Good morning. My name is Leandra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Equitable Holdings, Inc. Investor update call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Kevin Molloy, Head of Investor Relations, you may begin your conference.
Thank you. Good morning. Welcome to Equitable Holdings, Inc. investor call. Materials for today's call can be found on our website at ir.axaequitableholdings.com. Before we begin, I would like to note that some of the information we present today is forward-looking and subject to certain SEC rules and regulations regarding disclosure. Our results may materially differ from those expressed in or indicated by such forward-looking statements. I'd like to point out the safe harbor language on slide two of our presentation. Joining me on today's call is Mark Pearson, President and Chief Executive Officer of Equitable Holdings, Inc., and Anders Malmström, our Chief Financial Officer. During this call, we will be discussing certain financial measures that are not based on generally accepted accounting principles, also known as GAAP measures.
Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and related definitions may be found in disclosure on our investor relations website. I'd like to now turn the call over to Mark and Anders for their prepared remarks.
Good morning. Thank you for joining us. We thought it would be helpful today to cover two things. Firstly, we will share progress on our 2020 targets and strategic priorities. In addition, in view of the recent market volatility, we will provide for the first time guidance on the sensitivity of our earnings and cash flows to movements in the market. Anders will cover this in detail, but at the very high level, we will show that while short-term earnings can be impacted by the markets, our cash flows are resilient due to our hedging program and the strength of our balance sheet. Because of the multi-levers we have in our business, we continue with high conviction that we will achieve the three-year growth and capital return commitments we set out at the time of our IPO in May 2018.
Before handing over to Anders to go into detail on the sensitivity guidance, I'd just like to use three slides to remind you all of our business model, our aspirations, and recent history. As you can see on slide three, the breadth of our business model continues to provide benefits, and we are seeing an increase in our market share, for example, in the VA market for new business, which is fueled by our premier multi-channel distribution platform. Over the last decade, we have repositioned the business towards less capital-intensive segments of the market, and this is coming through now in robust cash flow generation and good returns on capital. We've maintained a strong balance sheet. In terms of our RBC ratio, we are amongst the highest in the industry.
At the Q3 results announcement, I was able to tell you that all four of our segments showed positive earnings growth. Turning to slide four. I'm very pleased to report that we have delivered these commitments we made at the time of our IPO. A key target of ours is growth, and we remain on track to deliver our 5%-7% non-GAAP operating earnings growth target through 2020. EQH generated a 15.6% operating ROE in the third quarter, which is in line with our mid-teens target. This is supported by our 65% ownership stake in AllianceBernstein, which is tracking closely to its operating margin target of 30% at 29.1% through the third quarter, as well as growth across all of our insurance business segments. We have maintained our financial discipline and the strength of our balance sheet.
Currently, we're holding assets in excess of CTE 98 for Variable Annuities and 350%-400% RBC for other insurance lines. As of September 30th, our consolidated RBC ratio is approximately 600%. In terms of capital return, we are at the upper end of our 40-60 cash payout range. We have returned $143 million in quarterly cash dividends, $0.13 per share per quarter, and completed over $650 million of share repurchases as part of a total $800 million authorization for 2018. Let's turn to slide five to explain why we remain confident in our ability to deliver on our growth targets. Whilst we are not immune to a market downturn, two of our three levers to drive earnings growth are within management's control.
Beginning with the GA optimization, we are making meaningful progress here, having completed over 50% of the initiative through the third quarter of 2018, and we've achieved a $62 million towards our $160 million pre-tax earnings goal. Looking ahead, we expect to complete the rebalance by the end of 2019 with the full $160 million benefit realized by 2020. In 2019, we will also continue to migrate selectively from Treasuries to high-quality corporate credit whilst maintaining a conservative A rating on our overall portfolio. Second, from a productivity standpoint, we continue to reduce net costs in our insurance business. We remain confident that we are on track to deliver $75 million pre-tax expense target, net of any reinvestment by 2020. In 2018, we have completed approximately 20% of over 90 specific productivity initiatives contributing to this 2020 goal.
Moving into 2019, we anticipate an acceleration of net savings to be driven primarily by three major sources: shifting our real estate footprint to locations outside the New York metropolitan area, migrating to a cloud-based technology infrastructure, and expanding outsourcing arrangements to improve our cost base. I will now hand over to Anders to explain to you the sensitivity of the earnings growth initiatives to market movements. We go into 2019 with good sales momentum in our insurance segments, which we continue to see through the third quarter, and good progress at AB in improving its margin towards its 30% target. There are decent tailwinds in the business, but as you would appreciate, results are sensitive to equity and interest rates. Let me hand it over to Anders to give you guys guidance on how to anticipate EQH's results.
