Afternoon, everyone. I'm Ryan Krueger from KBW, and pleased to have Equitable with us this afternoon for our virtual conference. Representing the company is Anders Malmström, who is Chief Financial Officer. Just a reminder that at the bottom of your screens, you will have a box to submit any questions you have as we go through this. To kick it off, Anders, when Equitable IPO'd in 2018, you provided several 2020 financial targets. With six months left, or less than that now in 2020, can you review your progress towards achieving those targets and what has either gone better or worse than you had originally anticipated?
Yeah. Good afternoon, Ryan, and good afternoon, everybody, and thanks for having me. Look, I think it's a good question. When we came out a couple years ago with the IPO, we put out a number of targets. It was about growing the business. It was about productivity and then optimizing capital. I think where we are today, I actually feel very confident that we are right on track to basically achieve most of them, if not all of them, even though we had some difficulties along the path and just most recently with the COVID crisis, which clearly impacted the economy severely. Overall, I'm very happy where we are. From an earnings growth, I think we had decent earning growth over the years. This translated then into cash that we were able to bring back to shareholders over the last few years.
We have a range that we talk about, 50%-60% of operating earnings. Well on track to achieve that. Even so this year, with all the turmoil, we are still on track to achieve 50%-60% payout. For the more specific targets that we had, mostly the general account rebalancing. As you know, we already finished that program by the end of last year. We're still working to optimize the GA, obviously, since then. Also on expenses, where we put out a target to achieve 75% net saves. I think we're well on track to achieve that by the end of the year. Overall, I'm very happy with the progress despite the very difficult environment. Now going forward, obviously with LDTI coming, this will be kind of an inflection point to update all the targets.
Until then, I think what I can expect is that we're going to continue the course and have similar long-term targets. Over the short term, we suspended any guidance just because of the crisis we are right now. Yeah, I think with that, I think we're pretty much on track.
Thanks. Following up there, as you do develop your future plans, can you go into what the company's key strategic objectives are going forward? I guess, do you expect to provide new financial targets if the environment improves, but ahead of LDTI?
Yeah. Look, I think first of all, during this crisis, I was very clear in all the presentations and talks we had. Focus in this environment has balance sheet and liquidity. That's what each life insurance company needs to make sure to be able to fulfill our promises to policyholders and shareholders. I think that's what we did. As I said before, I think once we get through this crisis, I have to go back to kind of normal. We will be in a new normal, but we'll go back to targets similar that we had at the IPO. I would say from now till the end of that period and to the LDTI will then change that. We will have similar earnings growth in the long term.
Short term, as I said, focus more on balance sheet and capital, but then after we have LDTI, we're going to come back with new updated targets that will reflect the change to LDTI.
Got it. Maybe delving into your economic model, you've stressed that the company manages to an internal economic model. Can you elaborate on that more and also touch on some of the key differences between your internal model versus GAAP and statutory accounting?
Yeah, absolutely. Look, I think for us, it's really a cornerstone that we manage the company on an internal economic model. It is really a fair value-based economic model, which means we have both sides of the balance sheet, the assets and the liabilities, and mark-to-market. Important really, when you look at the economic balance sheet is really that, particularly on interest rates, where we just use the forward curve as the reference rate, so we don't have any interest rate assumptions that are reverting back to a mean. That's by far the biggest difference between the statutory framework and in particular on the GAAP side. Both of them have a reversion to the mean assumption. Statutory is given by the regulator, which has a kind of 3.5% reversal over the next 10 years.
On GAAP, we actually reduced our long-term interest rate assumption significantly down to two and a quarter. I think, which is much lower than the rest I've seen. Two, basically I'm signaling that reversion to the mean is not the right approach. We have to have realistic assumptions for interest rate because our liabilities heavily depend on these, and we really want to be in a position to be able to commit to our promises that we make to our policyholders.
Sticking with that topic, there were several positive aspects of the NAIC's variable annuity capital reform, but they kept the prior interest rate generator that reacts pretty slowly to the current interest rate environment. What is your stance on that interest rate generator? Are you in favor of it being revised? What is happening at the NAIC in that regard?
