We're going to get started. Pleased to have AXA Equitable with us today. On stage with me is Anders Malmstrom, the CFO, and I also want to recognize Jessica Baehr and Priya Mehrotra from Investor Relations. Anders, just to kick off, it's been about 16 months now since the IPO. Can you review how things have gone so far relative to your 2020 targets that you laid out when you did the IPO, and also your progress fully separating from AXA?
Good afternoon, everybody. Thank you, Ryan, for having us here. Look, I think the first, it's now we had probably 6 quarterly calls, has been a good journey. As you know, we laid out our target at the IPO, I will go through them in more details, I think we are pretty much on track in all dimensions there, even though the environment is changing as we go, we obviously have to adapt there. Overall, I'm very happy, I'm very confident about the journey we're going. I think it's a good start. From a target perspective, we had earnings targets, 5%-7% earnings CAGR. We're on track there. I think so far earnings are really in that corridor where we want to be.
From a capitalization standpoint, we said, clearly, we want to be at CTE98 for VAs and have it for non-VAs and RBC between 350-400. We're well above that target as well. I think that's important in order to be disciplined from a capitalization standpoint. I think the area where we really performed well is on the dividend and buybacks, on the payout ratio out to shareholders. When we started the IPO, we announced a payout ratio of 40%-60% of operating earnings. We narrowed that range after 1 year to 50%-60%, because we felt very comfortable with the AB transaction we did, I think we are well on track there as well to get the payout between 50% and 60%.
In particular, this year, 2019, many of you know we front-loaded a lot of the buybacks when we concurrently bought back from AXA when they sold down in March. We've already paid out, I think, more than $900 million this year. We have $200 million left for buyback authority, obviously every quarter comes the dividend. From a separation standpoint, again, I think it's a very successful journey. An important step happened in March when AXA went below 50%, because that triggered a lot of governance changes. AXA had to cease control. They're not the chair anymore. The number of directors dropped from 5 to 3 out of the 9-person board. It also triggered a lot of other separation activities when it comes to TSAs, when it comes to branding.
Yeah.
We basically have we got 18 months left where we can use the name AXA. I don't think we need 18 months, but we're only allowed to use the name AXA for another 18 months. You hear us talking much more about AXA Equitable now, and I think foreshadowing which direction we want to go, going back to something old that's very well established in the U.S.A.
On the buybacks, you mentioned $200 million remaining on the authorization. I guess if the opportunity did arise to participate in another AXA offering that happened before the end of the year, could you potentially accelerate some of the buybacks that you would do for 2020 into 2019 to participate?
Look, I think first of all, we have this target, the 50%-60%. I think that's really where we want to be. I think that's the discipline we want to have, to be within that range. As I said, for this year, we're already there. We have $200 left. We actually have now cash at the holding company probably for the next nine months, because from the operating entity, we get it once a year. We got in July $1 billion. I think I'm in the good position that I can say I have the cash capacity for the next nine months until mid-year next year. As I said before, I want to use the majority of that with AXA.
Yeah.
It's clearly next year's money, but of course, opportunistically, I look at what makes most sense for shareholders. Yeah.
Can you just remind us, I guess, what at the holding company you target for a cash buffer and what the actual holding company liquidity position is right now?
Yeah. We actually usually only disclose once a year.
Okay
where we are. At half year, we were pretty much at our target, which is $500 million, which I think is a good position to be in. It's kind of twice the interest and need we have here.
On the second quarter call, you updated the Variable Annuity cash flow scenarios. Can you go over again some of the key moving parts when you think about interest rates, policyholder behavior, hedging, other factors that kind of led to various puts and takes when you did the update?
Right. The primary objective when we did the update, just show to the public that basically a year later, after the numbers we had, or 18 months later, that not much has changed, that the cash flow is actually robust. We really wanted to make an apples-to-apples comparison with the previous cash flow, show that Basically how they behave on the different scenarios. We used exactly the same scenarios. The one thing we incorporated was the NAIC VA reform, because now we know how it's coming. We assumed in our projections that by January 2020, the VA reform is intact, so we built that into our cash flows. I wanted to show that, yes, it has an impact. It's not a dramatic impact, but it has an impact because the new VA reform actually recognizes hedging more than the old one.
That's why we get an upfront benefit from adopting it. At the same time, the new framework is more equity sensitive in particular, which means you actually need to hedge more going forward. That's why you see a positive change to the old cash flow in the short term, and you see a negative change in the long term. That's really coming from the two offsetting factors. One is short-term and one is more longer-term. This doesn't incorporate any future possible changes to the hedging strategy. It just assumes that we do the same we did in the past, going forward target CTE98.
Got it. A question I get a lot is you give two different scenarios. You give the net present value of cash flows over the life of the block, and then you give distributable earnings over the next three years. I think if you look at the next three years, it's about $5 billion relative to $12 billion over the whole life.
Yeah.