Thank you, Mark, and good morning, everyone. Underlying the growth targets Mark laid out are our basis case assumptions of 6% S&P 500 appreciation from today's market levels and interest rates following the forward curve. When considering our equity market assumption, I want to note two important points with respect to separate account returns and related fee revenue. First, our separate account is comprised primarily of allocation funds with broad domestic and international equity exposure of about 75% and 25% in fixed income. As a result, separate account assets will not exactly match movements in one specific index such as the S&P 500. Second, revenues in our fee-based businesses are typically based on average daily account values. Moving now to the impact of economic conditions on non-GAAP operating earnings. We've included key market sensitivities at the bottom of this page.
As illustrated, a 10% move in equity markets translates to approximately ±$150 million of operating earnings. A 50 basis point parallel shift in the yield curve translates to approximately ±$10 million of operating earnings. The impact on net investment income is limited initially as the investment portfolio turns over and is reinvested gradually. Both of these sensitivities were estimated in isolation and are relevant based on today's market level as a starting point. However, we believe that these scenarios, along with additional considerations included in the appendix of this presentation, provide a useful framework for better understanding key sensitivities which impact our results. Moving to the balance sheet on page seven, we have a strong capitalization and liquidity profile in addition to a well-diversified investment portfolio. As of the end of the third quarter, our debt-to-capital ratio was 25.5%.
Today, we hold over $500 million of cash at the holding company, both in line with exceeding our long-term outlook. We are capitalized at CTE 98 for our VA business and 350%-400% for our non-VA business. For our VA business, we expect to remain at CTE 98 in all but extreme scenarios. For example, a 40% equity decline and interest rates below 1.5%. Even under that circumstance, our capitalization remains at CTE 95. In fact, hedging has performed well during the recent market turbulence and protected our balance sheet at the CTE 98 target. As of end of September, our combined RBC ratio was approximately 600%. Overall, our investment portfolio is conservatively positioned with an outsized U.S. Treasury position and high-quality credit portfolio. At the end of the third quarter, the overall fixed maturity rating was A.1, and the rating for the credit portfolio was A.3.
Total fixed maturity exposure to below investment grade debt is 2%. Non-agency structured exposure is 1%, Baa2 exposure is 11%, Baa3 is at only 4%. We continue to execute on our GA optimization initiative with over 50% complete as of the end of the third quarter. We expect to complete the rebalance by the end of 2019, with the full $160 million benefit flowing through in 2020. Given the flattening of the yield curve, we have tactically shortened our new allocations to longer credit in favor of shorter durations, still at attractive yields. As we complete this transition at the end of 2019, we still expect to maintain the portfolio's conservative quality at A rating. Turning to slide eight, our balance sheet is further supported by our diverse sources of cash flows through our insurance and non-insurance operations.
We have two primary sources of cash flow which have historically and should continue to generate free cash flow for the company. Including one, our insurance operating entities, and two, our stake in AllianceBernstein, which has increasingly contributed to our cash flow generation as our ownership levels increased. As you can see, on an annual basis from 2014 to 2016, these businesses consistently provided more than $1 billion of free cash flow to our holding company across a variety of interest rate and equity market environments. Of note, in 2017, we strengthened our balance sheet by $2.3 billion and did not upstream the approximately $1.2 billion of dividend capacity at our operating entities in preparation for the IPO. For full year 2018, we expect approximately $1.4 billion in free cash flow to be upstreamed to the holding company, including $1.3 billion already upstreamed through the end of the third quarter.
Our capital management program is supported by these cash flows, allowing us to return 40%-60% of operating earnings to shareholders. On an annualized basis, our cash return to investors for 2018 is expected to be approximately $1.1 billion, above our near-term guidance, in part due to a one-time tax benefit we do not expect to recur. During the second half of 2018, we repurchased $657 million of stock, including $57 million in the open market. Assuming full execution of the remaining $143 million share repurchase authorization, this results in an 11% cash return yield for 2018, one of the highest among industry peers. We believe a key differentiator is our ability to upstream cash flow from our operating subsidiaries. Many of you have seen slide nine previously, we thought it is a good reminder regarding the resilience of our VA cash flows in adverse scenarios.