Look, I think first of all, as we say, I think overall, we're pretty happy with the VA reform, the NAIC reform VM21, because it really moves towards a more economic framework. As you said, I think the one item that really stands out is really the interest rate generator. Today, interest rate generator still generates scenarios that all of them, all 1,000 scenarios, are actually above the current forward rate, which doesn't seem right. I think that's why we really support the NAIC in that regard to update the interest rate generator and make it much more realistic. From that perspective, we really like that, because otherwise you are going to get a false sense of security because your liability just don't reflect the reality. We're very supportive of that.
Do you have any sense on the timeframe where this may be revised and I guess any interim steps that the NAIC may consider?
Yeah, I don't have precise dates here. I know that the NAIC is working on two fronts. One is really the long-term update of the generator, really make it a sustainable generator. Then they're working on some short-term intermediary steps, which I think at least they want to make sure that the companies test and then show to the regulators. I don't know exactly on the timing where they are.
Got it. You've discussed that your variable annuity business, you feel like is fully hedged for interest rates. At least from an in-force cash flow standpoint, are you truly agnostic about what interest rates do from here?
Yes. I think if we really look at the in-force, we fully immunize the interest rates, which means whatever interest rates do, the balance sheet moves up and down in parallel. We are not sensitive to interest rates. I think that's why also we believe if we would then change to the new generator, at least from an interest rate perspective, it should have very minimal impact on our statutory balance sheet. Yeah, absolutely.
Could you expand on that a little bit? That has been one question I've received is, in general is, if you reflect a lower interest rate assumption, it would seem like that would still increase your statutory reserves, or total asset requirement. I guess what would be the offset from a statutory standpoint for you that would negate the impact?
Right. I think the way we look at it, I think the way it would then manifest itself is obviously the pre-hedge reserves would go up because you reflect then the lower interest rates, at the same time, you get more interest rate hedge credit because you're hedging interest rates. Because we already hedged these interest rates, we believe this should be pretty neutral, everything else being equal.
Got it. Okay. Sticking with, I guess, legacy variable annuities, can you discuss how much of a priority a de-risking transaction is for the company now that you're fully independent?
Yeah. Look, I think first of all, I think you're talking about our older and accumulated book and legacy book or fixed rate and accumulated book as we talk it. As we said before, from a reserving and from a capitalization standpoint, I think we're well reserved, very capitalized. This book is generating significant cash flows. We are in a very good position. We don't have to do anything here. I think the question is more because we believe that the public is kind of discounting this book relative to our internal valuation. Could a reinsurance transaction, in our case, it would have to be a reinsurance transaction. Could that actually create value for shareholders? That's the question.
I think our position was very clear on that since a while, is that if we would get to a deal where we would be able to get close to our economic value that we internally attribute to this business, we would be definitely very open to that, but we don't have to. We're not in a position where we have to do any transaction. The other thing we just have to keep in mind, because in our case, it has to be reinsurance. We would have to be very comfortable with the counterparty because that basically becomes the risk once you do a transaction. It's more a counterparty risk than a business risk.
How do you assess a situation where the transaction you think would be above the public market value today, but somewhat below your own internal view of the economic value? I guess, is there a compromise in between those two points that you'd be willing to do? Or do you feel like a transaction really needs to be very close to your own economic value estimate?
Yeah, look, I would say, and obviously this is a hypothetical question, but I would believe the transaction has to be close to the internal economic view. Look, and that's true with each and every reinsurance transaction. It creates certainty. That's why you can attribute some value to that. That's basically the difference to your own internal economic value, which still has some uncertainty because the world can change in the meantime. Yeah, I think it has to be close.
Okay. You recently issued $500 million of preferred stock. Can you discuss the motivation for doing so, and then how you're thinking about the leverage targets overall at Equitable?
Right. Look, I think when we IPO'd, we basically had two sources of capital. We had common equity and we had common debt. I think what we tried to do over the years now is really to diversify our capital and capital base. We did that. When we first issued preferred equity, I think it was end of last year, which was really retail and preferred, and this time we used institutional preferred really to diversify our capital base. At the same time, it was a bit opportunistic because market conditions are really, really strong right now. We're very happy with the outcome. Primary focus is really higher diversification. Now, to your question about the leverage ratio, where we want to be, I would say we want to be somewhere in the mid-20s.
