Good morning, everybody. Thanks for joining us. I'm Yaron Kinar, Goldman Sachs' insurance analyst, and very pleased to have with me today Equitable Holdings CFO, Anders Malmström. Sorry.
Morning.
Morning. One housekeeping item. If you have any questions, please use the box at the bottom of your screen. You can send those to me. With that, why don't we start? Again, Anders, thanks for joining us this morning. It's been, what, two and a half years since Equitable's IPO. How do you think about the company's positioning and the progress it's made since then?
Yeah. Good morning, everybody, and thanks for having me, Yaron. Look, I think if I look back these two and a half years and when we did the IPO, we laid out a plan, we laid out targets. Targets about growth, about capitalization, individual targets on the general account, on expenses, about capital return. I can tell you, I'm very happy where we are today. I feel like we're achieving basically all the targets, we're in a really good position. Today, when you think about that, nobody thought about having interest rates at historic lows. Nobody thought about going through a pandemic, a health crisis, an economic crisis. Being here today and basically can tell everybody that, "Hey, all the targets are achieved after two and a half years," I think that's a huge success. Very happy where we are.
With the targets having been achieved, what are the company's main priorities going forward? What are the next steps?
Look, I think, first of all, the targets are really targets that we're going to continue to maintain. We want to have an EPS growth long term of 8%-10%. We want to be well-capitalized. We want to return capital 50%-60%. These are all things that we're going to continue to do. Business-wise, from a priority, obviously, and we might talk more about the transaction, priority number 1 is to close the transaction, clearly. That's by far the most important in the short term. Growing the business areas organically, where we have good momentum, continue to do so, continue the capital management program. I think it's very important for us. We didn't stop it at all during the crisis, and we want to continue to return the capital to shareholders.
When you think back over the last two and a half years, we were actually able to return more than $3 billion in capital to shareholders, and we're going to continue to do so to deploy capital in the best interest of shareholders.
Got it. Before we dive into the transaction, as you can imagine, I have a few questions on that.
Maybe touching on the 8%-10% EPS growth target. In this environment with greater interest headwinds, what offsets does the company have to meet or beat those targets?
Look, I think it's really important when we think about the business and how we manage the business. We separate between in-force and new business. On the in-force, we fully immunized interest rates. The interest rates, yes, they collapsed in a way, but we were fully prepared for that, so it has very limited impact on the earnings. We're more sensitive to equity, and we have these sensitivities of about every 10% equity corresponds to $150 million in earnings, but very limited to interest rates. Think about 85% of earnings is really coming from the in-force. That's the driver of the earnings, and we're going to continue to optimize that through the general account and through expenses. New business is, I think, a slightly different story, but again, there, I think 85% of our business is not interest sensitive.
The other areas we updated, we repriced, we de-emphasized some of the products in that environment. We have many products that actually provide a lot of value in this environment. There is still a huge retirement gap in this country, protection gap. People need income, particularly to prepare for retirement. Probably even more when you think about where interest rates are right now. I will just take the example of the buffer annuities, our SCS product. It's actually the perfect environment for people to go into this product. They provide meaningful participation in the upside, but they also provide the downside protection that people want. That if something happens, if we have a correction, that you don't lose too much. Basically, the first 10% are protected or more if you choose more, but that's a very interesting value proposition in this environment.
Got it. As promised, a few questions on the transaction. To those who may be a little less versed, you announced at the end of October, I think, that the company's going to transfer $12 billion of legacy VAs and release about $1.2 billion of capital through that transaction. I guess the first question is: how did you choose that block to re-insure? What was the rationale for that?
Yeah. Maybe a little bit background. We always got asked about should we do a transaction. We always said, we don't need to do a transaction. I think we're well reserved, we're well hedged , and I think our capital position is strong, and we get the cash flows. Having said that, I think there seems to be a big discount in the public view of these books. I was actually very pleased to see with this transaction that outside, the private buyer values our reserves, validates our reserves and capital, actually transacting even with a slight positive and ceding commission.
Which means that they take our reserves, they actually give us money back and says, "Okay, your reserves are clearly adequate and for that block of business." The block we chose, as you said, consists of $12 billion of general account, but it also transacts $14 billion of separate accounts. All in all, it's actually a $26 billion transaction. I think we just focused on the reserves, which are $12 billion. These policies are the policies written pre-crisis, where there was really this arms race going on in the industry. They have the highest guarantees, and by that, they have the highest reserve requirements. I think with this transaction, we're actually able to reduce our CTE 98 by 64%.
