We will go ahead and get the next session kicked off. First off, thank you to Mark and Robin for being here. We've got Mark Pearson, President and CEO, Robin Raju, CFO of Equitable Holdings. You know, I like to kick these things off with a more broad strategy, update type question, so that's what we'll do here. You obviously gave us a lot more detail at your Investor Day this year, I guess about half a year ago.
Yeah.
What, what are the items that you're focused on day-to-day, and, and what's most important in terms of those initiatives as we think through the next 12-18 months?
Well, good morning, Alex. Good morning, everybody. Thank you very much for joining this conference. You're right, it was about half a year ago we spoke to the market. I think the real takeaways at the moment are the real favorable tailwinds that we see for our industry, particularly on retirement planning, where Equitable is very, very strong. Tailwinds, I think, are caused by two main factors: one, interest rates being higher for longer. That's very favorable for us, and secondly, the demographics themselves. With 11,000,000 Americans today retiring, these two factors make for the most favorable conditions we've seen since our IPO. So that's the context with which we start.
I think as well, for Equitable, the distinctive features for us, I think, come down to our business model. We're strong in advice, we're strong in retirement protection, product manufacturing, and of course, we have the investment in AB. So with this business model, we participate in all parts of the value chain, and we're also able to design and execute solutions which are very favorable for clients and shareholders. So that, that's really good. You asked what we really focus on. As we said at the Investor Day, our real true north is the cash generated by the business. We gave guidance to the market that we would grow the cash generated by 50% over the next five years to $2 billion by 2027.
The performance so far this year means we have a very strong conviction that we can do that. It's driven by the business model. The business model itself now means that 50% of our cash flows are coming from non-insurance regulated entities. Alex, these are wealth management and asset management, higher multiple businesses as well, and gives us a nice certainty on our cash flows. And that certainty enabled us to increase our payout ratio to 60%, 60%-70% of earnings. So the focus really is on free cash flow generation, and the conviction remains high on those numbers we gave at the Investor Day.
You touched on this a bit just now, but, you know, one of the ways that we've been looking to the valuation of Equitable to hopefully, expand, is just this transition to, you know, free cash flowing, asset management-like business. Are there things you could do to speed up that process?
Sure. Well, Alex, first, I think it's finally good to get into the index. We're quite pleased about that. That's gonna increase the visibility of Equitable's stock and also gives us access to a greater universe of investors. So we think that's a positive momentum factor for our stock. But that's not something we ever controlled, but it's good to get that in yesterday, and we've joined S&P 400 on the 18th. So we're excited about that first. But second, on what we control, as Mark spoke about earlier and what you just mentioned, Alex, we're really trying to optimize the company to drive free cash flows and free cash flows that are consistent for shareholders. If you look at IPO, about 17% of our free cash flows were coming from unregulated sources or asset management and wealth.
Now, we've grown cash flows since IPO, and about 50% are coming from those higher multiple businesses in asset management and wealth. The guidance that we gave out to market to grow those cash flows to $2 billion, or roughly 50% from here now, comes from those higher growth businesses. So we're going to double our earnings and our cash flow growth in wealth management. We're going to continue to grow in asset management, and then our capital-light products are going to continue to drive increased free cash flow generation. So the business model is working as it should, and the tailwinds that we have in the industry will help support the growth in achieving those cash flows and helping the valuation over time. But since you asked about valuation, valuation is perplexing to us at times outside in.
If you think about it, our overall free cash flow yield is about 11.5%. That's higher relative to the life insurance industry and doesn't represent the quality of the businesses or the cash flows that we have. As we've stated, 50% of those cash flows are from asset and wealth management. Very few insurance peers can talk about the quality of those cash flows and the high unregulated cash flows that we have coming from our businesses. So we think there is opportunity there as that cash flow that free cash flow yield comes down as people see the consistency of that cash flow. But our focus is going to continue to grow that cash flow. That is the true north of the company.
Next, let's go into the individual retirement business specifically. How is the environment, you know, higher interest rates in particular, impacting the returns and growth profile of that business?
As I mentioned in the opening, very favorable demographics are in our favor, and the higher interest rates mean our hurdle rates are easily achieved on the new business. We have a minimum IRR of 15% on the new business. Just take you back a little bit, Alex, we were the company that invented the RILA, the registered index-linked annuities. We invented the RILA market, and we've maintained our number one position in that, in a fast-growing part of the sector. We've seen record net flows in the last two quarters. Last two quarters combined, net flows of $3 billion on the individual annuity side. So, favorable conditions, but enhanced, if you like, by our distribution reach.
