Good morning. I'm Tracy Benguigui, Insurance Analyst at Barclays. Welcome to day two of Barclays Global Financial Services Conference. I'm pleased today to have a fireside chat with Mark Pearson, CEO of Equitable Financial. Welcome, Mark.
Thank you very much, Tracy. Good morning.
Good morning. Maybe just some quick housekeeping items before we kick off. On the left side of your screen, you will have two options. One would be to submit questions, in the Q&A box, and the second would be to follow along our audience response system, which is our polling question. With that, I'll kick off with the first question, Mark. We're witnessing a trend of U.S. life insurance subsidiaries separating from European-owned larger insurance companies. Given your IPO two years ago, how has the former European parent shaped your risk philosophy and business acumen? At the same time, Equitable Brand has a deep heritage. How do you blend both worlds?
Well, thanks, Tracy, and thank you for this opportunity. Yes, Equitable does have a deep heritage. We were established in 1859, the year before Abraham Lincoln was inaugurated, so a long time ago. In those 161 years, there's only been 16 CEOs. I'm very conscious of being a steward, if you like, of a great institution and just absolutely privileged, as you say, to have experienced the IPO two years ago. My mission is clear, to leave this organization strong and thriving for the future. Yes, for 30 of those years, AXA was our parent and a good parent. I think some of the things to your question that the qualities that AXA had, which I'd like to continue into the new Equitable, very strong risk management orientation, AXA is a good corporate citizen, and a progressive organization.
I think these are important qualities for the future, we will take from AXA as we go forward. You mentioned about a trend of European insurers divesting. I think of it more as strategic choices. If you look at AXA's situation, AXA saw its strengths in P&C and health and hence decided to spin off Equitable, where our strengths are on protection and retirement and asset management. In that regard, not too dissimilar to Met. Met focusing on capital-light businesses and spinning off Brighthouse. I see it more as strategic choices rather than a trend. Of course, there are plenty of European insurers still here in the marketplace, Aegon and Jackson and others, for example. You asked about the differences. I think it's important as well to look at the similarities.
I mean, you probably know, Tracy, I've worked in 15 different markets around the world when I was with AXA. One is struck with the similarities. I think insurance and asset management companies add to society with the protection we offer, helping people retire with dignity and look after their wealth. There's a lot of similarities in terms of all markets. I guess what's unique and different between Europe and the U.S. is on the regulatory side, where, as you know, it's quite a different story between Solvency II and US GAAP and our statutory, particularly on the treatment of interest rates. This can lead to different risk profiles that people take. From our point, if you're going back to AXA, if you like, we manage the business. We at Equitable manage on a fully economic basis, a fair value approach, if you like.
Excellent. Yeah, you've mentioned the Solvency II and IFRS, growing up in that framework. I guess it's no surprise that you're used to a market consistency way of looking at a balance sheet, which led to, in my view, Equitable updating your interest rate assumptions in the first quarter.
Yeah
from 3.45% to 2.25%. At the same time, you've actually been quite vocal to regulators, rating agencies, et cetera, that the industry should abandon a reversion to the mean mindset. For example, the NAIC's interest rate scenario generator has a 3.5% interest rate floor under the VA capital reform. I guess my question to you is why is it so important to you that others in the industry follow your lead?
I'm glad you asked the question, Tracy. I think it's the number one issue facing insurance companies in the market today. Why? Because we write long-term liabilities, 30, 40, 50 years. Just last week, Tracy, we paid out on a policy that had been with us for 85 years. That is extreme, but I'm illustrating the fact that we are in the business of providing long-term protection and long-term solutions for American families as we go. With that in mind, we must ensure that we are properly reserved and properly capitalized if we are going to meet those promises in the future. Today, as you say, the U.S. statutory regime permits using an arbitrary 3.5% in the calculation of reserves and capitalization. A 30-year U.S. Treasury today, as you know, is around about 1.4%.