We plan to update this information for our year-end 2018 in in-force and will share with you in early 2019. Presented on the page are lifetime cash flow projections for our variable annuity portfolio, discounted at 4%, across different economic scenarios. We also include the next three years forecast distributable earnings for this portfolio. Please note these illustrations have no assumption as to future new business. Because of the strength of our reserves and our hedging programs, you will see that our VA portfolio generates significant cash flows even in adverse scenarios. As illustrated here, for our base case, we assume an equity return of 6.25% per annum, the 10-year treasury rate will fall on the forward curve and reach 2.8% by 2027, basically where they are today.
Under this scenario, the present value of cash flows from our VA portfolio would amount to $12.9 billion and provide distributable earnings up to the holding company of $4.1 billion over the next three years. Going further to the right, in a downside market scenario of a 25% shock to equities and a simultaneous drop in 10-year U.S. Treasury rates to 1.4%, our cash flows, assuming slow recovery in both, would fall to over $9 billion. Even in this downside scenario, we would still have substantial distributable earnings in the next three years. Our VA portfolio provides attractive and robust free cash flows. Downside is protected, and investors have the option to participate in market upside, as you see from the substantial growth in present value of cash flows when equity returns reach 10%. Moving on to slide 10, we have a balanced and disciplined approach to our capital deployment.
Our strategy will be focused on two key areas. First, we will invest in the organic growth of our insurance business, where we will allocate approximately $400 million. We will continue to invest in less capital-intensive businesses, targeting a portfolio IRR of greater than 15%. Second, and in line with our long-term target, we expect to return 40%-60% of our non-GAAP operating earnings to shareholders through the form of share repurchases, primarily from AXA and our quarterly dividend. Our capital management program is supported by our strong operating earnings generation and our robust capital position that is protected by our hedging program. These components support sustainable operating cash flows and provide us with confidence as we plan our 2019 capital return program. With that, I will turn the call back to Mark for closing remarks.
Thanks, Anders. On slide 11, we show a familiar snapshot of our key financial targets. The momentum inside the business, strength of our balance sheet, and our hedging program means that we remain committed to achieving these goals as we successfully execute our strategy over the next two years. We do have time for questions now, but before breaking for your questions, allow me to summarize today's presentation using slide 12. 2018 has been a historic year for Equitable Holdings, Inc., and as we look towards 2019, we will continue to execute on the commitments we set out at the time of the IPO
We've delivered strong results through our first three quarters as a public company and have multiple organic levers to drive earnings growth and achieve our financial targets across a range of various market environments. Protected by the strength of our balance sheet and risk management framework, we believe our business remains well-positioned to generate sustainable cash flows and produce attractive returns to shareholders. With that, I'd like to open it up for questions.
At this time, I would like to remind everyone, in order to ask a question, you can press star and the number one on your telephone keypad, and we'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Ryan Krueger with KBW. Your line is open.
Hi. Thanks. Good morning. On the $150 million sensitivity for a 10% change in the market, does that assume any management actions around things like expenses or other things, or is it more of a static point-in-time number?
Ryan, it's Mark Pearson. It's more a static point-in-time number. There's no assumption in that number that we will adjust our productivity goals.
Okay, thanks. I think this was your point of the cash flow resiliency, but just maybe just to be clear. In a downside scenario, for example, the same downside scenario you give for your variable annuity cash flows, would you still expect to return the 40%-60% of capital?
Good morning. This is Anders speaking. I think in the normal, regular scenarios, we would always stick to the 40-60. I think we would probably only deviate in a really extreme scenario. The -25, I would still expect that we are within the 40-60.
Okay. Thank you.
Your next question comes from the line of Erik Bass with Autonomous Research. Your line is open.
Hi. Thank you. One more clarification on the earnings sensitivity for equity markets. Am I correct in assuming that there's no impact assumed in there for your alternatives portfolio? If that's the case, can you give us any help in just thinking of, based on your portfolio mix by asset class, what the equity sensitivity might be there?
Yes. Good morning, Erik. This is Anders again. I think the sensitivity is really to in equity, in total equity, 10%. Our alternative is very small, so I wouldn't expect that this should change the sensitivity there.
Got it. Thank you. Then on capital return. If AXA chooses not to come to market, given where the share price is currently, can you discuss other options you would have for returning capital? I guess how should we think about the timing of deploying in that scenario?
Yes. Again, I think as we said, look, we are really committed to pay back the 40%-60%. About $300 million are coming from the dividends and the rest in our plan in the form of buybacks. Of course, we prefer if AXA sells down, we prefer to do it concurrently. As you know, it's not in our control, and we don't know fully when and if they do. If they wouldn't sell down for whatever reason, we would then probably look for what's best for shareholders, and we could think about doing a buyback directly with the parent in order to basically get to the 40%-60%. We're very committed to the 40%-60%. We'll find solutions that are in the best interest of shareholders.