Again, I think it's really a validation because our reserves are adequate, our capitalization is adequate, and with this transaction, we are now able to reduce that. I think from a public perception, I think we really took off two-thirds of the risk and moved that over to Venerable. We're very pleased with that transaction. As we said, it releases about $1.2 billion of capital that over time, I think we can then deploy back and then give back to shareholders in the most appropriate way.
Got it. I think you've said that you'd expect about $150 million of reduction in earnings in year one and less so over time. In terms of capital generation, does this mean that the 50%-60% payout ratio or cash conversion ratio that you've talked about in the past, is that just coming off of the lower earnings base going forward? Or does that payout ratio change?
Yeah. As I said, and as we confirmed, it's $150 million earnings impact in the short term. There is also a small impact on cash flow, but it's actually quite limited. With this transaction, we can actually confirm that the 50%-60% payout ratio doesn't change going forward. I think that's actually really a positive side effect of this transaction as well.
Got it. I think as part of the transaction, you also announced that you were planning to deploy an extra $500 million into buybacks in 2021 through the capital release. What are your plans for the other $700 million?
Yeah. As we said, it frees up about $1.2 billion in capital.
Most of that at the insurance company. In order to deploy that, we actually have to bring that up to the holding company, which will take some time through the regular dividend and up streaming and maybe some extraordinary dividends. That takes some time. What we decided is that we can actually return $500 million upfront immediately when the deal closes, and then I think the remaining part will be used over time and once we actually have it at the holding company.
Got it. You touched on it earlier that the public markets don't seem to value variable annuity blocks at the same level that private markets do. Do you have any thoughts as to why that is? Do you think maybe that that gap closes over time?
Yeah, I look at it a little bit from the other side. I think it's important that I'm really glad to see actually that the private market looks at it the same way as we look at it. I think that was the validation part that we got through the trade. I think for the public market, it's very complicated. They're very complex products. Also, the statutory and the GAAP framework is not really helping the public market because there's huge disconnect. There's reversion to mean assumptions in the statutory that doesn't fully reflect the true risk, the true liabilities. So that's why I believe it really confuses public investors. When they see this uncertainty, they just put a discount on it. I think I'm really happy to see that private investors actually look at the same way with us.
They don't take interest rate bets. They don't take reversion to the mean assumptions that are reflected in statutory and GAAP assumptions, which then the public investor just basically neglect by putting a huge discount on it. I think that's for me, that's why it's so important that this really validates the way we look at the business.
Got it. If we shift gears a little bit. We touched on the 50%-60% payout ratio. Now, the way I think about it is those are earnings that are available to be deployed externally, right? Buybacks, dividends, M&A. How are you thinking of the remaining 40%-50% of earnings? Where does that get deployed? How much of that goes to support organic growth, for example?
Yeah, look, I think it's a good question. Overall, I think you have 100% earnings and how are you going to use these earnings? I think we are in a good spot here that we can actually deploy 50%-60% back to shareholders through dividends, through buyback, and also through potential M&A. The rest, I really see as reinvestment back into the business, running the business, infrastructure, growth areas that need some investment. For me, that's really the business growth that we should see, then come back, come through over time. That's really investment into the business.
Got it. Are there any other capital needs that you need to use some of that 40%-50% to just support legacy blocks, building reserves, or is it really mostly there to support new business?
I think it's mostly to support new business. Absolutely.
Got it. Shifting gears again, I guess. As of the third quarter, you achieved the $75 million of annual cost saves on a run rate basis that you had set. Do you think that the COVID environment and/or lesson learned over the last three years would suggest additional potential opportunities for expense saves going forward?
Yeah, look, I think there's many things. First of all, I think expense is, and efficiency is something a company has to look at all the time. This is something that never stops, and you always have to become more efficient. When it comes to the overall expense reduction, it's also to use then, I say, cyclical trends and make them permanent. I think that's where we see right now, 2020 was really a kind of a pivotal year here. Because just what we do here. We have this investor conference, now virtual. Maybe it's not perfect, maybe it's not how we want to do it all the time in the future, but it's working. Nobody has to travel, no hotel rooms, everything. We save a lot just on the travel side.
