Ladies and gentlemen, thank you for standing by, and welcome to the Equitable Holdings Legacy VA Reinsurance conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star one on your telephone. If you require any further assistance, please press star zero. I would like to hand the conference over to Ms. Jessica Baehr, Head of Investor Relations. Please go ahead.
Thank you. Good morning and welcome to Equitable Holdings investor call to discuss our legacy variable annuity reinsurance announcement. Materials for today's call can be found on our website at ir.equitableholdings.com. Before we begin, I would like to note that some of the information we present today is forward-looking and subject to certain SEC rules and regulations regarding disclosure. Our results may materially differ from those expressed in or indicated by such forward-looking statements. I'd like to refer you to the safe harbor language on slide two of our presentation for additional information. Joining me on today's call is Mark Pearson, President and Chief Executive Officer of Equitable Holdings, and Anders Malmström, our Chief Financial Officer. Also on the line is Robin Raju, Head of Individual Retirement.
During this call, we will be discussing certain financial measures that are not based on generally accepted accounting principles, also known as non-GAAP measures. Information regarding these non-GAAP measures, including reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and related definitions, may be found in our 10-Q and 10-K SEC filings or quarterly earnings materials, all of which are available on the investor relations portion of our website. I would now like to turn the call over to Mark and Anders for their prepared remarks.
Good morning, everyone, and thank you for joining the call. We are pleased to announce a landmark transaction for Equitable, the reinsurance of a significant part of our legacy variable annuity block to Venerable. This transaction is the culmination of a decade-long effort in managing a portfolio of policies issued between 2006 and 2008, the peak of the VA arms race. I'll begin by providing an overview of the transaction before handing to Anders to walk through the details of the agreement. Turning to slide three. We've been able to reach agreement with Venerable at an economically attractive valuation, unlocking statutory cash flows, and generating a positive ceding commission on our most capital-intensive block. As such, this transaction validates our fair value economic philosophy, including our reserve assumptions, hedging, and risk management. After completion, our capitalization and statutory solvency ratios will further improve.
After closing the transaction, our board has approved an additional shareholder distribution. This deal is important to us. Investors and analysts know that capital intensive in our industry signifies complex blocks which are difficult to value due to rich guarantees and policyholder options that cannot be hedged. This transaction demonstrates that the Equitable team can manage complex businesses in line with or even better than market value. Now we're pleased to have reached agreement with a credible partner like Venerable, backed by smart money, which both validates our approach and puts a capstone on this uncertain legacy portfolio. Looking forward, this deal now enables us to focus on the pursuit of what really matters, value accretive business. Turning now to slide four. I would like to highlight the most significant numbers behind the transaction.
The best way to evidence the de-risking of the balance sheet is that the amount of CTE98 required capital we hold to cover tail risk will reduce by 64%. The transaction creates $1.2 billion of value on a statutory basis and will result in an increase in the combined RBC ratio of approximately 60 points. From a capital return standpoint, our board has authorized an additional $500 million of share repurchases in 2021 after completion of this transaction. Our partner, Venerable, brings significant expertise in managing variable annuity blocks. In addition, the structure of the transaction includes meaningful protections through a comfort trust. Under the terms of the agreement, AB will be the preferred asset manager for Venerable and will continue to manage the majority of the general account assets. Finally, our best estimate is we expect the transaction to close in the first half of 2021.
I will now hand over to Anders to walk through the details of the transaction. Anders?
Thank you, Mark. Beginning on slide five, I'd like to illustrate the rationale for this transaction and highlight the key benefits for shareholders going forward. I will walk through each of these five points briefly before diving into more detail on the following slides. First, the transaction validates the strength and prudence of our robust risk framework, including our approach to reserving and hedging. As Mark mentioned, it enables us to significantly de-risk our legacy VA block through a reinsurance transaction structure with a highly credible reinsurer and significant protections. Finally, the $1.2 billion of unlocked statutory capital is attractive and consistent with our economic valuation, allowing for the acceleration of capital return to shareholders and more certainty in our cash flows going forward. Turning to slide six.