Obviously, I think because it's GAAP driven, we always have to be conscious about the GAAP book value that is also driven by the hedging program. Long term, it's mid-20s, and short term it can vary. I think at the end of Q1 we were actually at 19% just because of the mismatch between hedging and the accounting. Mid-20s.
How do you assess leverage in the context of LDTI? Because your GAAP balance sheet will change meaningfully after LDTI. It would seem like traditional targets might become less relevant. I don't know how far along the rating agencies might be in this, but how do you think about that?
Look, I think the first question is, just because you do an accounting change, economically nothing changes. Your economic leverage ratio would not change. Under that aspect, I don't expect that rating agencies would act immediately just upon once you apply LDTI. Obviously, I think it would then show maybe new differences between companies, because every company reacts differently to applying LDTI. I'm not overly worried. I think it's something we clearly monitor. Just in our case, look, I think we already took a step even though it wasn't LDTI, but just taking the interest rate assumption down to two and a quarter early in the year, was a meaningful step towards more realistic assumptions, which LDTI goes to the full fair value for the annuity business.
Got it. I guess after the preferred issuance, if I just do pro forma, your holding company would have about $2.5 billion of liquidity, I believe. Should we continue to expect the 50%-60% capital return target despite this? Or do you feel like you have potential capacity to do more than that over time?
Yeah, look, I think first of all, I think as a CFO during a crisis, I feel very good about having that much cash at the holding company. It just makes me sleep much better than otherwise. Overall, I think we're in a good situation, clearly, we want to make sure that we can get through this crisis in a safe way. By that, having more cash than usual at the holding company is really what we try to achieve here. Overall, I think we committed or we confirmed the 50-60 payout ratio as the right range. Going forward, we sometimes do tactical accelerations of buyback like we did last year with AXA when they sold down or like we did a bit in Q1 when the share price was lower.
Overall, I think you can just expect us to stay the course here, because we still have to monitor the economy, make sure that we are safe, and we're not through that crisis. We're not through the health crisis, we're not through the economic crisis. I would argue we're still on life support by the Fed from an economy. I think we have to be very cautious before we use cash again above what we see going forward.
Got it. About a year ago, you started talking about doing a strategic review of the 65% ownership stake in AllianceBernstein. I think you commented that that's probably a bit on hold now given the environment. Can you give us an update on how you're thinking about your stake in AllianceBernstein, and if there's any sort of timeframe that you'd like to make a decision one way or another about how you'd like to move forward there?
Look, I think in our ownership of AllianceBernstein of 65% is maybe not a natural one, but it's a good one. I think it's to the point, natural, it's not maybe how you would start a relationship. Because this relationship is very old and very strong, and since, I think, since the beginning that AB was kind of created, AXA, now Equitable, owns 65%. It has been this situation for a very long time. Having said that, I think we always have to assess, is it the right ownership structure? Should we increase it? Should we decrease it? Should we change something else? We clearly decided for the time being, I think the focus is really not on AB ownership. Focus is on managing the company through that crisis. For the time being, we keep the 65% as is.
As you know, I think we have a strong relationship with AB. Both companies, Equitable and AllianceBernstein, really benefit from each other. On one hand, AB manages the general account. At the same time, Equitable seeds new investments into AllianceBernstein. I think last but not least, we get unregulated cash flows to the holding company out of AllianceBernstein, which is very, very helpful, in particular in times of uncertainty. You get this amount of cash without going through a regulatory process. Overall, I think we're in a good position, and we don't see any need to change that in the short term.
Got it. The M&A was not part of your initial three-year plan post-IPO. As we do get closer now to a new planning period and you're fully independent, is M&A something that you'd consider more? Are there any particular lines of business that you're interested in?
Look, I think we were very clear when we came out of the gate with the IPO that M&A is not an option. We want to make sure that we gain credibility in the market, we get traction as a management team, and we're really able to show that we can organically grow that business. I would say after the two, three-year period where we've shown that, I think M&A becomes part of the game, and we will start monitoring the landscape and see if there are areas where it could make sense to do acquisitions. I think two areas I just want to highlight, businesses that we are growing internally. One is employee benefit. We started an employee benefit greenfield business a few years ago. It's actually growing really nicely. We have a nice track record.