We at Equitable, we are saying we don't know if interest rates will rise. But we have seen the 10-year Treasury going one way. I've been working for 40 years now. When I came in the business in the late 1970s, the U.S. 10-year Treasury was 16%. Today, around about 0.6. What we're saying is, we don't know which way interest rates are going. We are saying 3.5% is totally arbitrary. We see no reversion to mean, no cycle of interest rates whatsoever. We are saying that the people who manage insurance companies, and we're not alone in the market, many others also adopt this, should not gamble. We should reserve and make sure that we're able to withstand current rates where the market is today, not an arbitrary 3.5% in the future.
Yes, you're right, the arbitrary 3.5% is within the rules, but we think it's unnecessarily risky to rely on that. We hope this dialogue continues because it's important, and it's our responsibility to contribute to a strong financial system. Going back to my answer to the first question, we are stewards of these institutions, and we need to pass them on in a strong and vibrant way. Relying, and I use the word relying on an arbitrary 3.5% is unnecessarily risky.
Got it. This is actually a good bridge for my next question. Equitable has mentioned that LDTI adoption Protection Solutions will no longer be in loss recognition. Now that given the impact of COVID-19, LDTI has been delayed further to January 2023, but there's actually an option to early adopt. Maybe just bridging what you said on where you're at on your interest rate assumption, and maybe the fact that you like to take the lead on certain positions to the rest of the market, would Equitable be in the position to early adopt? When can we expect you to provide updated guidance on this?
As you say, Tracy, in Q1, we reduced our interest rate assumption on GAAP to 2.25. I believe it's the most conservative in the market and closer to the fair market rates I just mentioned. Because of that, no surprise, we are very much in favor of the new LDTI fair market principles. We think it will vastly improve shareholder transparency. A little bit disappointed that it was delayed, but understanding with the COVID and everything going on, it's a reasonable thing. We don't expect to early adopt unless the majority in the industry do. I don't think there's any point in being out there as the only one in an accounting change like that. We look forward to adopting LDTI. This transparency, I think, is important.
As you know, Tracy, the book values are not believed by investors, and that cannot be a good thing for the long term. I think when we move to LDTI and a more fair market principle based, I think we'll have greater transparency and greater interest from investors, and I think that's a good thing for the long term.
Great. What about just even sharing some early guidance with the market on maybe non-GAAP measures that you would introduce or a way to interpret the day one impact?
Well, the information we share quite a lot with the market is our cash flow projections and what we anticipate going forward. Obviously, in this COVID time, we are prudent and cautious in giving out sensitivities because it's just too uncertain. In giving out our cash flows, we really are signaling to the market that we are taking a good look at the economic side of our business, the economic liabilities, and this is the cash flow that's coming out on top of that. That's how we really address it in the meantime.
Okay. Great. I think maybe it's a good time to turn to some of the polling questions and answers. The first one.
Sure
Just remind folks on the left side of your screen, you could fill that out. The first question is, my confidence that Equitable's ROE will be in the mid-teen range by 2021 is, and the choices are very high, high, medium, low, very low. With 80% so far at high, and 20% responses medium. Then moving on to the next polling question, what measures should Equitable pursue? Organic growth, closed block, risk transfer, disposal of AllianceBernstein, buying remaining stake in AllianceBernstein, share buybacks, and dividend increases. You wouldn't have a virtual conference if I got closed out of a polling the participants.
I'm going to get back in, but maybe I'll just get your take of the second polling question in, I guess, if you had to pick and choose where you think Equitable should pursue on a capital management perspective, what do you think is, in your mind, most attractive out of those options I shared?
I think the most important thing in these times, Tracy, is to make sure we maintain a strong balance sheet. All other options flow from the strength of the balance sheet. The work we've done as a team over the past 10 years in putting in our hedging program based on economic liabilities and in changing the profile of our product mix means that we are in a position of having a very robust balance sheet. I think that's evidenced by $2.5 billion at the holdco over and above our normal levels of capital. Our number 1 priority, no surprise, in a time of this coronavirus is to make sure that we have a strong, resilient balance sheet. That's really what we're gearing to. Secondly, is to control those things we can control. You'll know that our program has been to secure productivity gains.