It's a pretty big percentage over the next three years relative to the full lifetime. I know the calculations are a little bit different, and that's probably a lot of it, but can you help us, I guess, understand that at all?
Yeah.
It just seems like based on the next three years, it seems like it would be a lot higher than.
Right
12.
Look, I think as you say, these are two different calculation methodologies, there's really historical reasons how we got there, because we wanted to compare ourselves to peers. Peers wanted to compare themselves to previous IPOs. It's kind of I don't think it was the best way to show cash flows, but it was a way, and now we were able to compare.
Okay.
That's why we said one more time, we do it this way. I don't really like the lifetime, the way it's calculated, because what it does, you basically put your assets, you have your reserves to the side, and then really just look at your future cash flows in and out. It doesn't incorporate the investment income you get on the existing reserve, but also it discounts at a much lower discount rate that you would do so. Really the methodologies is different. That's why I would not compare too much.
Okay
the two methodologies. What it does, I think it shows, and that's why year-over-year comparisons make sense and scenario over scenario makes sense. Just don't compare the fact that the numbers.
Okay
too much because the methodology is different.
Yeah. When you're talking about a change to the methodology for the next time you do it.
Yeah
Can you give us any sense of what you're contemplating, and would you still give it for VA only, or would you do it, I don't know, combined?
Yeah. We haven't made any decisions when and how we're going to update cash flows. I think one thing I can tell you, I will not do it the same way.
Yeah.
I really like the distributable earnings concept because it's a very real one. Now, of course, it discounts new business, but it shows you how much an existing in-force business generates as free cash flow. I think that's a very valuable and powerful concept. It will be something around [build-over], but we have decision.
On hedging, do you anticipate much of a change to your hedging strategy based on the new NAIC reform? I guess I'll start then. I have a follow-up.
As I said before, look, the new NAIC reform is more equity sensitive. I think we are going right now through the concept, and I want to see how we can optimize. I don't expect any radical shapes to the hedging strategy. I think we have a very well-thought-through hedging program that we run now for a very long time. It's a good time to think about what's the best way to optimize it, and should we do more dynamic and less static hedges, or vice versa. I think that these are the things we're going through right now.
Follow-up was, I guess, what is your cash hedging costs at this point? How sensitive is it to interest rates and based on when you have to roll the hedges?
Yeah. As you know, we have the dynamic program where you basically have no cash upfront.
Yeah.
We have the static program that supplements and makes sure we stay at the CTE98. We have given a range of between $100 million and $150 million. I think in the beginning, we were at the low end. This can move around depending on volatility, how much you want to hedge. We usually hedge opportunistically from a timing, not from a strategy, but timing-wise. Whenever volatility is low, you go long, lock this in. I think the range is still reasonable. As I said, because it's becoming now more interest sensitive, we might think moving more to the dynamic program to keep that number in the range. That's the area we actually look right now what's most optimal.
Shifting to free cash flow or the distributable earnings. When you raise the 40%-60% to 50%-60% for capital return, what were the key reasons for that? If we are in a prolonged interest rate environment, would you expect to be able to maintain that 50%-60% over time?
Mm-hmm. Yeah.
We're going to get started. Pleased to have AXA Equitable with us today. On stage with me is Anders Malmstrom, the CFO, and I also want to recognize Jessica Baehr and Priya Mehrotra from Investor Relations. Anders, just to kick off, it's been about 16 months now since the IP-
Yeah. the main reason-
Management team has to look at them from time to time and see where it makes sense. You always have to then evaluate, does it make economical sense to how you look at the business, also how people from outside look at the business and then evaluate if this is a meaningful transaction. It has to be in the best interest of shareholders at the very end. I think, as every management team, we look at the options, but I think there's no urgency. Yeah.
Yeah.
Shifting to sales. You've had good annuity sales momentum, particularly in the SCS product. Can you talk about your outlook, and how it's impacted by the change in the interest rate environment? Also, you have generally seen increased competition for the SCS product category, to what extent that's impacted you?
SCS is an interesting case study because, yes, you have seen more competition, but at the same time, the market is growing, and we didn't have to adjust our pricing at all because of competition, and we are growing market share. We have new competitors coming in. In itself, I think it's a great value proposition to consumers and manufacturers. What we see right now is, in particular in this low interest rate environment, that actually consumers even go further into this kind of product because it's more short-term. You have a five, six-year product. You don't lock yourself in for too long. It has the equity protection. This is a strong sales pitch, and I think it works pretty well. Our distribution relationships help a lot here. Yeah, it's actually going well.
I actually think, in a way, it's probably good to have more competitors in that market because it makes the product more known to the public, and it's a great value proposition.
I guess, at one point, it seemed like you were considering selling more traditional fixed annuities. It's not really a part of your portfolio. I guess, is that something you'd still consider or are you kind of not really looking to do that?