In the grand scheme of the overall company, it's really not material. In order to make it material, I think an inorganic boost to that business would really be very helpful. We're going to do it in any case, but that's an area we would like to accelerate that growth because we really like that business. The other area is what we call wealth management or broker-dealer business. We have about 4,500 advisors within Equitable Advisors that are solely focused on wealth management broker-dealer business. It's really a nice growing business. Again, it's not really material that we could talk about it as a separate segment. That's also an area we would like to grow faster, and I think inorganic growth is a way to grow faster. Just two examples where M&A could really help and boost our strategy.
Given that you haven't done M&A as a public company, at least, are these opportunities where you'd be considering pretty small bolt-on deals? I guess, would you consider something more meaningful in size if there was an opportunity?
I don't think we would limit ourselves here. I think what I would say here is it would have to make sense. I think we're going to be very disciplined with what we do. We won't do anything where we would put kind of the franchise at risk. M&A is always important that you also then do the integration well. I wouldn't limit ourselves here to a certain size. I think that would limit the opportunity. Yeah, can be both.
Got it. In the annuity business, we continue to just have more and more companies that are launching buffer annuity products. Are you seeing much impact so far to the competitive environment from these new competitors? How much of a concern is this longer term for you?
Look, I think first of all, the buffered annuity and Equitable was really kind of the, I would say, at least on the insurance side, I think we really created that business, we created that market, and we attracted competitors to that market, which is a good thing, because the market in itself grew over the years, when new competitors came in. Having said that, I think it's now really visible that people see that as a very attractive area. I have to tell you, it's probably the best product in this environment. I think you participate in equity markets up to a certain cap, and you have downside protection. In particular, in volatile times, your cap even becomes higher. From a value proposition, this is really the product you as a consumer want to buy.
At the same time, as a manufacturer, you can fully ALM match it, because we're going to reprice it every two weeks. There's no ALM risk, fully locked in. It's really a good product. I think many competitors saw that as well, and got attracted to that. It's getting more crowded. At the same time, I think competition also boosts innovation. I think we continue to make sure that we're always a step ahead here, by adding new features like what we did with Dual Direction, which is a nice feature that in particular differentiates us from just the normal buffered annuity. Yeah. The strong distribution relationships we have will help us in this environment. It is an area that becomes more competitive.
I think you and everyone else that sells this product has certainly been very positive and kind of comfortable with the return profile in a low interest rate environment. What do you view as the biggest risk to earning targeted returns in the buffered annuity product?
Look, I think, again, as you say, this is a product that you can lock in at point of sale from an interest rate exposure. Hedge the guarantees or the buffer with the cap. I think from that perspective, you have zero risk. I think the biggest risk is really just the business risk, that you get less new business and people roll off. I would say that's by far the biggest risk, just through competition. I think that's where you have to make sure you're always a step ahead with the smart innovations.
You have recently become somewhat active in the funding agreement market. What led you to do that, and how meaningful do you see that opportunity?
Look, I think the funding agreement area is really a nice addition to what we already do today. I think it leverages really our existing expertise at generating spread-oriented income at very minimal cost. We can really leverage here the relationship we have with AllianceBernstein. It has no impact on the other businesses. It actually helps. In addition, with this funding agreement-backed notes, we can also use that for duration management, because you can go longer or shorter on your assets based on your liabilities and really take a global company view where you want to go from a duration management perspective. It's an attractive additional opportunity. It will never become dominant in our case. I think it's going to be a nice addition here to the existing platform.
Are there any other new product areas that you're considering? At one point you talked about fixed annuities. I think given this interest rate environment, it didn't sound like that was that likely, but any other thoughts on any new product areas?
Yeah. Look, first of all, we have to make sure that all the existing products really work in that environment. I think most of them do. About 85% of our new business offering is not interest rate sensitive. The other ones we have to adjust. Some products become less attractive in a low interest rate environment than would become more attractive if rates would go up again. I think FIAs is something you just mentioned. Definitely not on top of our list today. I think for us, it's more important to really grow the existing one and then add features, as I just said, on the buffered annuity. Make sure we really fulfill the client's needs. I think we have a pretty full product offering, but there's always opportunity, but nothing right now that would jump out like FIAs.