We're on track for the $75 million net savings that we guided the market towards, and improving the investment yield on our portfolio. We delivered the $160 million general account optimization target one year ahead of plan. I think that to really answer your question, the resilience of the balance sheet is really the most important thing for us to do in these times.
Okay. I guess one thing that maybe I'd like to touch upon a little bit further on capital management is M&A. How has the current environment impacted your appetite for M&A, and how do you view or think about M&A in the context of your overall growth strategy going forward?
Okay. Tracy, when we IPO'd the company two years ago, we said to the market, "Look, we're going to take three years to establish ourselves as an independent entity from AXA to get the credibility of the marketplace by delivering on the growth targets, the 5%-7% CAGR on our operating earnings, the 50%-60% buyback program we have in place, those two combined giving us double digit EPS growth, the $75 million net savings, and the $160 million improvement to our general account yield. We told the market at that time not to expect us to be active in the M&A side. That's how it's played out. We're delivering on those particular promises. Now, we're in the position where we do have strength on the balance sheet in the holding companies.
I mentioned the $2.5 billion, but I do want to stress we have not established that as a war chest. It is not there to go out on M&A. It is really to make sure we have resilience during these unprecedented volatile times. We always said to the market, if we can find a way through M&A to accelerate growth, particularly in capital-light businesses like employee benefits or wealth management, that would be something we would consider. No change in our strategy there. Also no change, the market should expect us to be prudent and disciplined, and that anything we do would complement the existing strategy, would make economic sense, and be value accretive to the shareholders over the long term. There hasn't been a change in our strategy at all.
It is something we always said we may consider, I use the word may consider, if the conditions and the target was right.
Got it. I actually was able to pull in the polling results. It seemed like the favored response was closed block risk transfer. I guess I would like to get your reaction, particularly under the context of current economic conditions. How attractive would that be or unattractive given the bid-ask spread for something like that?
Yeah, I think it's a value point, Tracy. We are well reserved on our VA block, and we are well capitalized, and we have a hedging program in place that immunizes us from changes in interest rates and the market on that particular block. There's no burning platform here, if you like. If there was some value to us looking at disposing of the VA, we're aware that there's a lot of money in the market. We're aware that there have been other transactions. We don't have to do a transaction, but if something came along that was economically attractive, of course, we would consider it.
Okay. Excellent. Just reminding folks that you could submit questions in the Q&A box, and that will be emailed to me. I guess, moving on and staying in the theme of capital management, in a very uncertain market, what gives you confidence in your ability to deliver on your 50%-60% target payout of earnings to shareholders?
I think the actions taken to fortify the balance sheet give us that confidence to deliver on those particular commitments. I think the evidence of that is, earlier this year, we upstreamed $1.2 billion from the life co to the holdco. That's higher than in previous years. It's an uncertain environment, but we do expect to continue to be able to meet that 50%-60% payout. In the half year to date, we've returned $776 million to shareholders. That includes $400 million acceleration we did in 2019. We continue to deliver on what we've told the market. We continue to be in the market buying back shares on a consistent basis.
I think it's the strength of the balance sheet and the management of the organization to the economic realities with the hedge program we have in place that give us the confidence that we can meet that goal.
Okay. Maybe I just want to tease that out a little bit.
Sure.
The $1.2 billion that you divvied up, that actually represents half of your ordinary dividend capacity. Just looking a little bit ahead into 2021, how do you think, just mechanically, you will be able to continue that 50%-60% target. Do you think you would extract the remaining capacity later on this year? Should we be concerned, given there's a one-year lag in that calculation, that you wouldn't be able to have that dividend capacity next year to continue funding payouts to shareholders?