Got it. Even if they don't come to market in 2019, you would expect to get the capital returned in that period?
Correct.
Got it. Thank you.
Your next question comes from the line of Andrew Kligerman with Credit Suisse. Your line is open.
Hey. Good morning. I'm wondering if you could give a little sensitivity on RBC. If the market's down 10%, what would happen with risk-based capital?
I think it's a really good question. I think right now, as we manage the business and before the VA reform, and maybe after the reform looks slightly different. We really stick to the CTE 98 target, therefore, the rest of the business is 350-400. RBC is more a consequence of that, because right now, it's not the right way to look at RBC as our primary target. CTE 98 for VA, and then we will be there in most of the scenarios, as you know. Then for the rest of the business, it's the 350-400. I can tell you the RBC is not always reacting procyclical. It's kind of countercyclical because we don't have hedge accounting. For example, in a down interest rate, obviously it would go up and not down as you would expect.
There's a lag on RBC. That's why we really stick to the CTE 98 as the right measure, as long as the VA reform is not in place.
The hedging would kind of maintain you at the targeted CTE 98 levels?
Yes.
It would. Okay, great.
Yeah, the hedging, that's why we have the supplementary hedges, the static hedges. Make sure that in all circumstances we are at the target level.
Got it. The sales environment has been outstanding with the DOL rule having been removed. What about with the new SEC legislation coming into play? I think some of the states are looking into their own legislation. Do you foresee a robust 2019 for your VA sales?
Yeah. Thanks, and it's Mark. We share the point you make there. We're seeing a return to growth in the VA market overall. Very pleased to report that our market share has gone up in the last three quarters as well. I think it goes to some of the products that we're offering out there now. Our SES buffered annuity is good for these markets because it protects consumers on the first 10% or 30% downside. In return, they get a cap on the upside. Good product design, we've been able to have an all-weather portfolio, if you like. Of course, we're watching the developments on the fiduciary duty. But I think we share the industry view that it's good that the DOL rules have been parked, we look forward to working with the regulators to have a sensible structure out there.
In the medium to longer term, the prognosis for annuity sales, we think is very, very good.
Excellent. Thanks so much.
As a reminder, if you'd like to ask a question, you can press star and the number one on your telephone keypad. Your next question comes from the line of Thomas Gallagher with Evercore. Your line is open.
Good morning. Just another question on the equity market sensitivity, the $150 million impact from a 10% reduction. Can you comment on, is all of that just the expected revenue impact, or is some portion of the $150 million impacts on reserves, DAC, hedging costs?
Morning, Tom. This is Anders. The majority is coming from the fees, obviously. From a hedging perspective, we don't expect that the sensitivity impacts our hedging costs. It's really the fees. There is a component to variable costs that obviously also reflect. I think about in particular on the AB side, where the up and down of fees directly impacts their expense side. That's reflected, but nothing else.
Got you. Then, Anders, do you have a percentage of your variable annuity fees that are based on guaranteed amounts versus based on AUM or account values?
I don't think we have the breakdown of the fees, but the way to think about this, all the guarantee fees that basically reflect for the guarantees is based on the benefit base, and then everything coming from the underlying investments is based on the asset under management.
Anders, is that true of all vintages, meaning all of your living benefit and death benefit guarantees are going to be based on benefit amount and not account value on pretty much all your contracts?
Yes. That's true for the older ones and also for the new business that we've wrote since the crisis. The guarantee fee is always based on benefit base, and the rest is based on the asset under management.
Okay. That obviously limits your sensitivity to equity markets then from a fee standpoint.
Correct.
Final question is, can you provide a little more insight as to how we should think about hedging? The reason I say that, the main question I get from investors or concern for anyone with a big Variable Annuity book is, if markets become more dislocated, what happens to hedge programs? Can you talk a bit about how often your hedging portfolio would need to get rolled, whether there is really a mismatch, and also how we should think about whether the new Variable Annuity standards will have changes regarding to admitted assets that are allowed for hedging.