Since the pandemic has begun, you've pretty consistently talked about new business levels running at about, I believe, 70% of normal. Is that still in the ballpark of what you're seeing now, or have you seen some improvement as the economy has started to reopen some?
Yeah. Overall, what we said is always the new business is somewhere north of 70%. I think that's true for the total company. If you actually go deeper, you see some differences. It's very encouraging, because if you go, let's just focus on Equitable Advisors. What you actually see there is that the experienced advisors, they're running at 100%, if not higher. I think they can really benefit from the strong relationships with their client base. There's tons of interactions between them, clients and advisors, which really shows the value of advice, and particularly in a volatile environment like we are right now. Now they do all of that virtually, we don't really need the physical presence there, and they do it very successfully.
The areas where people have more difficulties, really, in finding new clients, and that's where the younger advisors then just struggle a bit. Because it's more difficult to find a new client than just interact with existing client. Also, take the example of group retirement, where we are very dominant in the K to 12 educators market. It's obviously very difficult for them to interact when schools are closed, because traditionally they were going into the schools, talk to the teachers, talk to the educators. Now they have to do all of that through digital media. Which I think they successfully are in the process of transitioning, but that's still something that will take some time. At the same time, we were actually able to increase our overall net flows. We see less outflows, and that's clearly also a consequence of the advice that we're giving.
We also see higher contributions from the existing clients during that period of time, which clearly also is a consequence of the advice, I think the interaction that we see between advisors and clients. It's a mixed bag. Yes, overall, maybe it's running lower, but overall, from a flow perspective, I think we see very encouraging development.
On the second quarter call, I think you talked about you've seen some expense benefits in the near term due to the current environment. I believe you also said you thought some portion of that may be sustainable. Can you just talk a little bit more about what opportunities you're thinking about that are emerging from this environment from an expense standpoint?
Right. Look, as I said in the beginning, expenses, and we had this expense plan that is just finishing now with the $75 million. We were actually starting to think about the next phase of expenses, then COVID hit. As you said, in COVID- As difficult as it is, it also created some opportunities that will stick and will not just go away once the COVID goes away. One is clearly on the real estate. I think we all experience it now, a different world, and we have to pivot very quickly with working from home, and we see how efficiently it works. Just this conference now. In the last few years, I attended in person. Now we do it from home, through BlueJeans or Zoom or whatever, and it works pretty well. It's very efficient. People don't have to travel. We can switch rooms within seconds.
You don't have to look for your room. Where is it? That's kind of also how we work. Yes, I think everybody wants to go back to the office sometime, probably not 100%. We're really thinking hard how we can optimize our real estate footprint by adding more value and saving money. Probably reducing the footprint, save money, at the same time, make the environment really cool that people want to come in for two or three days a week. They can also work from home, which gives everybody a lot of flexibility. That's clearly one area. We have been in a fortunate situation that our leases are coming up in a few years, not too long, so that we can really now get some saves there. The second one is travel.
Obviously right now nobody's traveling, travel will come back. I don't expect that travel goes back to where it was before, because again, I think for the same reason with the technology we have today, we can meet easily without flying for a one-hour meeting or two-hour meeting across the country. This is a save in time and it's a save in money. That's just two examples where we see benefits. Overall, I would say the digitization has accelerated during this crisis. We have many examples where it took us a very long time to get to the kind of digital adoption. Now within weeks, people adopted it and much more happy in using the digital version than the paper version we used before.
We see a number of benefits here from the situation that just accelerated a trend that was already there.
Great. Moving to your group retirement business, I feel like not much gets asked about it because the results have been so stable and good over time. How is the economic environment and interest rate environment impacting that business? What do you view as the biggest risk to results kind of continuing in this stable growth range?
I think first of all, we believe that the public sector is more immune just to the economic downturn, and that's why we continue to do business in this space. We clearly see that. Teachers had to work from home, but teachers didn't lose their job during this period of time. Specifically in this area, as I said before, I think we really have to pivot to digital media. Make sure we have a way we can reach out to the teachers, to the administrators, because as I mentioned before, traditionally this was a work site marketing model, where the advisor really came into the school and approached and talked to the people and advised the people in the school. This is now something that they have to change.