Tracy, two points on that. Firstly, we have quite a lot of excess capital at the holdco now. Secondly, in terms of the ability to take more dividends out of the life co, it's something we're constantly watching with where the markets are now and working with the DFS. I think the combination of the buffer we have at the holdco, plus however markets evolve and our continued discussions with the DFS, I think we remain confident in our ability to deliver on that target.
Great. All right. Let's shift gears a little bit. Is there a silver lining in a period of market dislocation? Where are you seeing opportunities, either on sales, asset allocation, or expenses?
I guess, at these times, myself and the management team, we have to really focus on those things we can control. There's a lot we can't control, but what we can control, we have to be even better at it. We've been very focused on managing those variables. Firstly, you mentioned on expenses. We're on track to achieve that $75 million target I mentioned. We mentioned in Q2, there's about $25 million incremental savings because we're not traveling as much, and all of those sort of normal business activities are giving us a one-off windfall, if you like, on there. I think the other thing that Equitable has going for it, we had this very big program to separate from AXA. There were about 150 different systems, technology platforms we shared that we had to separate.
Our teams have done an absolutely incredible job in not just separating from AXA, but upgrading the technology at the same time. For example, now 80% of our applications are on the cloud. That gives us access to tools, variable costs, and the ability to renegotiate deals, which has really been to the benefit both of our productivity drives, but also our new business initiatives. That's been a real one-off benefit for us. You wouldn't ordinarily do that, we had to because of the separation from AXA, we decided let's leapfrog rather than just replace what we had on there. I think the other area you mentioned on the investment side, earlier in the year, we capitalized on the dislocation in the market. You'll remember we saw very wide credit spreads there.
We were able to improve our yield without compromising the quality of the portfolio. We shifted about $2.5 billion from treasury to corporates and other high-grade quality. We've also taken this opportunity to launch our second funding agreement backed notes as well to improve the yield. Very busy here, focusing on those things we can control, but also taking advantage of the separation from AXA as well.
Yeah. Maybe I just want to follow up on a few of your comments.
Sure.
I know one of your stated objectives was the GA rebalancing.
Yeah.
Even though you met your target, will there be a second round? Is this still a work in progress since you do still have a lot of concentration in government bonds?
Yes. Very much so. The $2.5 billion I mentioned is since we achieved the $160 million increase in the yield. The program continues. If you like, going back to your first question, Tracy, the Solvency II regime had us very, very heavy in treasuries for the reasons you know. There isn't really a recognition of the credit premium in Solvency II. It's good for us in IPO-ing because we've been able to take longer duration and more credit premium into the general account. It's helping boost our growth targets as well. Yes. Very much continuing.
Just piggybacking on this whole theme about being previously under a European parent, Solvency II and IFRS.
Yeah.
I guess in the last number of years under that parent, you really weren't playing in the spread business. You kind of shied away from fixed annuities, for instance. Should I interpret your initial launch of a funding agreement as, I guess, a play into institutional spread business? Was that within your overall risk appetite? I may even expand that to PRTs.
Yes. I think one of the things that we've built under Anders, our CFO, is our own treasury capability, looking at the whole balance sheet. Previously, that would've been done by AXA, of course, now it's done here in New York by our own team. You've seen a number of those strategies coming out. FABN giving us a spread there, I think of 120 bps, if my memory is right. We've been in the market with an issue of preferred stock as well. These are all things you would expect of a modern listed company, they're good revenue enhancers for us as we move forward. Yes.
Okay. Maybe to one of your more traditional products. Equitable introduced the now very popular buffered annuity product to the insurance market in 2010. There's been a barrier of entry to some extent, given the product has to be registered with the SEC, and it seems like Congress is simplifying that registration process. It's a move that actually Equitable supports. I guess I'm wondering, by relaxing some of those rules, are you worried that the buffered annuity moat is drying up around you as new entrants pile in? I guess arguably the pie is getting bigger, but there's also more people chewing that pie.
Yeah.
How do you think your slice is going to look like?
