Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the AXA Equitable Holdings Inc. First Quarter 2018 Results. 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, please press the pound key. I would now like to turn the call over to Mr. Kevin Molloy. Please go ahead.
Thank you. Good morning, and welcome to AXA Equitable Holdings First Quarter 2018 earnings call. Materials for today's call can be found on our website at ir.axaequitableholdings.com. Turning to page two, I have an important reminder. Our discussion during this call will include forward-looking statements within the meaning of the federal securities laws. AXA Equitable Holdings' actual results may differ materially from the results anticipated in the forward-looking statements, as a result of risks and uncertainties, including those described in AXA Equitable Holdings' filings with the U.S. Securities and Exchange Commission. Information discussed on today's call is current only as of today, June 20th, 2018. The company undertakes no obligation to update any information discussed on today's call. Joining me on today's call is Mark Pearson, President and Chief Executive Officer of AXA Equitable Holdings, and Anders Malmström, our Chief Financial Officer.
Also in the room is John Weisenseel, Chief Financial Officer of AllianceBernstein. During this call, we will be discussing certain financial measures that are not based on generally accepted accounting principles, also known as non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures and related definitions may be found on the investor relations portion of our website, in our earnings release, slide presentation, and the financial supplement. I would like now to turn the call over to Mark and Anders for their prepared remarks.
Thank you, Kevin, and good morning, everyone. I'm pleased to be with you today for our first quarterly earnings call since becoming public on May the 10th. We are aware that there may be a number of investors listening who are just getting to know us, so we thought it would be helpful to provide a quick overview of our business operations before getting into our first quarter results. AXA Equitable has been around for 159 years now, providing advice and solutions that help our clients retire with dignity, protect their families, and prepare for their financial futures with confidence. Today, we serve more than 5 million clients, have over 12,100 employees and financial advisors, and total assets under management of $665 billion. Moving to slide four. AXA Equitable Holdings operates through two well-established and iconic brands.
Firstly, 100% ownership of AXA Equitable Life, which serves 2.8 million clients with individual retirement, group retirement, and protection solutions. Secondly, we own 65% of AllianceBernstein, the investment management and research house. It's self-listed on the New York Stock Exchange with a market cap of over $8 billion. Although our subsidiaries are distinct businesses, they have grown up together and complement each other well. AB manages approximately 69% of AXA Equitable's general account and 29% of the separate account. AB also provides deep expertise for our hedging and asset liability matching, and in return, AXA Equitable provides a source of seed capital for new product development, a key part of AB's recent success. Both subsidiaries have very strong financial strength ratings. AXA Equitable Life is rated A2 from Moody's and A+ from S&P, both with a stable outlook.
AllianceBernstein has also received A2 stable from Moody's and an A stable from S&P. We are differentiated by the breadth and size of our businesses. Our insurance operations are conducted through three segments. Through our individual retirement business, we are a top three provider in the variable annuity market with $102 billion in account values. In group retirement, we are the number one provider in the teachers K through 12 supplementary retirement market and have $34 billion of assets under management. In protection solutions, we have a long heritage in the life insurance market. Today we play in more select markets where we are the number four player in the variable universal life market. Finally, AllianceBernstein has a global presence in 22 countries with $549 billion of assets under management and best-in-class private wealth management and sell-side research that sets them apart from other asset managers.
We support these leading positions through multi-channel distribution platform, including one of the largest affiliated sales forces in the country. Turning to slide five. Prior to our listing, there were a number of reorganization transactions necessary to establish us as independent and standalone from AXA. It is important to understand that these milestones were completed in the second quarter of 2018 and are not reflected in the results we are presenting today. In April, we raised $3.8 billion in public long-term debt to repay internal loans to AXA SA and purchased AXA's remaining interest in AllianceBernstein, bringing our ownership of AB to approximately 65%. We also merged our primary variable annuity reinsurer into AXA Equitable Life, which positions us well ahead of the upcoming anticipated NAIC variable annuity reform.
These activities enabled us to list on the New York Stock Exchange on the May 10th, 2018, at $20 per share. Turning now to slide six and our first quarter results. During this first quarter, we saw several important developments impacting our industry. First, we estimate the benefit of corporate tax reform to be circa $150 million per annum. Going forward, we estimate our effective tax rate will be approximately 19%. Second, our industry continues to work through important regulatory reforms, including the NAIC's new variable annuity capital standards. We support these efforts to better align capital standards with the economics of variable annuity products as they are closer to how we manage and hedge our products. The various proposed fiduciary standards have created an uncertain regulatory environment, which has impacted industry sales for the past two years.