We have our affiliated advisors, Equitable Advisors, which gives us certainty of revenue flows, plus very strong positions in the third party side. So it's the product we know and invented, plus the distribution power that we have that's bringing those record flows. In addition, worth noting as well, in terms of interest rates, this is giving us higher net investment yield flows on the money in the general account as we reinvest. We gave the number to the market in our last quarter earnings. Net new money is 160 basis points higher than the portfolio yield, so that's helping as well.
Very helpful. So while we're on annuities, you know, I did want to go ahead and touch on the Department of Labor rule. You know, what are your latest views in the potential impact for Equitable and maybe the industry more broadly?
Maybe if I just talk quickly about the industry. I mean, it's obviously good that regulators are involved in improving the trust in the industry, so we support that. But we'd also say we want to really work with regulators to encourage Americans to retire for their retirement and to save adequately for a retirement with some dignity. So the regulators have an important role to play in getting that balance right. I worked and lived in the U.K., where they didn't quite get it right.
They pushed so hard on the best advice regulations that it resulted in savings rates falling, which is really not good for society as a whole, so we want to work with regulators as we're going. Specifically for Equitable, the DOL rules as drafted, they don't give us any cause for alarm, I think for three reasons. Firstly, our annuity businesses are all registered with the SEC, so we're operating to the Reg BI standards already. Equitable Advisors operate to that level now. And thirdly, our 403(b) business is outside the scope, so it's not something that is overly taxing us at all. We do note as well some of the changes on the right to private action.
We think this is a much better than the 2016 version. The right to private action can only be brought in a federal court. That's important for the industry, 'cause otherwise we could have had 50 different states determining what was best interest, and that would have been very difficult to administer. And the right to private action does not include a best interest contract, which was going to be again very, very difficult. So I think from an industry point of view, that is better than we saw in 2016. But for Equitable, we support the regulators in terms of trying to bring good standards into the market, but we do want to encourage them to make sure Americans are incentivized and understand the personal responsibility we all have to save for retirement with some dignity.
Next, I wanted to ask about the process you've had of you know, novating the annuities out of the New York legal entity. You know, maybe also just a reminder about some of the optionality and benefits of doing that.
Yeah, so if I take a step back, Equitable traditionally had all its business in one legal entity, which was in New York. And having all your business in New York exposes you to one regulator, and the New York regulator is a good regulator, but at times they can come out with conservative, conservative reserving standards that could impact the visibility of the cash flows, and we've seen that over time. So what we've done is we wanted to move our legal entity structure for the regulated company to have all of our non-New York business outside of New York. Our first step was that, writing new business from our non-New York entity. We completed on that, so all of our individual retirement business is now written outside of our non-New York entity.
In the second quarter, we announced our internal reinsurance transaction, which enabled us to reinsure the non-New York policies from New York to our Arizona company. So now, if you look at the company, about 50% of the retirement business or insurance business is in New York and 50% in Arizona. And that provides us more visibility on cash flows because the Arizona dividend formula is more transparent, and it's more focused on RBC.... So that means that that'll help that consistent cash flow generation story. We are in the process of now novating the policies, so taking them off of New York Paper and moving them to the Arizona Paper. That's probably a two-year process. We're in the midst of getting all of our state approvals in place.
We're also going to novate a set of policies to Venerable that we did in the reinsurance transaction, and that helps reduce our counterparty risk to Venerable, as well. After this is completed, it gives us more optionality in terms of other types of transactions we may look at to continue to optimize capital, but it doesn't preclude us from entertaining transactions that we think are accretive to shareholders prior to that being completed as well. So this is just another effort in our capital optimization and ensuring consistency in cash flows, but gives us further optionality going forward as well.
One of the things I've heard from investors is just, you know, some, I wouldn't say concern, but some discussion around, you know, the diversification benefit between some of these legacy products and the new RILA products that you write. And, you know, whether we need to consider that when we think through some of the optimization of the remaining legacy, which is becoming, you know, less and less a part of the discussion. You know, will there be some, you know, sort of drag or offset that we need to think about related to diversification?
It's just like most companies, Equitable benefits from diversification. I think unique for Equitable, we benefit from diversification across all of our annuity businesses, so that includes group retirement and individual retirement, and that decreases our cost of funds in terms of, new business and capital optimization. Your question on, SCS and whether that diversification benefit, changes over time, not necessarily, because when we price new business, we price it on a standalone basis. So we don't assume diversification benefits when we price products. They have to hit that 15% IRR on a standalone basis. Secondly, with novation, take into account, we already did the internal reinsurance. There is no diversification loss in- after we novate the policies as well.
