Good morning, everyone. I'm Nigel Dally, Morgan Stanley's life insurance analyst. Before I start, for important disclosures, please see Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, it is my pleasure to introduce Anders Malmström, Chief Financial Officer of Equitable Holdings. Anders, thank you for joining us this morning. Thought a good place to start would be on the recent news events, which have been dominated by the protests and the pandemic. Perhaps we can address the protests first that we've seen in response to George Floyd's death taking place around the country and even the world. I know the issue of racial equality is important to Equitable, so I wanted to ask you how your firm has responded to these recent news events.
Yes. Good morning, Nigel, and good morning, everyone, and thanks for having me at your conference this morning. Look, first of all, as an organization, we are really heartbroken by these recent events in our country and deeply disturbed that injustice and social disparities are still very much evident in America. We have issued a public statement on the recent events where we state that we stand in solidarity with our Black American colleagues, and we pledge to do all we can to combat racism and embrace the diversity and inclusion of all individuals. Mark Pearson, our CEO, he also issued an internal statement sharing the actions that we as an executive management team have committed to, which includes the prioritization of D&I efforts. Within finance, I'm organizing specifically events, and we facilitate them dialogue around race and racism in America.
It's really important for us that we live in an open and transparent society where racism has no place.
I guess the second key item has been the pandemic. Yeah, I think most insurers have talked about the impact from COVID on the second quarter or even the full year 2020. Do you expect any lingering issues from COVID to go beyond 2020?
Yeah, look, I think that's a difficult question in a way. I would say my expectation is that the economic impact will last longer than we hope for. Obviously, we see a strong recovery at the stock market right now, but I'm not sure if this fully reflects the true economic impact. I think we discussed before, the COVID impact, as tragic as it is, all the death cases that we have because of COVID, at the end of the day, I think the economic impact will have the longer impact on all of us. Today it's been hard to say how long this will take. Today we don't have a vaccine, we don't have a treatment, until I think we have that, we will not go back to normality. What you also see is that people adapt quite quickly and organize themselves.
I think that's really the positive. I think we see some offset in the economy and some areas do really well, others will struggle for a very long time. Long story short, I think we will have an ongoing impact that will take longer than we believe, at the same time, I think the economy shows that it's actually strong and can adapt to the environment.
I guess just on the direct impact, you spoke about in Protection Solutions, the estimating approximately $100 million to $130 million impact per 100,000 COVID-related deaths in the U.S. Has that number held up thus far given what we've seen?
Look, I think honestly, it's still early days, even though I think we have the 100,000 and more death count, which I think is very tragic that we got there that quickly in the U.S. Still claims come in, they get reported. Not all of them get reported. Not on all of them it's actually clear why people died. I think we still have to go through that. Long story short, again, I think we stick to our guidance that the overall impact will be in that range, we will give a more detailed update at our Q2 earnings.
Perhaps if we can shift the topic to the issue of capital management. Capital management has been a very important element of the overall Equitable story. I wanted to start first on dividends that you expect to get out of the subsidiary. Obviously, there's been a lot of market turmoil, how has that impacted the regulators' views as to the dividends at which they are comfortable in you getting out of your subsidiaries given the current market conditions?
I think first of all, I think we talked about that many times, as an insurance company, it's most important that you have a strong balance sheet and that you have strong liquidity. These are the key points when you go into a crisis, because that's why we are here. Insurance companies really are here to protect people, to protect policyholders in a difficult situation. Our balance sheet is very strong, our liquidity is very strong, I'm pleased to basically share with you now that we upstreamed $1.2 billion out of Equitable up to the holding company, I think which is a proof of the strong balance sheet, of the strong liquidity.
We might have the ability to upstream more later in the year, as we said before, we really want to make sure that we have a strong life core, we have a capitalization that is above our target. We feel good about that. We upstreamed the upper end of our base case, then can we take it from there.
I guess in terms of the lead to the next question as to capital management plans. You're one of the few companies to maintain your capital management plans despite the pandemic. Given that you've been able to take those dividends out, does that give you additional confidence in being able to continue your buyback plans, or are there circumstances where you will consider suspending buybacks?