Those that follow us know that we manage the business to our economic model, taking a fair value approach to reserving, hedging, and risk management. Specifically, we set reserving assumptions that reflect a fair value approach to our liabilities, including the forward curve for interest rates. Further, we have a mature book, and we have remained prudent throughout the years in reflecting policyholder behavior experience and assumptions around credibility. Second, by hedging to our economic liabilities, our balance sheet is fully immunized from interest rates and the equity exposure on the GMXP rider guarantees. Finally, through a series of management actions since the last financial crisis, we have successfully shifted the risk profile of our in-force. Collectively, these economic principles and management actions have enabled us to tightly manage risk and volatility, limiting potential adverse outcomes and providing more certainty into the future cash flows of the business.
As you can see, the benefits of this approach are clearly reflected in the transaction, which resulted in a positive ceding commission and reserve release on the portion of the block with the richest guarantees, validating our reserving assumptions and our prudent approach to risk management. Turning to slide seven. You can see here that the transaction significantly reduces our total VA exposure through a divestiture of the portion of the most capital-intensive block. Our net amount at risk is meaningfully reduced by 44% for our GMDB policies and 51% for GMIB. As a reminder, these figures should always be assessed in the context of reserves held, and importantly, are not additive as policyholders are only eligible to receive one of these benefits.
On this point, the transaction will drive a reduction of over $12 billion in the required CTE98 capital backing those policies to about $7 billion, which further validates the level of reserves we hold against these liabilities. Altogether, this results in an increase in RBC ratio by approximately 60 RBC points, which would increase our pro forma RBC ratio to approximately 475%, way in excess of our 375%-400% minimum target. Importantly, we are able to achieve this significant risk reduction while only transferring 13% of our variable annuity policies, reducing our fixed rate GMXG policy count by approximately one-third on a pro forma basis. Moving to slide eight. Given the structure of this transaction, it is important to emphasize the significant protections in place for Equitable and our shareholders. This transaction will be completed through a two-step process.
The first step is the legal entity sale of Corporate Solutions Life Re to Venerable, followed by reinsurance of $12 billion of assets to a comfort trust. Venerable will also contribute over-collateralization to the trust and will provide a holding company guarantee of its reinsurance obligations to Equitable, which also includes assets from Venerable's prior transaction. Venerable's risk management philosophy and hedging approach is well-aligned with ours. The company utilizes a dynamic hedging strategy that largely mirrors Equitable's program with daily rebalancing and top-up contributions to ensure the trust is fully matched. Venerable will also provide robust reporting on their hedging program for ongoing oversight and monitoring. These provisions ensure the comfort trust and Corporate Solutions Life Re remain appropriately capitalized. Overall, Venerable's expertise in managing and hedging variable annuities and the comprehensive protections in place should provide further confidence in the benefits of the transaction.
Slide nine illustrates the breakdown of the three primary components of the $1.2 billion of value we expect from the transaction. First, there is a net statutory surplus release of approximately $800 million, including a surplus release related to Corporate Solutions Re. Second, a positive ceding commission of $300 million paid by Venerable, which includes the legal entity sale. Third, approximately $100 million in tax benefits we expect to realize. This attractive value, consistent with our economic valuation, will accelerate capital return to shareholders and improve key capital metrics, which I will walk through in more detail on the next slide. Turning to slide 10. Upon regulatory approval of the transaction, we intend to return an additional $500 million to shareholders through share repurchases, incremental to our existing 50%-60% target payout ratio.
As mentioned, the transaction results in a 60 percentage point improvement to our combined RBC ratio. Additional capital metrics such as debt to capital remain in line with our targets. From an accounting standpoint, the transaction is expected to initially reduce annualized non-GAAP operating earnings by approximately $150 million, which will decrease as the book rolls off. We expect ongoing net income volatility due to the amortization of the reinsurance transaction and ongoing accounting mismatch until LDTI adoption. This is partially offset by lower hedging sensitivities related to variable annuity product features. I will now turn it back to Mark.
Thank you, Anders. In summary, we are very pleased to present this first of its kind reinsurance agreement. It creates substantial value for the business and significantly de-risks our balance sheet. Looking forward, we aim to complete the transaction in the second quarter of 2021. We will continue to relentlessly look for opportunities to create long-term shareholder value. Thank you. With that, I would like to open it up for questions and answers.
If you'd like to ask a question at this time, please press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. First question comes from Elyse Greenspan with Wells Fargo.