We will continue to benefit from diversification across our businesses, and that is a strategic differentiator for us between that group retirement and individual retirement business, and will continue to lead to strong cash flow generation. That legacy business, Alex, runs off, as you said, less than 5% of earnings by 2027, but that's also a contributor in that $2 billion guidance that we gave out to the market. As that legacy business runs off, it'll kick off cash flows, and that supports the $2 billion guidance that we've given to the market.
Got it. Pivoting over to the group retirement business, can you describe the competitive environment, and what you're seeing? You know, maybe also if you could talk about the interplay between net investment income yields and crediting rates in that business?
Equitable today, in our group retirement business, the main driver of value is the tax-exempt business, the 403(b). Equitable today is the number one provider of supplementary retirement benefits to K-12 teachers. So that's our real sweet spot, and where we've gone well. It's not a segment of the market that's served by many players, and we... It's really driven by the advice that we give through our 1,000 dedicated advisors, and that's been good in the sense of maintaining margins, yeah, in there as well. Good for teachers, too. We know that teachers who receive advice contribute up to 70% more for their retirement planning, so that's good for them as well.
I think it's sort of think about this as a more mature side of our business that should result in steady flows coming through. We are seeing a bit of an uptick in quarter four to offset some of the slightly lower than anticipated flows we've had year to date. We're seeing things tick up a little bit in quarter four. Also, in our group retirement segment, we account for the SECURE Act business that we're starting to write. We have two marketing agreements here, one with AllianceBernstein, obviously, and a second one with BlackRock. We're pretty excited about this longer term, Alex.
You know, if you take the $7 trillion 401(k) market today, annuities are approximately 0% of any target date funds in there. If we're to capture just a small percentage of that in annuities following the SECURE Act and the safe harbor provisions, this will be a real good boost for us and the industry. We know from our partners at BlackRock that they have 11 or so clients who are at the final stages of putting annuities in their target date funds. And so that should mean we start to see cash flows coming in in first half of 2024. We're pretty excited about this, but in particular, excited about the long-term benefits of putting annuities into 401(k)s.
Next one I have for you is on mortality. I know you've probably been getting these questions a lot post-quarter, but you know, I would be interested in just any update you have on the mortality trends you're seeing in the book. And you know, particularly just with you know, some of the older age mortality that we've sort of heard about at the industry level, and confidence in the book.
Protection solutions is about 10% of the earnings profile of Equitable Holdings, and very limited or a small percentage of the overall cash flow that we have that's generated. When you dive into mortality specifically, as you mentioned, the whole industry had seen elevated mortality on older age policy post the pandemic. We call it the endemic structure. So you're seeing some pull forward in mortality. Equitable is unique relative to the industry in two areas. One, we do have more older age policy just by the fact that we focus on variable universal life, and not term, because variable universal life is a more profitable part of the market. And then we also have higher retention limits on our insurance business.
That's just a function of us being a subsidiary of AXA pre, prior to IPO, and so for AXA, volatility was a small aspect, and you get warnings when you keep larger face amounts. So historically, we've had those two instances that are unique relative to the market. In 2022, we actually updated, we worked with the reinsurers and got some input on what potential endemic mortality could look like, and we updated our statutory assumptions to be more conservative. And so the mortality, the pull forward that we're seeing this year, is actually in line with our statutory assumptions, so therefore, there's no impact on our cash flows. From a GAAP perspective, we or we were holding the max amount of allowed under GAAP, so we couldn't hold any more than what we than what we do today.
As a result, you're seeing some GAAP volatility, meaning the pull forward, people passing away now is having some volatility on GAAP results, but that's already accounted for in our cash flow assumptions, so no impact on cash flow. Now, what are we doing about it? We recognize it's, again, 10% of our earnings, a small portion of cash flow, but we recognize it's creating a lot of noise for investors and for us, honestly. So we're looking at actions to explore of how can we reduce the volatility of it. That may mean decreasing the retention limits. There may be a cost for that, so we're assessing those trade-offs, and expect us to give an update in the fourth quarter in February timeline.
Shifting gears a little bit over to wealth management, could you provide an update on that business and the growth strategy you have there?
Yeah, maybe I'll, I'll cover that one. Going well, Alex. We gave guidance in May that we saw a path to double earnings from our wealth management sector from $100 million to $200 million. So far, with interest rates being high and very positive net flows year to date, we would be ahead of that trajectory. We see as well a path to grow the financial wealth planners that we have in there. We started with about 450 at the IPO.