As we said before, because we have that strong balance sheet, we feel very comfortable with the economic liabilities we have. I think we expect that we are going to be in the range of the 50%-60% payout ratio. Obviously, the payout of the dividend then gives me more confidence on that. Yes, I think we are very confident that we should expect to be in the 50%-60% range by the end of the year. Absolutely. It is now mid-June, and I think we have to continue to see the environment and see how it goes. So far so good.
I guess one of the things that has kind of played into that has been your hedging strategy. Your hedging strategy, I guess it is a little different to some of the other companies, given that you focus more on the economics. Perhaps if you can just discuss your hedging program and obviously the hedging program did result in a large gain in the first quarter results. Given the strength that we have seen in the equity markets, should we expect a good portion or all of that to kind of reverse in the second quarter if market conditions remain stable from here?
Look, I do not really like to talk in gains and losses on the hedging because I think our hedging strategy is really to immunize, to ride or to manage our economic liability. On the economic terms, it is not a gain and it is not a loss because we basically just neutralize the market impact. Your question is more about GAAP, on the GAAP, obviously we saw a large gain because we have the disconnect between liability and assets, and if markets improve, you are going to see the opposite as we saw in the past. Again, I think this is one of the main reasons why I am really looking forward for the FASB targeted improvements because it brings assets and liability much closer together. It is a fair value framework that really reflects an economic view and reflects the way we hedge and we manage our business.
In our hedging program, we do not really take a market view. We do not take a position. We just want to manage the liabilities to the economics. I think that is what we do. Another point where I just want to mention here is really, you might have seen that the NAIC is also now looking to implement interim solution to reduce the interest rate and reversion to the mean parameters in their new VM-21. As of today, the NAIC framework still assumes that rates go back to 3.5% over, I think, 10 years. That in the current environment, just not right because it basically gives you a free hedge in your statutory framework, which does clearly not reflect the situation. Very pleased to see that the NAIC is moving here, at least with an interim solution.
This is much more in line with how we think we should manage the business by not taking an interest rate view, but just let the market tell us what it believes about interest rates, and that's what we do.
Right. I think we can switch to some of the segments, perhaps starting first on individual retirement. It seems like sales there could become more challenging. Just interested what you're seeing with regards to sales, given the very volatile macro conditions and especially the stay-at-home orders, given a lot of insurance or annuity products have historically been sold more face-to-face.
Yeah, look, I think it's with all difficult situations. I think at the end of the day, we're going to be stronger afterwards than before. I think what's happening right now is here, the digitization of the sales process, of how we reach out actually accelerated drastically over the last few months. Drastically. I think that's really the good news. I think right now, 100% of new applications within our retail distribution can actually go online. No paper necessary. Everything goes through directly. This is a direct result of pushing because of COVID. People had to work from home, people couldn't access clients directly. We've really accelerated digitization here in the sales process. Nevertheless, I think we're still running below normal levels, and we disclosed at Q2 that we're running roughly at about 70% of normal levels, and we continue to see the softness.
I'm positive that at some point it will come back. One thing that you actually see is when you go a bit deeper here is that the experienced advisors, they are actually running at 100%, if not higher. They have a client base, clients are actually reaching out to them because they see a need right now to talk through and maybe do some adjustments. Where we see kind of difficulties are really the younger advisors that don't have that large client base, that still have to find new clients, and they're having more difficulties than to just do that. Finding a new client is more difficult online than maintaining a client relationship. Overall, if I look at SCS, I think we're still up 11% year-over-year, which we reported in Q1, which is actually really great news.
Overall, I think we're still on track even though we see some softness.
Is there anything that needs to change with regards to the products which you offer? The environment, especially as it relates to interest rates, has obviously significantly changed from where we were historically. Does that lead you to kind of reconsider some of the products which you now provide to the agents?
Yeah, absolutely. You see different products work differently in different environments. SCS, our buffered annuity, in a way, is the perfect product for this environment because the caps go higher when you see high volatility, and we have a high volatility environment. Actually the product is more attractive today than in a low volatility environment. At the same time, it's the environment where people actually are looking for downside protection. That's the perfect product for this environment. Other products like our Retirement Cornerstone, which is an income product, it's much more difficult because of low interest rates. The guarantees are coming down, which reflects reality, but obviously from a client perspective, it's less attractive. We also see less demand there.
