Morning. I'm Jay Gelb from Barclays. I cover the U.S. insurance stocks. It's our great pleasure to have AXA Equitable CEO Mark Pearson with us today. Mark has been in this role for nearly a decade. AXA Equitable comprises two well-established franchises, those being AXA Equitable Life Insurance, which is among the largest U.S. providers of life insurance and annuities, and also majority ownership in AllianceBernstein, which is a leading asset manager and research firm. With that, it's my pleasure to turn it over to Mark Pearson.
Thanks, Jay. Thanks, Jay, and good morning, everyone. I'm delighted to be back here again at the Barclays Global Financial Services Conference, and I'd like to thank you all in the audience for attending. Before I begin, I'd just like to note that some of the information I present today is forward-looking, and I'd point you to our website and the SEC filings for all necessary disclosure. I'm conscious that we are joined today by investors who know our story and some organizations that are new to EQH. I thought to be helpful, I'd cover both recent performance of the company since the IPO in May 2018, and I'll also give you a quick overview of our strategy, financial targets, and key differentiators. Then I think Jay and I sit down for some Q&A.
Here on slide three is a quick update on the journey we've been on in transforming from a major subsidiary of the AXA Group to an independent listed U.S. company. At the time of the IPO, we set out clear financial targets for the organization to 2020. A key target was growth, and we are on track to deliver 5%-7% non-GAAP operating earnings growth annually. Throughout our first 16 months or so as a public company, a key differentiator of ours has been our capital management program, and in particular, our ability to deploy cash generated from our businesses. Since the IPO in May 2018, we have returned approximately $1.7 billion to shareholders in the form of quarterly dividends and share repurchases, which includes nearly $900 million so far in 2019.
Earlier this year, we announced an $800 million share repurchase program, of which $200 million remains, and an increase in our quarterly dividend by 15% and an upward revision to our target payout ratio to 50%-60%. We believe this is a unique part of our value proposition, reflects the strengths of our results, and confidence in our ability to continue to deliver value for clients, partners, and shareholders. Overall, the business has performed well, generating 15.9% non-GAAP operating ROE in the second quarter of 2019, in line with our mid-teens target. Finally, we have maintained our financial discipline and the strength of our balance sheet across mixed macroeconomic environments. We ended the first half of the year with VAA capitalization levels in excess of CTE98, bolstered by the effectiveness of our hedging program and a combined RBC ratio of approximately 675%.
We're encouraged by the momentum of the business and confident in our ability to continue to deliver on financial targets. Those are some of the highlights from our journey over the last year or so. I thought it'd be helpful if I provide a quick overview of EQH. Here on slide four. Although we've been publicly traded for a little over a year, AXA Equitable is not a new company. We've been around for 160 years providing advice and solutions to help our clients retire with dignity, protect their families, and protect their financial futures. We have more than 12,000 employees and advisors, and as Jay mentioned, we operate through two complementary, well-established franchises, Equitable Life and AllianceBernstein. Through these businesses, we manage $691 billion of assets under management, and in 2018, we generated over $2 billion of non-GAAP operating earnings.
These figures help to underscore that AXA Equitable Holdings is one of the most prominent life and retirement companies in the U.S. Listed under the ticker EQH, AXA Equitable Holdings comprises of 1, 100% ownership of AXA Equitable Life, which serves 2.8 million clients with individual and group retirement and Protection Solutions. 2, a 65% stake in AllianceBernstein, the major global asset manager with a presence in 25 countries and $581 billion of assets under management. Although our subsidiaries are distinct businesses, they've grown up together, are strongly connected, and complement each other well. For example, at the end of the second quarter, AB managed 73% of AXA Equitable's general account, over $65 billion of assets, and approximately 30% of the separate account, another $37 billion of assets. AXA Equitable Life is AB's number 1 client by AUM.
AB also provides deep expertise for our hedging program and asset liability matching and adds value to us through market leading investment performance. In return, AXA Equitable provides a source of seed capital for new product development, which has been a key part of AB's recent success. As shown here on slide six, our strategy is supported by initiatives designed to grow our business, drive productivity, and optimize our capital. Underpinning this and ingrained in everything we do, is our commitment to disciplined risk management and having a sound people strategy built on a culture of inclusion, professional excellence, and continuous learning. I'll use this presentation to expand on these strategic priorities and share progress on our near-term financial targets.