Hi, thanks. Good morning. My first question. You guys have announced a increase in buybacks around $500 million with this transaction. As we think about this deal closing, you're obviously freeing up more capital than the $500 million. How should we think about additional capital return over time? Is there some balancing with the extra component of capital you're releasing here to just have some flexibility on M&A? Should we expect it to come in via buyback over a longer time period?
Hi, Elyse, it's Mark Pearson. Thank you very much for the question. As you say, look, we believe the additional $500 million is a very strong commitment in these times. We still are in the middle of this awful pandemic and uncertain times. This is a very good transaction for us, and I think it reinforces the strength of our current capital and liquidity position at the holdco. I think that gives us continued confidence in our ability to deliver on the guidance we've given of the 50%-50% payout ratio. We think this is the appropriate amount. It's a strong signal reflecting a very good transaction for us at this time. Over time, we'll continue to evaluate things and the primary goal will be to make sure that we continue to add to shareholder value. That's our position on the capital return.
Okay, thanks. Over time, you guys are going to have obviously a good amount of buffer above your RBC target following this transaction. How should we think about potentially you taking that down over time?
I think, Elyse, our priority now is going to be to complete this very large transaction, and all of our efforts will be to meeting that Q2 deadline. Look, we're very pleased to be in this position of such financial strength at this time. It is testament to how we've managed risk, particularly in a falling interest rate environment. All of our attention is going to be on closing this deal by Q2 2021.
Okay, great. One last one. What's the impact on a transaction close on book value?
Anders?
Yes, good morning, Elyse. As you might know, this transaction uses reinsurance accounting. With reinsurance accounting, there is zero impacted at time zero, and then you amortize the impact over time down to zero over the next 20 years. It's really reinsurance accounting here, so no impact up front.
Okay, great. Thanks for the color.
Thank you.
Next question comes from Andrew Pleiderman with Credit Suisse.
Hey, good morning. Congratulations on that value enhancement transaction. I was kind of curious about the 9.9% investment in Venerable that you specified. Could you give us a little backdrop on the rationale and maybe, I don't know if you've settled the transaction yet, but what the range of the cost might be?
Let me ask Robin to deal with that one, Andrew. Good morning.
Thank you.
Morning, Andrew. Hope you're well. The 9.9% stake is important for us. 114,000 Equitable policyholders are moving over to Venerable in the form of financial risk transfer, and we believe that keeping interests aligned over this 20-year plus partnership is important, and a 9.9% equity stake with a board seat does that for us.
Got it. The cost range?
We haven't settled on a cost yet of the transaction. It's still being negotiated, but it's not going to be anything out of the ordinary for a transaction of this size.
I see. Would it absorb a good portion of that additional $700 million of capital freed up?
No.
Got it. On the other front, such an interesting transaction. Could you size the separate account assets With the $12 billion transferred into the Comfort trust, what was the separate account asset amount, and is there room to do a lot more of these deals going forward?
In terms of the I'll deal with the deals, then I'll pass to Anders on the separate account, Andrew. Look, we've always said we're aware that there is interest in these books, particularly from private equity players, and we've always said we will keep looking at them, and if they make economic sense for our shareholders, we will go for them. This is certainly the case with this very, very large transaction. We're delighted to be able to present it to the market. It's as we've said before, Andrew, we will keep looking, and if it makes sense, we will go after them. Anders, can you deal with the separate account question?
Yes. Good morning, Andrew. Look, I think that's such a great question, though, because we only talked about the term account that moves over the $12 billion. It's another $14 billion of separate accounts that move over with this re-insurance transaction. Overall, we're actually talking about a $26 billion transaction, and you can imagine this $14 billion separate account over time will actually become general accounts when people annuitize.
Got it. Thanks. Great stuff.
Next question comes from Jay Bieler. Please go ahead.
Hi, good morning. First, just on your planned share buybacks and the increase in the authorization, I think by $0.5 billion. Should we assume that most of this would be done once the deal closes, or would you be open to doing this prior to the deal given just to be able to take advantage of the stock price being depressed?
We have our normal buyback guidance we give you, so we will take opportunities there. Our authority from the board for the additional $0.5 billion is subject to completion of the deal.
Okay. There had been talk last year, and I think you had mentioned that you would look into it as well on what your long-term intentions are in terms of your stake in AllianceBernstein, whether you dispose of it or you increase it and buy more of the company. Any views on how this deal changes that or just any comments, any updates on that?