Yes, that's why it's good to have an all-weather portfolio, where some products work better in certain environments and some not in other environments. You see a shift there. Yeah.
I guess, also with interest rates coming down, has the cost of hedging those variable annuities moved higher as well? Is that something that we need to be considering with regards to the returns that you're generating on your new product sales?
It's less the cost of hedging, because for hedging, particularly interest rates, we use swaps and TRS. We basically lock in a certain level. Obviously guarantees are just significantly lower than with higher interest rates. The perceived value for a customer is just less attractive. If you look at the real value, which is relative to inflation, that's obviously a different discussion, but the perceived value is clearly lower for a customer. It's not because of hedging, it's really just because of the level of interest rates.
I guess if you can move on to group retirement, there's an interesting news article or news release which came out last week with regards to the partnership which you've created with BlackRock. Just hoping to get some color as to what that partnership is and how you expect the passage of the SECURE Act to change the 401 business more broadly.
Look, I think we're very excited about this partnership with BlackRock because it provides consumers here really with a feature that they haven't had in the past. This is really a direct consequence of the SECURE Act. We're able to include annuities within the 401 plans. The beauty here is really that we can now start also showing a solution for the decumulation phase. Traditionally, everybody focused on the accumulation phase to make sure that we have as much money as possible when we retire, but then nobody cares about how you actually decumulate for the rest of your life to make sure that you have enough, particularly if you live longer, which we see people do. Now, together with BlackRock, we can offer the solution where a part of the allocation goes into annuities, which gives you an income protection.
I think this is a strong combination between BlackRock, who is the largest asset manager, and us as an insurance company, I think really provides value to consumers. I'm very positive that the American people now have more options and more ability to plan for the future. Are you still on, Nigel?
There we go. Sorry, I was on mute. I just wanted to-
Oh, okay
I wanted to ask about the teachers. One of the areas that is obviously big for Equitable. You mentioned on the earnings call last quarter that they remain active and employed. I think schools have been out for longer than people expected, and there's some uncertainty as to when they come back. Just some color as to what's happening in that part of the market as well.
I think, as you mentioned, we are the number one player in the 403(b) K-12 market. As you say, I think the good thing is teachers are obviously still employed. I think no issue there. Teachers work from home. The good news is premiums are still coming in. Most of the renewal premiums are payroll deducted. People continue to save money. That's the good news. We actually see less outflows because there's less churn, but we also see less new business coming in. That's really a direct consequence that our advisors don't have direct access to the schools anymore. Traditionally, the majority actually went to the schools and met the teachers and the administrators in the schools. Now, because everybody's working from home and try to figure out this new way of teaching, they're all having more difficulties to interact.
I think we are working hard to find more digital solutions so that we can reach out to the teachers, even though they're not physically in the school. Clearly, that's where we saw an impact over the last few months, that we see less new money and less interactions there. I'm sure this will come back when school's going to reopen later in the year. Overall, the business model is very resilient because, as I said before, premiums are payroll deducted, and obviously teachers continue to be employed. That's a positive there.
That's not as big of an issue today, but has been in the past as to where fee rates, in the group retirement market are going. It remains somewhat of a fragmented market. There's been some concern about the fee rates as to where they would likely head going forward. Any update there? Has the turmoil put any pressure on fee rates, pushed that out to the future, or is that still an issue that we need to be keeping an eye on?
I wouldn't say that there has been any change. Look, I think the one thing that's really important for everybody here to understand, this is supplementary pension that we provide to the teacher. It's a B2B2C sales process. Once the school district decides to go with Equitable or whoever, then the provider really works closely with the individual, and it's really an advice-driven product. It's really very tailored to the individual need of each teacher, of each administrator in this business. I think that's why it is a bit more intensive from an advice process. That also reflects in some higher fees. Overall, I think people understand that this is a really good product that really provides value in addition to their DB scheme that they already have in the school district. There haven't been any other discussions there.
I think it's still very appreciated.