First, I think it's important today for me to be very clear with you about what sets us apart from other financial services firms and why we are confident about the future. In essence, we are differentiated by the breadth of our business model and the strength of our balance sheet. Included in this presentation, I'll illustrate these five points shown on slide seven that we believe differentiate us. On slide eight, you can see that our strategy is to be focused on markets where we have scale and competitive advantages and can get attractive returns on the capital invested. We are the number 3 player by sales in the $90 billion variable annuity market. We have strong relationships with third-party distributors, such as banks and insurance companies, who are drawn to our innovation in manufacturing accumulation and income in retirement products.
On the group retirement side, we are the number 1 player in the U.S. 403(b) K-12 educators market. Here we have a unique value proposition for the market, advice at the worksite. We're proud to serve over 1 million teachers, public sector employees, and small businesses with supplementary retirement products. I'm sure as everybody knows in the room, we trace our heritage back as one of the earliest life insurance companies in the country. Today, we play in select parts of the market and are the number 3 player in the VUL accumulation space. Finally, AllianceBernstein's deep commitment to research excellence is reflected in superior investment performance. 81% of AB's U.S. retail assets were four or five-star Morningstar funds as of the end of 2018.
In addition, the depth and global presence of AB's distribution and best-in-class sell-side research, I believe sets them apart from other asset managers. Turning now to earnings on slide nine. AXA Equitable Holdings generated $2.1 billion of non-GAAP operating earnings, excluding the impact of assumption updates across our four business units over the 12-month period ended 30th of June 2019. Our biggest contributor, as you can see, is the individual retirement business, which generated $1.5 billion of trailing 12-month operating earnings from $104 billion of account values. In the second quarter of this year, the pre-tax return on assets for the business was 173 basis points, and our return on capital was approximately 22%. Our group retirement business currently manages $36 billion of assets and generated $377 million of trailing 12-month operating earnings, 15% of our total.
The pre-tax ROA in this business was 138 basis points, and ROC was 32% in quarter two. AB, as you can see, provides AXA Equitable Holdings with 15% of its operating earnings, with average fees of 41.2 basis points, giving rise to an adjusted operating margin in the half year of approximately 25%. Protection Solutions is our individual insurance and nascent employee benefits business, which generated approximately $242 million of trailing 12-month operating earnings, nearly 10% of our total. Looking forward, one major asset that sets us apart and the key to our ability to generate future earnings is our distribution platform, which I illustrate here on slide 10. On the affiliated side, we have one of the largest networks in the country, 4,400 AXA Advisors, as well as a direct network of 200 Bernstein Financial Advisors.
We have a long track record of being able to run distribution within our pricing allowables. Through our individual retirement and protection businesses, we've built a broad range of more than 1,000 third-party partnerships. AB itself distributes to more than 500 institutional clients worldwide, which along with its retail business, accounts for 83% of its AUM. We believe that the close alignment of our affiliated platform, in conjunction with our network of third-party providers, differentiates us in the marketplace. Bottom line, looking through all of our agreements, we have line of sight to over 150,000 advisors through our affiliated and third-party channels. This distribution and our mix of distribution has been a key part of our ability to reposition the portfolio over the past decade. I'll cover this on the next slide.
This next slide, number 11, shows the results of our work in repositioning our product portfolio over the last decade. As you can see at the top, 90% of VA sales pre-crisis were in capital intensive, fixed rate GMXB accumulation products. By comparison today, more than 70% of new sales have no living benefit, and most of the balance are in less capital intensive, floating rate living benefit products. As a result of the significant change in sales mix and our success with in-force liquidity offers, our in-force today has less than 45% of the book in fixed rate GMXB benefit products. Also note that our fixed rate GMXB book has typical outflows of approximately $4 billion a year. By taking this into account and reflecting approximately $7 billion to $8 billion of new sales each year, we should continue to see this shift in mix towards less capital intensive products.