I think that some of that's going to stay permanent, and some of it, I think companies will bake into the future expense base. Same thing is, take real estate. I think this pandemic completely changed the thinking about how companies are going to use real estate going forward. You will have offices. I think you want to have offices, you want to meet there, you want to socialize there, you want to have workshops there, but you don't need to go there to just write emails or read a paper. I think that whole dynamic shifted completely where you want to spend money. It's not just an expense reduction, it's an expense shift, and where you want to invest.
I think also digital adoption drastically increased during this year, which then makes many processes much more efficient so that you can save money there and invest it into other areas. I would say, expense management is a constant topic management has to focus on, and I see that as an area where we always have to improve and then we can decide what we're going to do with the save. Is it to invest it back? Is it to reduce just the expense base, or is it a combination of that?
Got it. Can we talk about the investment portfolio a little bit? I think you shifted a good chunk of your investments from U.S. Treasuries to corporate bonds this year. Maybe you could talk about the rationale for that. Then as you made that shift, did it also, in some ways, I guess, increase credit exposure at a time that credit risk has come up a bit? If so, how are you managing that credit risk?
Yeah. I think that's a great question, and I think goes at the core of an insurance company. When we were under the AXA umbrella, we were under Solvency II, Solvency II is very penalizing in corporate exposure. That's why we had heavy exposure to Treasuries. The first step after the IPO over the last three years was really to reduce the Treasury exposure and go into corporates. Majority of it was really public corporates. We deployed, I think, in this news, about $5 billion Treasuries that moved into corporates. Within the corporates, we moved from shorter duration to longer duration. That was step 1. Step 2 is now to optimize that corporate portfolio and go more from public corporates into private corporates, into structures. Where I would say it's less about taking more risk.
It's more about taking smarter risk and using the ability to actually go into illiquid asset classes. Because an insurance company has such long-dated liabilities that, who else has the opportunity to actually go into these long illiquid asset classes? I don't see that as taking more risk. I think it's more taking the right risk, taking smart risk, and get paid for the risk. I think in the private and in the structured environment, you actually get more return for the same risk. We do that together with AllianceBernstein. We use the general account to then invest with AllianceBernstein into these alternative asset classes, call it private credit. Grow their business, but help the general account.
That's a very strong partnership that will help, on one hand, the general account to get this additional yield and building these capabilities at the AllianceBernstein side, and grow these asset classes also at AllianceBernstein. It's really a win-win, this partnership, and really helps us on the general concept. Maybe a few words, just tactically that we did during the year. I think when we saw these elevated spreads in the beginning of Q2, that was an area where we actually were able to go in quickly and deployed some of the cash that we generated through our hedging program. At the same time, when spreads came back, we were actually able to divest, and overall, I think about a $1 billion-dollar potential foreign interest. I think that's more optimizing and use tactically kind of the situation.
Strategically, it's clearly now go more into these illiquid asset classes and to get additional spread, and out of the corporate and portfolio.
Are there more strategic moves to come?
Sorry?
Are there more strategic moves or reallocations to come?
Yeah, I think that's an ongoing process that we're going. I think that's something we continue to optimize the general account then over the next few years, yeah.
Okay. Got it. If we shift gears again, the long duration targeted improvement standard that's going to change under GAAP in 2023. In your view, would the implementation of LDTI position Equitable more or less favorably relative to peers, compared to the current accounting regime?
Yeah, look, first of all, I think what we really like about LDTI, it really moves to a fair value concept. I think we are managing the company to a fair value concept because we strongly believe that's the right way to do it. We don't want to take, I say, interest rate bets by taking interest rate assumptions that have a reversion to mean that we see today in GAAP and in particular also in STAT. That's why I'm very supportive of LDTI because I think it really shows the right light on the business. Yeah, I think that's the most important point in LDTI, so very supportive. Now, of course, I think it's a complicated framework. It will take some time until people understand.
It will help to get better comparability between the businesses of the different companies, and maybe goes back to the point we discussed earlier on about the discount that we see in this complex liability. I'm very supportive of it, and I was disappointed that they moved the date. At the end of the day, I think it's important that it comes.
Right. Realizing that it's still a whiles out and you're probably still studying this diligently, can you give us any color as to what the potential major impacts would be to Equitable from LDTI?