We've grown that to 700, and we'll look to continue to grow our capability there, as well, through maybe some bolt-on acquisitions, small acquisitions, as we saw with Penn Advisors last year, but also from Equitable Advisors as well. So the progress so far is good. Something like $80 billion of assets under advice there now, and the momentum is good.
You touched on net investment income a bit earlier and just sort of where the portfolio yield is relative to new money yields. Could you go a little further with just, you know, any opportunities you're seeing? Are there any reallocation actions that can be taken in the portfolio?
Yeah, as Mark mentioned earlier, this is a great time for the insurance industry. We benefit from higher interest rates in multiple ways. One obviously being on net investment income, as you mentioned, across the board. We are investing now at 6% yield. That's about 160 basis points greater than our in-force portfolio yield, so that's gonna be a tailwind for us going forward. You can see this coming through results as well. If you look at our individual retirement business on the net investment income margin, so net investment income minus interest credited, you could see that up $65 million year-over-year. That's benefiting from those yields and also the growth in SCS. So we see that as a good thing for us, going forward.
As SCS grows, that net investment income will continue to grow as well. Secondly, you see it coming through the benefit of investment income and from the client demand in terms of growth. That's where Mark started off on in terms of we're at this time for the industry, we're seeing record flows in our individual retirement business, $1.6 billion of net flows, record sales in SCS. As SCS, the pie gets bigger and we continue market share, but we're getting significant value on the SCS product. So the client demand and the higher interest rate environment for retirement products that we offer has never been greater, and so it's the best environment for an annuity business in probably the last 10-15 years.
As you stated, in terms of allocation and reallocation of the portfolio, we continue to execute against the $110 million investment income target that we've given to the market at Investor Day. We're planning to be at $45 million by year-end, and given the fact that rates and yields are higher, there's upside to that $110 million number by 2027 if we continue at this pace. That's where we really benefit from the partnership with AllianceBernstein. We're reallocating to private credit, and AllianceBernstein has those underwriting capabilities, so we can keep the margin in-house. The insurance company benefits from a higher yield. AllianceBernstein gets assets and flows as they collect fees, but can also market now to build that private markets platform, which is now $61 billion. So it's a win-win and one of the proof points of our unique business model. So we're really happy with the higher rate environment. It's a tailwind for our business in multiple ways, and it's good for clients and good for shareholders.
Limited partnerships, I guess, have had some weight. Some of it has to do with real estate and just the valuations there. Could you help us think through when that's sort of gonna be more fully rationalized, particularly on some of the real estate elements of the LPs? And, you know, will there be less of a drag to consider as we get into 2024?
We have about 3% of our overall general account invested into private equity, which includes real estate partnerships. Real estate is about 20% of that allocation that we have. And there is a lag effect in returns, and we've seen that over the year, over the years. In 2022, when equity markets were down 16%, our private equity portfolio was up 8.5%. So, it's a lag effect. And so now this year, what we see coming in, that lag taking into effect, not only because of the lower equity markets in 2022, but also the higher interest rates. That's what's happened on the real estate valuations. Every quarter, we've posted a negative mark on the real estate side as interest rates have risen.
We continue to expect another negative mark in the fourth quarter on real estate, but also the overall private equity portfolio, because returns were lower in the third quarter. We're probably gonna come in $0.15-$0.20 below our fourth quarter estimate, than we usually will. Now, as it states going forward, we believe in the portfolio. If you look at IPL on an annualized basis, we generated an 11% return. That's on the higher end of our 8%-12% guidance, and even if you look further back over a 10-year period, it's approximately a 10% yield. So with equity markets up significantly this quarter and interest rates actually coming down, we think that's a good thing for the portfolio heading into 2024.
Got it. Next one I had for you is, is more specifically on private credit, and I know you, you touched on that as an opportunity recently. Do you have, any views on just the increase in allocation? Certainly, we've seen it for private equity firms, but even the broader industry. You know, what, what makes it possible for a life insurer to leg into that trade, and why is it a good asset class for you all?
I think for life companies, you know, the main principle on setting your investment strategy is asset liability matching. So when you're writing long-term liabilities, private credit and these asset classes can be a good match and can give you additional yield, which is helpful both for shareholder returns and for the proposition to clients as well. So as an asset class, it can be very good for insurance companies. For us at Equitable as well, it's an asset class that we are looking to grow out through AllianceBernstein as well. It's part of the synergy between Equitable and AllianceBernstein.