Looking forward, I believe our ability to respond thoughtfully and quickly to changing circumstances is an important competence for the future. As you can see from slide 12, our teams at AllianceBernstein have also done a terrific job in overcoming the challenges the business faced back in 2011. Underpinning this recovery has been research-based investment performance and building on this, a number of innovative new products, which have had great success through our strong global distribution platform. Adjusted operating income has more than doubled from 2011 to 2018. While adjusted operating margins have improved over the same period from mid-teens to mid to high 20%. Overall, a good foundation for the future with strong investment performance across all asset classes, strong momentum in our client channels, promising flow trends in the highest fee areas, and a proven track record of cost control.
From EQH's point of view, AB remains an attractive capital light business, which provides a nice source of non-insurance regulated cash flows each year. Cash flow generation. Key differentiator for us, is our ability to upstream cash flow from our operating subsidiaries. Historically, our operating subsidiaries have provided strong cash flow distributions of more than $1 billion annually. This reflects that our two principal operating companies are mature and have been generating, and are expected to continue to generate significant free cash flows. As I mentioned on the previous page, AllianceBernstein provides a good source of non-regulated cash flows, approximately 35% of pro forma cash flow for 2018. Contributing the remainder is our life company, including consistent cash flow from our in-force life book, and the majority stemming from our in-force VA portfolio.
As you can see from the right-hand side of this page, since commencement of our capital management program in the third quarter of 2018, we've been active in deploying this cash flow generated by our business to shareholders. As of June 30th, we've returned nearly $1.7 billion to shareholders in the form of quarterly cash dividends and share repurchases since our IPO. Including approximately $1.2 billion repurchased from AXA in conjunction with its secondary offerings. Even more recently, we upstreamed $1 billion from our life company to the holding company in July of this year, supplementing the quarterly AB distribution. We believe that this demonstrates the strength, financial flexibility, and earnings power of the company. On slide 14, we present the next three years forecasted distributable earnings, and also the lifetime cash flow projections for our variable annuity portfolio post NAIC VA reform.
As you can see, this portfolio generates significant cash flows even in adverse scenarios. To illustrate this, under our base case scenario of six and a quarter equity returns and rates following the forward curve, the present value of cash flows from our VA portfolio would amount to $11.9 billion and provides $5.2 billion of distributable earnings from 2019 through 2021. Looking at a downside scenario, equities down 25%, rates dropped to 1.4% and recover to 1.7% by 2018. Our book still generates lifetime cash flows of $8.6 billion and $3.4 billion of distributable earnings over the three-year period. We are in this position due to the maturity of our VA portfolio, which is beyond the peak funding requirement under the CTE framework. The release of CTE98 over time represents another source of cash flow that will provide us with additional financial flexibility.
To summarize, our VA portfolio provides attractive and robust free cash flows. Downside is protected, and investors have the option to participate in market upside. Supporting these cash flows are our robust hedging program and strong balance sheet. As a basic principle, our hedging program immunizes the product rider only, while leaving the base product exposed. We use a two-pronged approach with a dynamic hedging strategy offsetting changes due to markets in the economic liability and a static overlay component protecting asset levels at CTE98 in most scenarios. Throughout our first few quarters as a public company, our hedging program has continued to perform well across market environments, including the equity market correction in the fourth quarter of 2018. The subsequent rebound in the first half of 2019.
As a result, our capitalization levels remain in excess of CTE98 for our variable annuity business, and 350%-400% RBC for our non-VA businesses. Contributing to the combined RBC ratio of approximately 675% as of the half year, amongst the highest in the industry. Further, as of June 30th, our debt to capital ratio is 25.8%, and we maintain cash at the holding company in excess of $500 million, both in line with our stated target. Turning to slide 16, we are now at the halfway point of the three-year aspirational targets we set at the time of the IPO. Through our general account optimization, we have achieved $125 million towards our stated $160 million goal as of the half year 2019. We are on track to complete the execution of the rebalance by the end of this year.
Despite interest rate headwinds, we remain on track to realize the full $160. From a productivity standpoint, we are executing well against our target of improving expenses by $75 million by 2020, net of any incremental cost. As of the second quarter, we achieved $44 million in total cumulative run rate savings and are on pace to recognize the majority of the remainder through 2020. Finally, from a growth standpoint, we continue to generate positive momentum in each of our four business segments, giving us confidence in our ability to achieve our targets and generate sustainable organic growth earnings over time. This momentum is evident in our recent operating earnings, which I will highlight briefly on page 17. Compared to the first half of 2018, non-GAAP operating earnings increased 10% to $1.1 billion for the first half of 2019.