Yes. Maybe I start with an overall summary of our hedging program. As you know, we have the dynamic hedging program, which is really an economic program. That's really the main program we have. As I said, it's economic. We use futures and swaps for that, there's no initial cash that we have to pay. It's a first dollar program. It's rebalanced every day, it works in basically all environments. Just the last couple of months, where we have more volatile markets, it worked pretty well. It's within our ratio of 94% efficiency. That program works very well, gets rebalanced every day. In addition, we have what we call the statutory program to make sure that even after a severe market dislocation, we are within our stated CTE targets. That gets rolled periodically.
We check it every month and every quarter in more details, we roll it accordingly. That's really a supplementary program, the main program gets rolled every day.
Okay, thanks. Are there changes to what's permissible for counting as qualified assets or admitted assets under the new standards that are coming for VA, because I think today there's definitely limitations to what constitutes or qualifies as an admitted asset for hedge programs.
Yeah, I don't think that the change is going to impact our hedge program when it comes to admitted assets. As I said, the majority is futures and swaps, so that doesn't change. I also don't think that the new framework will materially change the hedge program, because I think we will still continue to do an economic hedge. It actually aligns more because the new program is much more, let's say, hedge supportive. It's a kind of hedge accounting that you actually get in the new program, I don't think that it's going to change our program there.
Okay, thanks.
As a reminder, if you would like to ask a question, you can press star and the number one on your telephone keypad. Your next question comes from the line of Alex Scott with Goldman Sachs. Your line is open.
Hi, good morning. First question I had was just on the accounting standard change, I guess, the FASB guidance. Do you envision a scenario at all where leverage would need to be reduced? Or are you comfortable with where the conversation's going with the rating agencies and so forth that you won't have to do that?
Yes. Good morning. This is Anders. Look, I think as we said many times, the accounting standard will be a big change to the industry, to the accounting view. It's a good change because it makes the accounting more economic and brings kind of the differences together we have today, where we have a big disconnect between the accounting and the economics. I think first of all, that's a very good change. We all expect that reserve's going to go up, by that the equity goes down and the leverage ratio will mechanically increase. The discussions we had with the rating agencies is that this change is a non-economic change, and it particularly doesn't change anything on the statutory. It's really a pure accounting one.
Even though if the leverage ratio will go up, it shouldn't change the view the rating agencies have towards the business, because it's actually no change economically, it's no change to the statutory framework.
Got it. I guess I had another question on just the cash flow projections that you guys provide. Could you help me think about, I guess, the duration of those cash flows if I were to think about adjusting the discount rate that's being used? What sort of duration would I be needing to apply there? And what portion of those pre-tax cash flows would sort of need to be taxed versus the release of capital that maybe is sort of the cost basis and doesn't need to be taxed?
I think it's hard to give you just the duration of the cash flow. It's into business. When you think about the duration of the business itself, it's many years out, and if we project to the future, we see that cash flows are coming in strongly for many more years. I don't think I can give you a cash flow duration right now.
Okay. All right. Thank you.
Your next question comes from the line of Joshua Shanker with Deutsche Bank. Your line is open.
Yeah. Good morning, everyone. I was hoping you might be able to give me a frame of reference to the extent to which capital is freed from the outflows and lapsations of high benefit, high fee products, and compare that to the amount of capital being consumed by the inflows from newer, lower fee, lower capital requirement products. Is there a way of thinking about how that impacts your capital on an annual or three-year or five-year basis?
That's a good question. Maybe, you saw the cash flow page we provided again there, this cash flow page really coming from the in-force. The majority of the cash flows there is really coming from the big mature book that is rolling off, I think we gave you a little bit guidance how much new capital we actually consume. That's the $400 million on a statutory basis. I think it's on page 10 of our presentation. Obviously, the majority of the cash flows is coming from the strong in-force.
Does that say that the majority of the cash flow is being generated by the outflow of assets or the majority of the cash flow is being generated by the operations? If you came to a inflow positive state, would that reduce the amount of cash flow you're receiving from the business?
Yeah. The majority is coming, obviously, from the fees of the business. It's not from the outflow, the cash flow. The in-force, as we saw before, generates strong fees, and these fees turn into cash outflow. Once the book rolls off, obviously, your cash flow you generate going to get smaller, but that's when then the new business becomes cash flow positive.
There's not a material amount.
Sorry?
You're not generating a material amount of cash from lower capital requirements as your book becomes less risky and smaller on those mature products?
No, we do. I think you remember the slide we had on the roadshow where we said that the CTE requirement reduces by 15% over 10 years. That's a capital reduction that directly turns into cash flow over time.
That would persist even if you got to an inflow positive state on your book?
Correct.
Okay. Thank you.
We have no further questions at this time. This will conclude today's conference. You may now disconnect.