Other than that, look, I think this environment made it even more visible that people need to save for retirement. Lower interest rates makes it more difficult. Advice is important, and I think that's what really our advice model tries to achieve, to make it visible for people and help them to close the gap they have between what they already save, let's say through their mandatory pension they get, to what they actually need when they want to retire.
Got it. Your protection business, it's following your interest rate assumption change. It's in loss recognition again. Can you help us think about, I guess, the rough earnings power of that business now that it's in loss recognition, and do you see a path to exiting it again, exiting the loss recognition status again over the next few years?
Yeah. Look, I think the life business or the protection business is probably the one with the largest headwinds that we have in our portfolio, in particular from an accounting perspective, because as you mentioned, with the lowering of the interest rates, we fell back into loss recognition. Logically, you would assume if you take a more conservative approach and take a charge, it actually helps going forward, but that's not the way the accounting works right now. Look, if nothing changes drastically on interest rates, we're going to be in loss recognition until LDTI comes. With LDTI, this is a new methodology, and we will be kind of mechanically out of loss recognition. You will again see the real kind of contribution of the protection business. Until then, it will just be very volatile.
What I can tell you is overall, the underlying economics are strong from the protection business. Protection business in particular benefits from the general account rebalancing that we're doing and from the expense saves we're having. It will just not come through in the short term as long as we are in loss recognition. Longer term, it actually does, and it will be a nice contributor to the rest of the company.
In regards to the general account, the invested portfolio was very conservative at the time of the IPO. You completed the first round of repositioning. Do you see more opportunities to make further tactical changes in the portfolio going forward that could provide some further uplift?
Look, I think the first, call it the first round or the first project with the $160 million uplift, was really to reorient the general account to a more U.S.-oriented general account, because being part of AXA Group, we were really subject to Solvency II, which really penalized credit, in particular long credit. That's what we did. We really increased our exposure to credit, in particular longer-term credit, but mostly public credit. What we're doing now is we're further optimizing the general account and go further more into private credit structured products with a sound risk approach. I think you get some uplift there. As an insurance company, I think we have the benefit of being able to invest really long-term and in illiquid asset classes.
I think that's kind of the next step here that we're doing, really, optimizing the general account and going more into illiquid asset classes. Overall, we also took the opportunity now to de-risk by selling what we call potential fallen angels. Because as I said before, the credit is probably still on life support from the Fed and is artificially untied. We used that also to de-risk from titles where we were not sure if they're good in a more volatile credit environment.
We have a couple minutes left that I was going to address a couple questions from the audience. One was, to what extent do you think there's risk if there's a change in the political administration, for a return of the DOL fiduciary rule, and how would you think that could impact the company?
Yeah. When looking at what could come from a change in administration, I think it's definitely 2 areas. One is what you just mentioned, the fiduciary rules, and one is tax. With respect to the fiduciary, what has happened since in the last 4 years is really the DOL rule has been unwind. At the same time, we now have Reg BI, under the SEC, that has been put in place, which really puts kind of best interest, where it should be under the SEC, because the SEC is really an institution that can enforce ruling. Our criticism on the DOL was always about enforcement. That was the main criticism. Obviously, it's hard to oppose best interest for clients. I think that's something that should always be in the center of an advice and what an advice gives to clients.
Yes, I think that there is a risk that the DOL will come back and impose some additional fiduciary rules. We don't know exactly where this is, but we hope that now with the SEC, I think the SEC would really take over that instead of the DOL.
Got it. Then the other one was, what's your comfort level with your variable annuity policy holder behavior assumptions at this point?
Look, as I said before, I think we believe we're well-reserved. I think we're monitoring, obviously, the assumptions on a regular basis. We update them based on what we see. I feel very comfortable.
Great. We are out of time. Thank you very much, Anders and Equitable for participating.
You're welcome
again this year, this time virtually. We'll wrap it up there.
Okay. Thanks a lot.
All right. Thank you.
Cheers.