This translated to $2.11 in non-GAAP operating EPS, a 22% increase over the comparable period from last year, aided significantly by share repurchases as part of our capital management program. Total AUM increased 12% since the end of 2018, supported by strong equity performance and net inflows across a number of our target markets in the retirement and investment management businesses. Compared to year-end operating ROE, expanded 100 basis points from 14.9%-15.9%, and this remains in line with our mid-teens objective. Overall, the first half of 2019 represented a continuation of solid results for AXA Equitable Holdings, strong performance across our businesses, and positive outcomes for our clients.
Bringing this all together, in summary, we're confident that our market-leading positions, premier distribution platform, and investment expertise position us well to continue to generate earnings growth, maintain financial strength and stability throughout market cycles, and generate strong cash flows and attractive returns. Thank you all very much for your time and interest today. With that, I'll join Jay for some Q&A.
Great, Mark. Thank you.
Thanks.
It was very helpful in terms of setting the stage and also addressing some of the topics we often hear from investors. Starting broadly, how would you describe the current operating environment and competitive situation for AXA Equitable, which of course, as you mentioned, is a major provider of annuities, life insurance, and retirement products?
Well, look, over the medium to long term, Jay, we're very positive and optimistic about the prospects for our industry, simply because of the demographics and the macroeconomic side. If you look at Americans turning 65, the number of Americans turning 65 will increase by 55% by 2030. The investable assets they have will double by that time. If you think about the flip side of interest rates being where they are now, Americans quite simply need to save more, to secure the same level of income that they need to live their lives with some dignity. I think the business we are in is a good business. Of course, there are always challenges in businesses, but it's a good business and the demographics.
Indeed, I think the regulators themselves, the government has recently through the SECURE Act, has recognized that allowing 401 trustees to provide some secure income in their model portfolios is a good thing. I think we stand to gain from that. I'm very comfortable with where we are as a business, and I'm very comfortable with the long-term outlook. Of course, we have some short-term headwinds.
Right. Of course. On the positive side, you mentioned the SECURE Act, which would allow annuities to be included
Yeah
in 401 plans.
Yeah.
Since that's such a large part of AXA Equitable's business, to what extent do you, or how much upside do you feel that could be for product sales and outflows or anything else?
I think it's a great move for society and a great move for the industry. I can't give any forecasts on it, but I think we're positioned well on it. I think as you know, Jay, I've had the good fortune of working in many other markets around the world, and most of us think about the accumulation stage of retirement, but it's actually the deaccumulation stage, the spewing of income, that really determines the life you're going to live at that time. I think we're all blessed these days with longevity, living longer. In order to do the things that make our life have a sense of meaning and some dignity to it does mean we have to educate and encourage people to save for those days. Longevity, is it a blessing or a curse? Depends on how you plan for it, I think.
We want to be part of this conversation, and, as you say, it's part of our DNA. I'm very proud of what Equitable has done in its product innovation. If you look at what we've done over decades, more recently with the buffered annuity space. I think these times when there's clearly misallocation of interest rates, at least, it is going to require some creativity and some innovation. Equitable has a really great history on that, and we intend to carry it on.
Excellent. You did mention some of the headwinds, which my guess, are taking the macro environment into account in terms of interest rates and the yield curve and to some extent, some equity market volatility. What are the implications broadly for the company, if interest rates stay low for longer? I know you put up that slide in terms of distributable cash flow from-
Yeah
your variable annuity block. Just wanted to see if the current drop-off in interest rates in the third quarter had caused any rethink around that.
Nothing, Jay, to threaten our targets for 2020. That's all. Guess we are well secure there. I guess my time in Japan, I didn't realize it was sort of training for coming to the U.S. I have run a big life operation, where interest rates were zero for a long time. It did help coming to the U.S. I think some of the things that Equitable, we're very proud of in there, the repositioning of the new business. I'll deal with new business first. Today, 85% of our new business would not be interest rate sensitive. Our big seller, SCS, is perfectly matched. This is a product that gives investors some downside protection in return for a cap on the upside, so we can perfectly match that. This is the work we did from 2010, 2011 onwards in really repositioning the portfolio.