No update on what we've said before, Jay. I mean, our priority has been on landing this deal. It's a mammoth size of $26 billion as Anders Malmström said. It's a landmark transaction for the industry. All of our attention has been on de-risking the balance sheet this way, unlocking value for shareholders and validating our reserves. That's really where we've been focused. I have to tell you, I'm immensely proud of what the team has been able to do here, particularly at this time. All credit to Venerable and us, we've been able to conclude this landmark transaction completely remotely, in a way that we've never seen before in the industry. That's really, really where our focus has been, Jay.
Okay.
Jay, maybe just to add here, I mean, AllianceBernstein is really part of this transaction since they are the preferred asset manager going forward for Venerable for this block of business. They are really part of that transaction.
Yeah.
They benefit from it.
Just lastly on sort of the closing timeline that you provided for 2Q. Does that sort of incorporate a little bit of a cushion given COVID and office closures and everything else? Because we have seen some deals that have been delayed, because of everything taking a little bit longer, potentially.
No, we think it's a realistic timetable. We've done some pre-work with both sets of regulators to make sure that we bring them along. That's often the case, Jay, where some of the delays can happen. We think it's a realistic timetable, even in these circumstances.
Thank you.
Next question comes from Nigel Daly with Morgan Stanley.
Great. Thanks. Good morning. With the variable annuities that were included in this transaction, how is it decided what was included or excluded? Just want to make sure there's nothing unique with the legacy exposures that will remain with Equitable.
Let me ask Robin to deal with that.
Morning, Nigel. Thanks for the question. This block is comprised of non-New York accumulator policies written between 2006 and 2008, containing some rich guarantees, as Mark mentioned earlier, and is capital intensive. When we looked at the policies and the transaction, this was a distinct set of policies, but only 13% of the overall policies of the Individual Retirement business and enabled us to reduce CTE98 exposure by 64% or $13 billion. It was a distinct set of policies sold during that time that allowed us to unlock value by de-risking the balance sheet.
Nigel, as Robin said, it was firstly doable in the time scale we wanted, and it was absolutely the biggest bang for our effort. 13% of the policies, reducing that tail risk exposure by 64%. You can see just on those two numbers that this is the most capital-intensive block we have.
That's great. Just second on the cash flow implications going forward. Would I be correct in just taking the 50%-60% of the $150 million of blocked earnings as the reduction to your go-forward cash flow, or is there anything else going on with hedges or anything else that we need to consider as well?
No, I think, This is Anders Malmström. As I said on the call, the capital impact is very limited. The earnings impact is as stated. I think with that together, I think we can confirm the 50%-60% tail risk.
That's great. Thanks a lot.
Next question comes from Suneet Kamath with Citi.
Thanks. Just to follow up on some of the questions that were already asked. In terms of, I know this is a large deal, but with respect to the remaining legacy VA, is the fact that I think most of it or all of it is domiciled in New York, does that preclude a larger transaction with the legacy block?
Suneet, it's Robin here. As we mentioned, this transaction really validates our economic reserving, hedging policy that we have in place for the entire business. As a result of taking the 13% of the policies, which are the most capital intensive, we're able to unlock a significant amount of value for our shareholders. We think this is the right block of the time, but also validates how we manage the entire book of in-force that we have in the Individual Retirement business overall. Our primary goal right now is to close the transaction, as Mark said, in 2Q. Over time, we'll always evaluate opportunities to enhance shareholder value.
Is the deal, the investment in Venerable, is this transaction at all contingent on that? If you don't reach an agreement, this transaction can still go through?
Suneet, it's not conditional. We do think it is a good thing from an additional protection point of view to make sure that we have a great working partnership with Venerable, which we certainly started off with. We think it is a good thing, but it's not conditional.
Okay. The last one I have is just on the general account asset transfer. Is the right way to think about that $13 billion, is that the available resources that were essentially backing the block, so that kind of corresponds to the drop in the CTE98 asset?
Absolutely. That's absolutely correct. These are basically the reserves that move over with this transaction. Correct.
Okay. Great. Thank you.
Next question comes from Ryan Krueger with. Please go ahead.
Hi, thanks. Good morning and congrats. Just had a follow-up on the $1.2 billion of capital you freed up and the $500 million of additional buyback. Understanding that we're in a pandemic and you probably want to be a bit cautious in the level of buyback, is there anything, I guess, specific that that $700 million delta is earmarked for or that, I guess, would prevent you from ultimately returning that $700 million to shareholders over a longer period of time?