Okay. I just highlight to the audience that, if you did want to ask a question, we would be happy to take it. You can just do it on the web. As questions come in, perhaps next area, investment management. A lot of investors would argue that the value of AllianceBernstein is not reflected in your current stock price. I certainly would. If this continues, what are the potential actions you could take to potentially unlock some of that value, or are the firms too intertwined to really make those kind of changes?
Look, I think we continue to emphasize that I think we work well together. We're well connected, from a business perspective. I think we have about 70% of our general account with AllianceBernstein manages about 30% of the separate accounts. At the same time, AllianceBernstein benefits from us seeding new investments into AB. I think this is a good story that we continue to talk about. Also at the holding company, I think we like the unregulated cash flows coming from AB. I think over time, I think people will realize that, and I hope, I'm the same opinion as you, but I hope that at some point this gets better reflected in the stock price. With regards to the ownership, I think 65% is not a magic number.
I think we feel good about where we are today, but we always take a look at, is there anything we should change right now? We feel comfortable with that. It's not top of priority. Right now we have other priorities, but it's definitely something we continue to explore and see if we should change that.
Is that exploration of potential alternatives something on the docket for this year, or is it more likely to be pushed out to next year given the turmoil that we're seeing, developments here?
Yeah, I would keep that open right now. I think we just have to continue to monitor the environment here.
Okay. I guess, just on the flows for AB, you mentioned that you're seeing net inflows. Can you talk where that's coming from, where you're seeing those sort of inflows and perhaps which are the areas that are a little weaker?
Yeah, I think I would refer to the disclosures of AB, and I think they will soon come out again with the AUM numbers, I think in the next few days. Basically what you saw is a sum of the rebound of what happened in March, where you had large outflows. I think it reversed back over the last few months. I think overall still a good flow story at AB. They will soon come out with new updated numbers there so that you have all the details.
Okay. On the investment portfolio side, you had a portfolio repositioning strategy. Given we've had a fair amount of turmoil in the market, a lot of it's reversed, but certainly it was a very volatile first half of the year. Did that lead you to consider additional actions beyond what you'd originally envisaged as part of that initiative?
Yeah. Look, absolutely. I think the last three months were quite interesting and tricky, at the same time, I think we saw the market come back. You saw credit spreads spike in March. Obviously where we are with our general account portfolio, we feel very good. We have a conservative portfolio. We also use that as an opportunity to actually take that as an opportunity to go into more solid credit opportunities at elevated spreads at that time. We took that as an opportunity. At the same time, we also risk managed some of the portfolio where we were still able to. In other words, we did offense and defense at the same time, which I think puts us in a better position now. I think we continue to optimize to cheer here in a positive way.
I guess one of the areas that people have been concerned about has been retail and hospitality. Perhaps if you can just spend a moment on your exposure there, especially with regards to commercial mortgage loans.
Yeah. On the CMLs, we have a very small exposure to hotels. It's about, I think about 5%. Overall, our CML portfolio is running very well. It has probably an average to lower average loan-to-value, but very experienced team there. If I just look back to during the last crisis, we didn't have a single loss there. Even now, I think we feel good about it. Obviously, I think every crisis is different that we have to go through it. Right now, I think we feel good in that portfolio.
Okay. Last question from me, unless there's any questions that come through on the web. One of your goals has been the 8%-10% operating EPS CAGR. Clearly, this has been a very abnormal year. As we look forward to 2021, are those kind of targets, those longer-term targets that you discussed with us still achievable?
Look, I think, the way I would look at it right now, in the short term, we don't give any guidance, any targets, because as I said, it's really important that you maintain your strong balance sheet and liquidity, and we can fulfill our obligations that we have to clients. Longer term, I think this is our target, 8%-10% EPS. That's the stated target, and I think we're committed to that target, and we will continue to work hard to achieve that target.
Okay. Well, I don't see any questions coming up on the web. We can go and end it there. I'd just like to thank you for your time this morning, for running through that, Anders. I really appreciate the overview. From our perspective, Equitable is our top pick in the life and annuity industry. Continues to be a very strong risk reward. Any questions that you have, feel free to reach out to us. We'll leave it there. Thanks a lot, everyone.
Thank you, Nigel. Much appreciated.