We call it capital light, but it's really a flip word for interest rate dependent as well. The new business has shifted very markedly. Two things behind that. One, the innovation. We brought buffered annuities to the market. Secondly, what we've done on the distribution side. If you look, I mentioned up there we're number three or number two in the market, but we have a very broad distribution base. We would be number 10, number 12 in the wirehouses. The wirehouses are quite difficult to move and are very feature driven. We've made that difference up through AXA Advisors and through some quite innovative distribution agreements with other insurance companies, for example.
We've moved very quickly, not just on the product development, but on the distribution side to get where we are. We have much less dependency on interest rates than you would think on the new business side. On the in-force side, we have had, and I guess we thank our old parent, AXA, for this one. We have always been very conscious of the economic liability and have been hedging to the economic liability. That's why you see on those cash flows, not so much sensitivity to movement.
It's more around equities.
Yeah, more around equities.
Okay.
Yeah. Longer term though, higher interest rates are better for insurance companies, but I don't see any threat from the current environment to those targets we've put out in 2020.
Okay. You mentioned a couple of things there that I think deserve some attention. On buffered annuities, can you sort of briefly explain what that is, how that's different from a traditional variable annuity, and why customers are being attracted to it?
Yeah. It's an interesting point you make because variable annuities covers a lot of different types of structures. A typical variable annuity in our case, would be giving a guaranteed roll-up of a benefit base, which can then be turned into an income stream at age 80 or whatever. SCS is also categorized as a variable annuity, but quite different. Its term would be 5, 10 years. The customer would elect for some protection. Typically, the first 10% customer would be protected, and then would choose an index. Of course, we can hedge too, and they get a cap. They spend on the index up to a cap. It's a product which fits well with investors today because they're a little bit jittery where the markets are, and they want some downside protection. Investment yields are so low, so they want some yield for it.
It's really great for us because we can manage.
Right.
It works well.
You also mentioned the advantages you have in distribution, including agreements with other insurers. Is that something you can shed a little more light on?
Yeah. One of the capabilities we have inside the company, because we have one, is working with large retail sales force. That's our AXA Advisor. We know how to internally wholesale to them, how to train them, how to put in technology to support them, how to put in sales training, how to manage them. We know this part of the business. We've been able to transport that into other P&C carriers. Because we're not a P&C writer, they do not see us threatening to take their agents, but we can give them supplementary income. We know the beast. We know how to talk to them. We know how to train them. We know how to put technology in. That's worked really well for us.
We've been able to get third-party insurance agreements, supplementary income for them, our sale, and we have the skills capability to do it. They don't chop and change as quick as, let's say, a wirehouse will. Once you're in there, it's quite hard to get in, and there's quite a lot of support you need to get in to support a big retail. Once you're in, you're in.
All right. The last question I have before we get to the audience response system. You discussed AXA Equitable's 65% ownership stake in AllianceBernstein, which of course, is publicly traded under the ticker AB. It does appear that the value of AllianceBernstein is not being fully recognized in Equitable's current valuation. If this situation persists, could AXA Equitable potentially change its ownership in AB to help unlock value in your stock?
Let me talk a little bit about the 65. That was the sort of hand we were dealt at the time of the IPO.
We, Equitable, had an investment in AB and so did AXA, and we consolidated it all under Equitable, and the sum of those two was 65%. As you indicate, Jay, it's not that logical. It's either naught, 51 or 100 normally, isn't it? Not 65. We did say to the market, we hold this at the time of the IPO, not to expect any changes in that through 2020. AXA maintains veto rights, holds 38% today, maintains veto rights above 30. AXA wants to be thinking about sell down rather than a big portfolio change. When we go out to the market with our plans post 2020, this will be our cue. Having said that, Jay, we like the business. It's a business now that isn't interest rate sensitive like other parts of our business, of course is. We've got hedging on it. It gives us those non-regulated cash.
It's low capital intensity, we like the business. We also think we're a good owner of it. Perhaps I can give investors in the room just two statistics to support that out. Firstly, we are very sticky, and we're an anchor investor. The general account and the separate account numbers I gave you there total in excess of $100 billion. It's $100 billion out of $550 billion that AB has. It was also $100 billion when AB fell to $350 billion after the financial crisis. We're sticky, we're long-term, we're anchor investors. That's great for an asset manager. You guys know the business. Secondly, we've had great success over the last decade in supporting AB from our general account. We invest seed capital from the general account into AB.