Look, I think, Ryan, first of all, the majority of the $1.2 billion value creation is in the insurance company. It will take some time until we get that money up to the holding company. I think the commitment to do $500 upfront from the holding company is a very strong one. I think that's kind of where we are today. We believe we can immediately release $500 before we actually have the money at the holding company. Over time, I think the money will move up to the holding company and will be used, as Mark said, in the best interest of shareholders. You're absolutely right. This will take some time.
Got it. Thank you.
Next question comes from Thomas Gallagher with Evercore.
Good morning. Just a few questions. Thinking about the dollar-for-dollar features within your variable annuity policies, does this represent the bulk of those, or do you still have a significant amount of those dollar-for-dollar features in terms of what remains?
Robin, do you want to handle this?
Morning, Tom. The way I would, again, point to you in terms of risk reduction, what we've done here is that NAR number that you saw. If you look at the IB or the DB, it's a significant amount of NAR reduction. All of these features go into those calculations as well as the CTE98 reduction overall. Again, 13% of the policies, 64% of the reduction in the tail risk exposure for the business.
Got you. Anders, I heard what you said about this shouldn't change the free cash flow conversion. Is it fair to say then the way to view this transaction is it materially reduces your annual volatility of cash flow if it's not reducing or changing meaningfully the annual amount of cash flow?
Yes, I think the way we look at this business, it basically accelerates a large portion of the cash flow into today. That's very clear. Then going forward, it reduces the economic volatility of the business, which includes the cash flow. It's absolutely correct, yes.
Got you. Just considering the trust structure that's being used here, I was curious if that, does that sort of encumber any of either the $1.2 billion of capital or is there additional capital that's being tied up that could be released over time based on the way this overall structure works?
Yes, I think the way you should think about the trust structure, this is basically the collateral for the reserves that moved over. That's the collateral behind the $12 billion that moves over to Venerable.
Gotcha. That's really just about the assets that they're going to be controlling. That wouldn't be something that would change from your ownership perspective or calls on capital.
Yes, absolutely correct. I think this is really the structure you set in place for this kind of reinsurance transaction. Make sure that Venerable, that we basically have the collateral for the reserves that Venerable controls.
Got you. This $1.2 billion of freed-up capital is all yours, free and clear. That's really just dependent upon the timing of dividends and such.
Absolutely. That's absolutely ours. Just to reiterate, there's the ceding commission, I think, which shows that we actually were able to free up part of the reserves. On top of that, the $800 million of capital that was backing the book. It's both. It's really important.
Got you. I guess final question is just the New York PBR standards, the Regulation 213. Have you looked at this transaction through that lens? Will that have any meaningful impacts regarding future dividend capacity or as it relates to that new standard?
Yes. Look, as we discussed before, Reg 213 is, how you say? A topic that we're discussing with the regulator, with and without this transaction, so it's not better or worse. The problem is really, we just have to work with the DFS, and DFS have other priorities right now. It's something that we continue to work with them. We're pretty confident that we will find a solution.
Got you. Thank you.
Once again, if you'd like to ask a question, please press star, then the number one on your telephone keypad. Next question comes from Peter Triossi with Barclays.
Hi, good morning. Anders, I think you said on page eight of the presentation that there was a holding company guarantee as part of this. Can you just provide a little more color on how that guarantee will work?
Yes, good morning. Obviously, I think what we discussed there, the main protection is really the trust. As we just discussed before, that's really the collateral behind the reserves. Let's assume, and we would need, in whatever scenario, we would actually need more, in case something goes wrong. That's when we would actually have access to the total holding company. The total holding company, Venerable, is guaranteeing the total amount that we use for reinsurance and collateral.
Okay, it's Venerable providing the guarantee, not Equitable.
Yes. Think about it. It's Venerable that guarantees these policies. You first have the trust, which is the most important protection. If you would need more, it's actually the total Venerable holding company that provides the guarantee here on top of the trust.
Okay, that's clear. Thanks very much.
At this time, we will turn the call over to the presenters.
Thank you all for joining us today. If you have further questions, we look forward to discussing you in one-on-ones. Thank you.
This concludes today's conference call. You may now disconnect.