Yes, I think we were the first to market to bring the buffered annuities. Our product is called SCS. That really goes back to our first question, Tracy, which was a look at the market with realism and not hoping that interest rates would come. We saw pre-2008, 6.5% roll-up products, assuming interest rates would be at that level before. Highly dangerous type business. The buffered annuity is a great product. It's a great product for consumers in this low interest rate. It gives them upside potential with some downside protection. Of course, for shareholders, it's perfectly ALM matched. It's got very nice yields in there, and low capital intensity.
It's a real win-win, and this is where I'm urging the industry to get to, is to face realities, because that will drive innovation and drive good solutions for consumers. I think that's what we're in business for, rather than hanging our hat on an arbitrary number, which may or may not happen. With regard to the proposed changes by Congress, the positives are it'll simplify the process, it'll drive down the cost, and increase speed to market. Yes, of course, bring some competition. I think the pie is getting bigger, and you can see that by the industry stats that are going on. I think what's very important to understand, though, is that the products will still be registered and sold via prospectus. I think disclosure and transparency to consumers is really strong here.
Equitable and others will compete based on their offer and based on their distribution footprint, which is something we're used to doing. From our point of view at Equitable, it's a space we're very proud of to have created, and it's a space we intend to continue to innovate into. It's good for consumers, good for shareholders, one of these win-win opportunities.
Great. I guess just piggybacking on the second part of my question on the size of the slice of your pie. Just looking at some market share data, it looks like one of your competitors actually now took the number 1 spot for this product. With the relaxation of these rules that we're talking about, yes, it's still going to be registered. However, it's my understanding that companies don't necessarily have to have GAAP financials, so I'm thinking about mutuals maybe coming in. How do you think about the slice of your pie, given the increased competition and your market standing currently? Maybe just to build on there, sorry.
Sure.
The Dual Direction product, are you optimistic that that might help you regain some grounds in your rankings?
Yeah, very optimistic. We've gathered about $20 billion of funds under management through this particular product. On our retail side, we saw sales up 7% in the quarter, despite all of the disruption caused by coronavirus to the sales process. We have a very strong distribution footprint. We're feeling very good about our position and where we are, and we will continue to innovate and compete as strong as we always do in this place. This is an area where we're very proud of what we've done there, and we'll continue to slug it out with the others. That's what it's about.
Got it. Let's shift gears a little bit on mortality risk.
Sure.
COVID-19 related mortality experience, what makes your insured population less impacted relative to the broader population? What are your expectations for mortality impacts related to COVID-19 in the third quarter?
Yeah. I think you're referring to in quarter two, the impact on us was $60 million, it was below the low side of our guidance previously given. I think that's simply down to the sad fact that the uninsured population, and by that I mean older populations and low income populations, have been disproportionately impacted by COVID. In addition, Tracy, we do reinsure our very large cases, as well. Taking that all into account, we've revised our guidance to $30 to $60 million impact for every 100,000 excess deaths in the U.S. You'll see that's quite a wide range, $30-$60. It's still a very uncertain number, but a lower impact than we at first anticipated. I think that's broadly in line with the rest of the market. I think everybody came in there.
Again, I think it's just this sad fact that the uninsured population has been disproportionately hit through COVID.
One of the polling questions we had was on AB. Could you discuss the benefits of an insurance company having a significant stake in an asset manager? How symbiotic is that relationship, and what opportunities are available for AB to manage more Equitable assets? Likewise, to what extent are Equitable Advisors offering AB funds within the VA sub-accounts?
Sure. For us, the strategic partnership goes back 25 years, so it's very normal for us. I'd categorize it as mutually beneficial. It generates a value for both Equitable and for both AllianceBernstein. Firstly, on the Equitable side, there are both operational and strategic benefits. Firstly, on the operational side, AB is extremely involved and helpful in running Equitable's hedging program, in establishing strategic asset allocation strategies, and is managing nearly all of the general account for Equitable. It provides Equitable Holdings with a diversified, stable earnings stream, and quite importantly for Holdings, it's a non-regulated stream of cash flow as well. We have the insurance company, which is, as you know, and appropriately, heavily regulated. This is a non-regulated stream of cash flow. That's very good. From AB's point of view, Equitable is AB's largest client, approaching 20% of the assets that they manage.