I think it's too early to give a quantification about the impact. Obviously, look, I think maybe with the interest rate assumption that we changed in Q1, which is pretty close to the forward rate, I think we took some of that upfront, but we still have to go through the details to give the full quantification. The key point, I think, is that after LDTI, you can actually again look at book value. Today there is this big disconnect between how you account for and how you manage the business, so that the book value can move in an unintuitive way. For example, our book value increased drastically after the drop in interest rate and equity markets at the end of Q1. You would expect that the book value moves by $5 billion-$7 billion in this environment.
That's purely because of the disconnect in the accounting. The hope is that after LDTI, again, I think we can have a discussion about the real book value and not an artificial book value.
Makes sense. On the annuity front, I think Equitable was a company that introduced buffer annuities to the market, right? These have been a pillar of the individual retirement business. We're now seeing, I think, more entrants in the market, more competition there. How does Equitable differentiate itself specifically in buffer annuities? Is it possible that the market will eventually become oversaturated on that front?
Look, I think this is a good question. What we liked about it is we were the first one, but we actually like to have more people coming in because it's actually going to grow the market itself. Yes, there's more competitors, but at the same time, the market did really grow over time so that you actually get more interest in this product. As I mentioned before, I think these products really provide a lot of value to consumers. I think in our case, it's really important to continue to innovate, and that's what we do. We just introduced a Dual Direction product that adds a nice feature in a down market. I think the key differentiator Equitable has is its distribution footprint. Because products you can copy, let's say, fairly quickly. You have some time to copy that, but it doesn't take too long.
The distribution footprint we have with Equitable Advisors, but also with third parties, in particular, the P&C carriers, where we are maybe one of a couple providers. I think this footprint is really something that benefited us a lot and continues to benefit us, I think, where we can differentiate and continue to grow, and we don't have to go into an arms race on pricing because we will continue to stay disciplined.
Got it. If we talk about the group retirement business for a second, where I think you're very weighted to K through 12, in the 403(b) space . With a third wave of COVID now upon us, or maybe a second wave, I don't even know how to count those, but clearly with a spike of COVID and infections again, how is this impacting sales here in this business?
Yeah. I think the important point was, as you said, I think we are in this 403 business really in the K through 12 market. Traditionally the way it worked that the advisor. It is a B2B2C model. You have a school slot, but then it's actually an individual sale. The advisor goes in, talks to the teachers, talks to the administrators. Traditionally, they did that in the school. With the first lockdown, this actually dramatically, completely changed the picture. Because schools were closed and advisors had no access to go directly to teachers and administrators. We pivoted very quickly to digital interactions. Since then, I think the advisors are really now able to connect with teachers, with administrators, mostly digital. This will continue for a while.
I don't really think in waves, because even schools reopened, they never reopened for advisors. Advisors were not allowed to go back into school and talk to teachers. They continued to talk to the administrator through digital tools. We were actually able to increase contribution from existing clients meaningfully over this year, even compared to last year. We actually saw an increase in contributions, which tells me that it's actually working with the existing clients. I think it's still difficult to reach out to new clients, but the existing one, that's an area where we actually have quite success. Overall, the flows of the business are actually positive, and we feel good. It is clear, the new business is still impacted, but I think I'm confident this will come back anyways.
Those new clients that are difficult to reach right now, are those clients that are just going without additional retirement support then? Or are they with incumbents? What happens with them?
Yeah. You have to think about the 403(b) through 12 market as everybody already has a pension, and we provide this supplementary pension.
Right.
I think that's where the advice model comes in, because everybody has a different need in addition to their base pension. That's where they need to talk to someone who tells them, "Okay, look, this is your gap, based on what you want to achieve." I think that's where the advisor comes in. I think that's very, very strong. I think that you just need to build a relationship and then you can grow it. I think that's what we continue to do.
All right. Here's a question not necessarily directed at Equitable, but maybe somebody who represents the industry here on the fireside. A lot of the products that the industry sells are very long-tail in nature, very assumptions-driven. I think we've seen the industry at times aggressively pursue products with a certain set of assumptions that prove to be too aggressive in hindsight. What lessons has the industry learned from past mistakes in your view?
Look, I would say, generally speaking, post the 2008 crisis, I would say, I think I see mostly rational behavior in the industry. I can talk a little bit more about what we have learned. I think we were one of the companies that really took action very early on for the new business immediately, but then also for in-force. Over the last 10 years, I think we were really able to, let's say, to improve the portfolio, not just for new business, but also for in-force. I think one thing that's really important is that companies act quickly. Traditionally, it took insurance companies always a long time to react to reality. I think for me, if there is one learning for us is that, and we were very successful in that, hey, if the world changes, act and change quickly.