Yeah. When we came out with the IPO, obviously, one of the questions was: what can we now do differently not being part of Solvency II anymore? Solvency II really penalizes long credit. If you can't do long credit, you can't do fixed index. That means you will and want to do fixed index annuities if you can't do long credit. We're still elaborating that right now, we haven't made any decision. I think we're interested, right now it's probably not the best point.
Yeah
to go in. I think that's where we are.
I guess on AllianceBernstein, the 65% stake. I guess, can you just talk about how you think about that? Is that something you're happy with the structure of the 65%, or do you anticipate or consider making any changes one way or another over time?
I think first of all, there's no magic to the 65%. This is the ownership AXA had before, I think since probably 20 years. We inherited that. We're very happy with it. I think we like AllianceBernstein. It gives us access to the unregulated cash flow. We see a lot of business synergies we're working on. We do provide seed capital to AB, which then AB can use that to cheaper manufacture new products. I think we see a lot of benefits there. We really like AB. Do we want to buy a higher stake or go out to a lower? That's a strategic question we are elaborating. I think it's an important one. Haven't made any conclusion there. We're in a good spot there right now, so we're happy where we are, but we are elaborating where we should go going forward.
Let's pause for a second, see if there's any questions from the audience before continuing. Anything? All right, I will continue. In the protection business, you've seen an improvement in the earnings there. The return on capital is now closer to the high single digits. One, I guess, what has driven some of the improvement from when you did the IPO? Where do you see returns in this business?
Yes. I mean, what we [I'll calculate with stake]. You clearly see that they are not coming through the earnings. Now, what has clouded before a little bit was we were in loss recognition. With loss recognition, you always see a lot of volatility in the earnings, and you don't really see through the real earnings power. Now that we are out, you actually see now how the earnings are coming through, and we really see the benefit of the geo rebalancing and the expense actions we've taken. We see good sales momentum there. We see employee benefit now slowly Actually, not slowly, really good growth, but it's still very small. The only area where you're going to continue to see volatility will be mortality by its nature.
We had a very good Q2. As everybody knows in this room, volatility should not be measured on a quarterly basis. One claim can make a difference there.
Do you see any risk of reentering loss recognition status when you update your interest rate assumptions, or have some of the other actions you've taken, is that likely?
Yeah.
balance out?
loss recognition, we made that clear, I think a year ago. We said interest rate helped us to get out of loss recognition, interest rate could push us then in that. I can't say more right now. There is always a risk.
Okay.
Exactly.
I guess in group retirement, everything continues to go very well there. You have over 25% ROE, good net flows. Can you talk a little bit about, I guess, some of the differentiators of that business? It doesn't seem like it's experiencing that much fee pressure compared to some of your competitors, at least maybe in the 401 business.
Yeah.
Can you talk a little bit about some of the key differentiators, and do you view these types of results as sustainable?
I think that's actually the one segment where we think we're going to see strong growth going forward. There's a huge need for protection, for retirement product. We're very focused on the teachers market, and our distribution model here is really, again, I think focused on the school district. We have about 1,000 advisors, with advisors sitting on the. They explain to us the solution works, what kind of gaps they have, and how they can close these gaps. That's one of the reasons why we don't really see the same fee pressure, because it's actually hard to get in. It's really through distribution. These people don't buy a product just because they see one. They buy it because somebody explains to them why there is need to close the protection or the gap they have right now.
That's a very strong business model we have here, and I think we provide a lot of good advice value to customers. It's focused on this. You really focus on this education market.
On the general account optimization, can you just remind us how much you've done so far?
Yeah.
I guess you had a very conservative investment portfolio when you started this.
Yeah.
I guess once you finish this, could you potentially do more, just given that's still a pretty conservative allocation?
Yeah. It was very clear when we said the general account rebalancing, we want to go back into the pack. We don't want to take crazy risk, in particular to where you are in the credit cycle. We came out and said we think we can get an uplift of about $160 million to the run rate. I think we are right now on a run rate basis at $140. We recognize $125, $140. We feel very comfortable that we get to the $160. Obviously, that's very helpful in the environment we are, at the same time, as we discussed before, you see the headwind coming through. I think going forward, we have to continue to look for opportunities where we can take an opportunity to get more yield without unnecessary risk. We want to increase the risk. We want to make smart decisions.
I think that's where we, together with AllianceBernstein, have a huge opportunity to improve further, yeah.
Just a similar question on expenses. Can you just remind us how far along in the expense save program you are and the expected timing?
On expenses, we laid out a target of $75 million net saves. That's really a net save relative to end of 2017. We're about $45 million in. I think expenses is something every company has to work on all the time. I think there's no end in it. It's really just what is the next step to become more efficient, more effective. I feel very confident with the 75 and we're working on them going forward, what is next. Every company has to make sure we get more efficient and more effective.
Open up to the audience one more time. If not, I think we'll wrap it up there.
Wonderful.
Thank you very much, Anders. Appreciate it.