We've put $20 billion commitment from our general account to help AB build out this, the private markets, and which will translate into a high multiple business for our shareholders as well. I think the second aspect for insurance companies in the, you know, in addition to the ALM is to ensure that there is adequate capital put aside particularly for tail risks to protect policyholders and shareholders there. As you know, Alex, there's a lot of debate in the industry, and the NAIC is closely looking at this. We think it's appropriate.
We think the NAIC should be looking at the capital charges here, simply because the capital charges were set before a lot of these instruments were either invented or as significant as they are today. So we think it's a good thing. I think the industry is working closely with the regulators on this, I think, on two aspects. One, reflecting that insurance companies have high asset leverage. So what may look like a small portfolio allocation can be a large amount of capital at risk because of the high asset leverage. So that needs to be taken into account. And secondly, the concentration, because there can be a lack of diversification on same vintage structures, particularly CLOs and asset-backed securities. So these are the two things that we as an industry, and certainly Equitable, is interested in working with the regulators. But as an asset class, very good asset class for insurance companies. We just need to make sure that there's appropriate capital charges on them.
Next, I wanted to pivot over to capital management. You have a pretty notable amount of excess capital at the holdco too. What are the latest thoughts on how you may look to deploy that as things hopefully become a little less uncertain in the environment?
Always good to have excess capital, so I won't complain about that. As of the quarter end, we had $2 billion of cash at the holding company and 400% RBC at the insurance subsidiary, so well capitalized. Keep in mind, though, every time at this point of the year, we're always gonna be at the high end of our cash at the holding company because we get the dividend from the regulated company once a year. So that usually comes out in the June or July timeframe. So that's why we're always gonna be at the highest point this time of the year. Expect us to naturally draw upon that as we continue to return capital to shareholders.
The strong cash flows that we have from both our unregulated businesses and our regulated businesses is why we've been able to be consistent in capital returns since IPO. We've returned $7 billion of capital to shareholders since IPO and have never stopped our share buyback program, even through the pandemic and that's a testament of how we manage risk, the diversity in those cash flows coming up from asset management and wealth management, and our ability to grow. And so we'll continue to focus on consistency of cash flow, and we'll draw that down over time, Alex. I am concerned, if I took a step back, of my only concern would be the overall credit market. Credit is an area that insurance companies do not hedge, and with higher interest rates, we could see...
Across the industry, there could be scenarios where you have defaults in some instances. We put out our stress test, I think it was in the second quarter, where we showed, or in the first quarter, where we showed in a credit crisis, where we define as 2008 for investment grade, the tech bubble for below investment grade, and also a 40% shock to the commercial real estate portfolio. We were able to have a 40-point hit to our RBC, but generate about 10 points of capital going forward, so we can recover quickly. But that is an area that I would be concerned about in the overall market, when looking out there, and so we'd need to see that surpass before drawing down excessively on that excess cash.
Robin, it's 10 points per quarter?
Per quarter, yeah.
Oh, got it. Maybe digging into the mortgage loan piece of the investment portfolio specifically. Can you update us just on, you know, how it was getting through the maturities that came up in 2023, and what you see in terms of managing, you know, the office piece in particular?
Yes, sure. Commercial mortgage portfolio is about 15% of our general account. The LTVs at origination were about 53%, it's now 62%, so we've taken some of the mark on the overall portfolio. Pretty high-quality portfolio that we have. Over 90% investment grade across commercial, the commercial mortgages. The debt to coverage ratio is 2.1x , over 90% occupancy rate. So we feel pretty good about the overall commercial mortgage portfolio. And the maturity profile, we have about 5% of our total maturities coming up in or came up in 2023 and 2024. So the profile of the maturities are pretty good for us in terms of managing through. Office specifically, you mentioned, that's about 5% of the general account portfolio.
The debt to service coverage ratio there is 2.3x , 99% investment grade, so very high quality. Again, anything related to real estate, you have to look at location. It's a very important factor. We're in Class A buildings, but it matters where you're in Class A buildings and in what city. You know, we don't have exposure to downtown LA, downtown San Francisco, Seattle, or downtown Chicago, so we stayed out of some of those cities that are seeing some of those struggles in those Class A buildings, and that's allowed us to have resiliency in the portfolio. As it relates to maturities, we had overall eight loans come up this year. We've managed through those. Two were paid down, five were done through extensions at market rates, and one was restructured. And then for next year, we're already in process of looking forward and working on our next year maturity profile. So we feel quite comfortable with the portfolio overall.
Got it. Okay, well, I think we're at time, so thank you everybody for being here, and thanks very much for joining us.
Thank you.