Why should we not change a crediting rate when rates go down? If you go into a bank, they change the next day, the interest rate. They change the next day. Why should insurance companies neglect reality and not change it? I think that's something where we want to be kind of clear. We want to react quickly, but at the same time, we also want to create products that don't need too much, let's say, don't have too much dependency on the market. SCS, I think is a perfect one. We actually reprice it every two weeks. The product itself doesn't have to change. You just take reality, put it into your pricing, and move on.
Right. Maybe along those lines, are there products in the market today that you feel like you just don't have the appetite for because those could become the products that in five or 10 years you look back and say, "You know what? Maybe the assumptions there were just not right.
Yeah, I can talk a little bit about our actions. We acted very quickly and repriced all products that we had to reprice. We see areas where with the repriced product, we're just not competitive anymore. I think the indexed universal life, particularly with a lot of protection, I think that's the area we saw that after repricing, it just doesn't sell anymore. For multiple reasons, mostly also because it's just not competitive anymore. We pulled that product, I think that's okay. I just don't want to go into, as you mentioned, I don't want to sit here and then in 10 years say, "Why haven't I?
Right.
We have to face reality, put it into our pricing, if it's not competitive anymore, hey, that's reality.
Right. Makes sense. If we talk a little bit about capital deployment, we touched on it a little bit earlier, dive a little deeper here. You do have several businesses that are very capital light. Some of them on the smaller side, like the employee benefits business. You have a small wealth management business as well. On the other hand, you have a pretty large and developed asset management business or franchise. I guess considering that these are capital light businesses, the shift that we've seen the company undergo, is there appetite to pursue deals in those spaces to build those businesses up?
Look, I think it was very important to us in the first few years as a public company to really grow organically and get credibility in the market. I think now it's the time to maybe accelerate some of the areas through inorganic growth. You just mentioned two of them, where we kind of said publicly that we're interested in growing faster through inorganic growth. It's really the wealth management business and it's in employee benefit. Wealth management right now, it's a nice growing business. I think it's about 450 advisors within Equitable Advisors that right now, put it the right way, have about $50, I think $58 billion of assets under administration that they manage for our clients. It's nicely growing. It's great business. It's not big enough to make it its own segment, which means we don't get any recognition in the market.
That's an area we would like to grow faster through inorganic growth, but not through something transformation, more through bolt-on. To be able to actually talk about it in the form of a segment. Employee benefit, the same thing. Nicely growing. Really very happy where we are today. Not relevant in the big picture. That's where if we could do some smaller bolt-ons to make it relevant, I think that's the area we would like to do so. We're going to continue to do the organic growth here, clearly.
Okay. In employee benefits, if you were to pursue opportunities, would those be more the employer-paid, the employee-paid? How are you thinking about that?
Look, I think it's probably a combination. I think we really like the voluntary space where it's more employee-paid, but it's both. I think you have to do both. You have to have the platform where the employer pays some of it, and then this gives you the opportunity to actually provide all these voluntary benefits for the employees in addition to what the employer sponsors.
In terms of prioritizing between the allocation to those various businesses as you see opportunities, on the one hand, and even between M&A, even those tuck-ins versus buybacks, how are you thinking about that?
Yeah. Look, I won't give you kind of, this is number 1, 2, and this is 3.
Okay.
It's a combination of all three. It's about what opportunities will be in the market.
I can guarantee you we're going to be disciplined from an M&A perspective. We won't do anything that would be highly dilutive. We want to grow the business, but at the same time, I think we're very conscious about them, I think the shareholders' expectations. That's why we're going to continue to deploy the 50%-60% overall, and we will use some of that to pursue opportunities if they make sense.
Got it. I think we do have to wrap up. One last one coming in from the audience. Going back to the VA transaction, do you think there's appetite or possibility for additional transactions on the VA block?
Look, I think, first of all, again, I think priority number 1 is to close that deal. I think this is really a landmark deal. I think it really validates our reserving and capitalization. Going forward, I think it's the same approach. If it makes sense, if it economically makes sense to us, I think we would pursue. Other than that, we no need. We don't have to. I think, yes, if it makes sense, we would continue to look for opportunities.
Got it. Well, I'm sorry we ran out of time. Thanks so much for your time and thoughtful responses. Hopefully, we get to host you in person next year.
Wonderful. Thank you. Thanks a lot.
Take care.