In that regard, it's an anchor investor as we go. I think, particularly in this time when AB is shifting and pivoting its business, it has been fantastic for AB to have Equitable, and before that, AXA, providing seed capital. Seed capital coming out of the general account to help fund growth of new strategies, particularly on the alt side. I think that's a huge benefit for an asset manager and an insurance company to be joined together. This ability to seed new strategies, particularly as we all know, when the active side of the business is under pressure and asset managers are shifting their strategies and their portfolios. Yes, the Equitable Advisors do offer AB funds on the wealth management side.
Yes, we do see opportunities for the two companies to cooperate even closer, particularly on the private client side, and particularly on providing insurance solutions, if you like, to enhance yield and on the estate planning side. They're distinct operations, but mutually beneficial partnership over many years now. We think more to come.
Okay. Do you think you would ever increase your stake in AB?
The last four, five months has been a time when we've been fortifying the balance sheet and finding connections to our clients. We're very happy with the current position we have with AB, and we look at it from time to time. That's all I can really say.
Okay. Maybe just shifting to group retirement.
Sure.
Are you concerned about the impact of school closures in the fall? We're seeing this now on the 403 business. Is there any opportunity to expand to new school districts where you're currently not doing business yet?
On our group retirement, we're the number one provider of supplementary retirement solutions to the K-12 teachers in the nation, and it's something we're very proud about. Something like 1 million educators and administrators rely on Equitable to be able to retire with some dignity. Of course, when the schools all closed, the business model had to change very quickly. I'm extremely proud of how the teams have switched to a digital offer so quickly. In the last month, digital adoption was running at 90%-odd for our group retirement business, which is a fantastic achievement. We also see this part of our business as being, because it's public sector workers, shall we say, more immune to an economic downturn. There's going to be more stability of employment in there. It's a good position to be in.
Whereas sales have come down, we have seen top-ups and retention of business actually improve, Tracy. Our net flows in the last quarter were $216 million, up $52 million. Net, it has been okay, yes, some disruption on the new business side, more people topping up and people staying with us longer.
Maybe throw in another product question. We have about.
Sure
Three minutes left, maybe this will be rapid fire.
Okay.
I think I mentioned a little bit earlier, I think companies now have to think about product design in this new environment, you added a new feature to your Structured Capital Strategies, with Dual Direction. What does that mean for your product? I guess how optimistic are you that it will address customer needs?
It's testing extremely well in the market now, we're very optimistic about it. You mentioned earlier, this is a market where we had a free run for a while, we deserved to because we developed the product. If you have success, you're going to attract other competitors, we need to stay ahead of that by innovating and by the power of our distribution networks as we're going. It's testing well, we're going to continue to innovate. I think that's the way forward, particularly, Tracy, with interest rates being as low as they are. You know, this translates to an even larger retirement gap in the U.S.
We do have to find ways as an industry to address that, I think these buffered annuities are an excellent way to give people upside potential in equities and other indices with some downside protection. It's a really great product for consumers. Consumers need it. American society needs it. It's something where we get rewarded with a very decent margin as well, without putting huge balance sheets at risk. We really like the space that we're in.
Great. We're almost up for time. I guess my last question for you would be any bold predictions you may have for 2021. It doesn't have to be limited to Equitable.
I think I would limit it to Equitable. I think you will continue to see Equitable innovating in a very uncertain market, and you will continue to see Equitable maintaining a very strong and resilient balance sheet no matter what.
Great. I really enjoyed speaking with you, Mark, this morning.
Thanks.
Thank you so much for chatting with us. Take care.
Thank you for the opportunity, Tracy.
Okay.
Stay well. Bye-bye.
Bye