While we have successfully weathered this uncertainty through product innovation, such as our industry-leading index-linked annuity, we are beginning to see an improved operating environment for our company, financial advisors, and the solutions they offer. Finally, the markets. After a robust 2017, mounting concerns over inflation, rising interest rates, and geopolitical uncertainty made for volatile markets in the first quarter of 2018. In this environment, I am proud of how our investment teams have managed to maintain strong, longer term track records. Through the quarter end at AllianceBernstein, 76% of our U.S. retail mutual fund assets and 89% of our Luxembourg-based fund assets held four or five-star Morningstar ratings. Against this backdrop on slide seven, we show highlights of our first quarter results.
Total AUM at the end of the first quarter was $665 billion, down 1% since December 31, 2017, and up 9% compared to the first quarter of 2017, reflecting market performance and positive net flows across our businesses. I am pleased to report strong non-GAAP operating earnings, which increased to $464 million from $304 million for the quarter 2017. When measured against our pro forma equity, which adjusts for our pre-IPO reorganization transactions, our pro forma operating return on equity for the quarter was 13.6%, in line with our goal to generate mid-teens ROE by 2020. As previously mentioned, we have fully executed on strategic priorities, including issuance of debt and launch of the IPO. Throughout the volatile quarter, we maintained a strong capital position in excess of CTE 98 for variable annuities and 350%-400% RBC for our non-variable annuity businesses.
Our hedging program worked as expected with an overall effectiveness ratio of 94%. At the business level, there were several bright spots during our earnings. Individual retirement operating earnings grew to $360 million from $202 million, driven by higher account values and improved variable annuity hedge margins. Group retirement account values were up 9% due to market appreciation and positive net flows. New analyzed premiums and protection solutions increased 10%, driven by sales from our new employee benefits division. For AllianceBernstein, our share of operating earnings increased to $81 million from $32 million, reflecting higher performance fees and higher fees on assets under management. As a result, AB's adjusted operating margin, as reported in its 10-Q, was up 600 basis points to 30.1% for the period. We remain on track to commence our dividend and share repurchase program later this year. Turning to slide eight.
I will shortly pass over to Anders Malmström, our CFO, to go into some details on these highlights. Before doing so, just a reminder on the priorities and guidance we have given to the market. We have multiple levers to drive earnings growth. Our priorities are to optimize our capital, improve productivity, and grow the business. We are targeting 5%-7% compound annual growth in non-GAAP operating earnings through 2020 after the benefits of tax reform. In terms of the general account optimization, we anticipate generating a $160 million pre-tax benefit by 2020 by transitioning U.S. treasuries to high-quality corporates. This will better align our GA portfolio with industry peers. In terms of progress, we are approximately one-third complete.
On productivity initiatives, we are expecting to generate a $75 million pre-tax benefit net of any reinvestment by 2020. Earnings CAGR from growth would be reasonable in the 3%-4% range, allowing for AB's publicly reported margin improvement to 30% by 2020. Calculating this out, we should see earnings in the $2.2 billion-$2.3 billion range by 2020, giving rise to a non-GAAP operating ROE in the mid-teens. Finally, we have committed to returning substantial capital to our shareholders in the range of 40%-60% of our non-GAAP operating earnings, which will include a quarterly dividend, and subject to board approval, we will start paying a dividend of $0.13 per share based on our second quarter results. I will now turn the call over to Anders to go through our quarterly results in more detail. Over to you, Anders.
Thank you, Mark. To first give you a sense of our overall results, I will discuss the consolidated results for the first quarter on slide nine. Non-GAAP operating earnings in the first quarter of 2018 increased 53% to $464 million. Excluding the benefit of tax reform, earnings were up 32% relative to the first quarter of 2017. First quarter 2018 results reflect the benefit of higher assets under management relative to the first quarter of 2017, as well as higher operating earnings from the individual retirement segment, which increased due to improved variable annuity hedging margins. Additionally, during Q1, we have recorded two non-recurring costs to net income. First, a pension settlement for a portion of our employee pension plan liability for $100 million, and second, $61 million of separation costs.