The benefit for the general account is they get an enhanced yield, and so far, the returns have been very attractive for us. Middle market lending, property, that type of alternative. If you think about it from AB's point of view, they get a source of capital that is free. They're getting seed capital in there in return for an expectation of performance, but they're not having to pay for that seed. The combination for AB of having a sticky anchor investor and a general account where we can use internal leverage, if you like, to support their new business generated has been great. The alts business inside AB today, please nod if I'm right here, is about $40 billion, which we've helped through the separate account around there. We like the business. We're a good owner, we believe, and we're reviewing the 65%. That's it.
Actually, I'm not really clear on that in terms of reviewing it. In terms of-
You-
continuing to buying the whole thing?
Yeah. We'll buy more or hold where we are. I don't think you should anticipate any changes through 2020.
Right. That makes sense. Okay. Let's go to the audience response system. The first question for the audience is, if you don't already own shares of EQH, what would cause you to change your mind? A couple seconds to key in here on the device for the audience.
I think it's launched.
We did.
Yeah.
Okay, the response is here. What would cause people to increase their I don't know if you can fix this one, Mark. A higher interest rate and a steeper yield curve.
Yeah. Much better.
That seems to be on people's minds. Around 85% of people saying that. AXA Equitable, you've already shown that The distributable cash flow the company can generate is really not as sensitive to that as some people might think, right?
No. Because the hedging kicks in.
Exactly.
Yeah.
Okay, next question, please. Investors' confidence that AXA Equitable's return on Sorry.
Equity.
Equity, thank you, will be in the mid-teens range by 2020, so essentially consistent with management's targets. Second slide. Investors' confidence that the company will achieve its targets.
More spread there, huh?
Yeah, exactly. Around a quarter each between very high, high, medium, and low. Any response to that, Mark?
As I said up there, we're very confident we will achieve that through 2020. I mentioned the hedging program as well. Perhaps if I draw investors' attention to quarter four of 2018, if you remember, sharp equity decline. At that time, our hedge effectiveness was 96%, 98%, kicked in the other way. We've shown that we can continue with that operating ROE through a downturn as well as through an uptick. We remain highly confident on it.
Of course. Okay, next question, please. This question is, what should AXA Equitable pursue more of? We give a range of options here. Let people have a chance to take a look at those. Ranging from organic growth, acquisitions, more share buybacks or dividend increases. Investors, 40% are saying more share buybacks, and a third saying more organic growth. It's pretty consistent.
It does. It's consistent with our one-on-ones as well, when we talk to everybody. I think everybody's reflecting that there. Yeah, the share buyback program, as I mentioned, $1.7 billion returned to shareholders since the IPO in May of 2018. That's helped us well into double-digit EPS. On the organic growth side, look, I agree with that. I think we have some really interesting businesses. If you look at our 403(b) business, you look at AllianceBernstein and the new parts of the variable annuity, they're worth investing in as well. Bolt-on acquisitions, of course, we'll continue to look at that.
What particular areas that could be of interest on bolt-on deals?
Just top of mind, you know we have a nascent employee benefits business, from a standing start four, five years ago, we now have 300,000 clients in that business. It would be a nice fit if we could have a step change in that. That would be one. The downside, though, Jay, is they're very expensive assets. We would like it, but we'd want to pay a disciplined price.
Do we have any more ARS? Last one. This is around my. We can end.
The last question here.
We can run my question around the majority ownership in AllianceBernstein. Actually, the way I position the question is if AXA Equitable divests its majority stake to unlock value in response there is three-quarters saying AXA Equitable should not divest majority stake in Alliance. Very consistent.
Good with what we said.
With what you're saying. One-quarter saying yes. Clear majority saying not to.
No not yours.
We've got a very decisive crowd here at the Barclays Financial Services Conference. Actually, I think we have time for one question from the audience if there is one.
I think we also have a breakout room as well, Jay, if anybody wants to go. Okay.
Okay. Excellent. Well, as Mark said, the breakout session for AXA Equitable will be in the Clinton Suite. Please join me in thanking Mark Pearson today.
Thank you very much, Jay.
Great job. Thank you again.
Great to be here. Thank you very much.