okay, thank you.
Thank you. Our next question comes from the line of Alex Scott with Goldman Sachs. Your line is now open.
Hey, good morning. First question I had is just around the definition of free cash flow here. Can you just talk about, you know, it sounds like this is pre-interest expense, but I wanted to find out if that was the case. And then if you could also talk about if there's any other service agreement, cash flows, et cetera, at the HoldCo . I'm just trying to get my head around, once this free cash flow gets up to the HoldCo , do I need to net it against anything, or does the interest expense roughly net out with service agreements, et cetera?
Good morning, Alex. Yes, the latter comment you just made is correct. So the non-dividend flows to the holding company are essentially what covers the fixed charges. So when you look at these free cash flow projections, this is our view of what is free cash flow. So it's dividends going to the holding company from the operating companies that could be used to do all the different things that you can do with free cash flow.
Understood. Okay, thanks for clarifying that. Second one I had for you is, is on some of the important assumptions. I mean, I think two critical assumptions are, you know, does this consider anything around the Economic Scenario Generator changes that are being contemplated? We've had one field test, and my understanding is it could go into effect as early as year-end 2024, you know, more likely probably 2025, fine. But that's still, like, squarely inside even the shorter period of time that you're giving us aggregated cash flows over. So I wanted to understand, is that being contemplated? And if not, what kind of impact could it have? And then the other critical assumption is, is there anything being assumed around cash remittance out of the Delaware captive?
You know, you guys have had a lot over time, over the last few years, I guess. But, you know, is there any more of that being considered in these cash flows?
Okay, sure. So first on the ESG, you know, the focus on changing the statutory generator was really around does it appropriately capture low rate risk, right? And so obviously, there was a lot of discussion and concern about that when interest rates were at very low levels. I think the statutory generator, what's interesting today is we now have a forward curve. Remember, a lot of discussion about we should be using the forward curve for rates for the statutory generator. I think it's interesting now, we have a forward curve for rates that has a level of rates that's about 100 basis points above the interest rate assumption that's driving the statutory generator today.
So there is the argument that, you know, a long-term approach to figuring out how to build in rates into statutory framework makes some sense. However, as we have this effort, which is a very significant effort, as I think you have just laid out in terms of the amount of field testing and analysis and the understanding of the knock-on effects when you change one thing related to rates, what does that mean for equities? What does that mean for credit spreads? There's a lot of impacts that you have to work through. This is going to take time. We're confident that the process will yield a reasonable result. We are obviously very engaged on this. It's very important to this company.
I would say, though, that the direction on this has always been to have more rate impact factored into the ESG, more interest rate impact. And so given that we are hedged for rates in a way that we have never been hedged before, I would say, you know, concerns or, you know, anything around the ESG, the economic scenario generator, are substantially less today than what they would have been in the past. And interest rates are up a lot, so that's another factor, right? I mean, obviously, right now, the statutory framework is more conservative than the forward curve, which I find interesting.
Then just on the-
Oh, sorry, sorry. Sorry, Alex, I forgot your,
Yep.
Yeah, sorry, I forgot your question about a BRCD. So I've said repeatedly that we do not think that you should look at the reinsurance captive as an ongoing source of free cash flow. We took the opportunity to release some excess capital in two increments. They were $600 million dividends each. We had to get approval for that from the Delaware regulator. They were obviously comfortable with our position to allow us to do that. But that is a runoff block of business where we feel we are appropriately capitalized today and really don't see that as something in terms of capital release going forward.
Got it. I can interpret that as the excess capital down in that reinsurance entity is not being... You're assuming that no further cash flows come up to BLIC for the purposes of this free cash flow analysis?
Oh, yeah. Oh, absolutely. There's nothing assumed in this free cash flow analysis, but I was going beyond that to say that I don't believe you should be assuming anything from that on top of this.
Understood. Yep. Thank you.
Thank you. As a reminder, to ask a question at this time, please press star one one on your touchtone telephone. Our next question comes from the line of Ryan Krueger with KBW. Your line is now open.
Hey, good morning. Can you just give us a sense of the credit impacts that were assumed in the 10-year adverse scenario?
Good morning, Ryan. You know, I would say that the credit impact we have this time is a little bit worse than what we had previously, but not materially so. I would say the composition is a little different. We have a higher loss assumption from commercial real estate, and that is offset largely by a lower loss assumption for fixed income credit, where we have, I think you've heard us discuss some de-risking actions we've taken in the last couple of years. Really overall, not a material change. And just as a reminder on even commercial real estate, you know, we've talked about the de-risking that's happened in that portfolio, where we had approximately 40% of that portfolio in office back in 2019, and it's less than 25% today.
So even in the, you know, on the real estate side, there's been some de-risking, but we are assuming higher losses. You know, we're not giving the, the credit loss impact, but I think you could probably deduce what that would be if you look at what you've seen in the past for this industry. You know, typically, you don't have losses for, you know, I don't know, 7-10 years, and then in a 3-year period, you might have, you know, some pretty big losses. So, we have used something that's not that dissimilar than what you should expect when you think about the type of credit losses you see over a 3-year period.
I'll tell you that the way we come up with it is we have corporate credit losses and migration that looks like the 2001, 2003, and 2008-2010 experience. Structured finance, we calibrated off of the 2008-2010 period, but we do reflect the improved underwriting standards today versus what you saw pre-crisis. And then we do obviously have stress scenarios that we run on the commercial mortgage portfolio.
Great. Thank you.
Thank you. Ladies and gentlemen, I will now turn the call over to Dana Amante for closing remarks.
Thank you, Shannon, and thank you all for joining us today. Have a great day.
This concludes today's conference call. Thank you for participating. You may now disconnect.