Total AUM grew 9% year-over-year to approximately $665 billion, driven by strong market appreciation and positive net flows, which was an important revenue driver across all of our asset-gathering businesses. Due to the stable share count over the period, per share metrics reflect similar trends. Pro forma non-GAAP ROE improved to 13.6% in the first quarter of 2018. This compares well with the 12.3% pro forma ROE we highlighted during our IPO process for the full year of 2017 and is in line with our mid-teens by 2020 objective. On slide 10, I would like to briefly walk you through our variable annuity hedging program, which is a part of our overall approach to risk management and supports our financial strength. This program seeks to protect the strong capitalization level of the company while allowing us to generate free distributable cash flows across a wide range of scenarios.
As you can see in the top left of the slide, the program is calibrated to maintain CTE 98 on the most economic scenarios and keeps a CTE 95 level under all scenarios. The hedging program performed as expected during a volatile first quarter, with hedge effectiveness of 94% relative to the movement in the economic liability. Our hedging program consists of two strategies, the dynamic hedging strategy and the static strategy. The most significant part of our program, the dynamic strategy, is a true economic hedge, where we forgo the upside and downside using futures and swaps. The fine-tuning element of the program, the static hedge, is used to maintain our target CTE levels, which is CTE 98 on the most economic scenarios and CTE 95 under the most extreme scenarios. However, this generates net income volatility under GAAP accounting.
The market movements of the hedge instruments, which are designed to match the economic liability of the VA riders, do not match the accounting for the GAAP reserves under the SOP reserve framework, which is much less reactive to market movements. This is why we believe that non-GAAP operating earnings is the best way to represent the economics of our VA business. Turning to our segment, I will begin with individual retirement on slide 11. AXA Equitable Life is the third largest provider of variable annuities by sales in the $90 billion U.S. VA market and serves over 750,000 clients. Account value increased $5.1 billion year-over-year, largely driven by market appreciation.
The positioning of our VA business continues to shift as we continue to see net outflows from our mature fixed GMXB block, partially offset by $579 million of inflows to newer, less capital-intensive products during the first quarter. This trend is an important driver for the continued evolution and positioning of our business towards less capital-intensive products and lowering the risk profile of our individual retirement business. Year-over-year, deposits and first-year premiums were lower following exceptionally strong sales in Q1 2017, prior to the Department of Labor rule implementation. This mix remains well-balanced at 62% of products sold without GMXB features. Overall, operating earnings grew 78%, driven by higher account values and improved variable annuity hedge margins. Turning to our group retirement segment on slide 12.
AXA Equitable Life is the number one player in the U.S. 403(b) K-12 educators market, with unique positioning, serving over one million teachers, public sector employees, and small businesses with supplementary retirement products. Account value increased $2.7 billion year-over-year due to market appreciation and continued positive net flows. The segment continued to experience strong net flows in the first quarter, increasing to $101 million from $55 million in the year ago quarter, driven by an increase in gross premiums and a reduction in surrenders and withdrawals. Gross premiums were driven by continued strong sales and higher renewals from client retirement awareness initiatives. Our renewal rate was higher than the prior year in all markets due to client engagement and retention. Overall, operating earnings grew approximately 29% due to higher fee income, due to asset growth from positive net flows and market appreciation.
Turning to investment management and research, which consists of AllianceBernstein on page 13. AB's deep commitment to research excellence is reflected in superior investment performance. The depth and global presence of AB's distribution and best-in-class sell-side research set them apart from other asset managers. Please note these first quarter results do not reflect the impact of the additional AB units we purchased in April, which increased our economic interest to approximately 65%. First quarter segment revenues of $909 million increased 22% from the first quarter of 2017, driven by higher performance-based fees, investment advisory base fees, and Bernstein research revenues. Net outflows of $2.4 billion during the quarter were driven by outflows from taxable fixed income and passive equity funds.
Active equity and tax-exempt fixed income funds were net flow positive, translating to positive organic revenue growth as higher fees on these inflows more than offset lower fees on larger outflows. Overall, operating earnings grew 153% in the quarter as double-digit revenue growth outpaced increased expenses. Finally, we'll turn to protection solutions on slide 14. Through this business, AXA Equitable plays in select parts of the life insurance market, where we are the number 4 player in the less capital-intensive variable universal life and Indexed Universal Life accumulation space. For the quarter, higher annualized premiums in the growing employee benefit business were partially offset by lower annualized premiums for life insurance. Operating earnings declined primarily driven by higher DAC amortization costs associated with our ongoing loss recognition testing. We expect to remain in LRT for the foreseeable future, which will create some volatility in the results of this segment.
Overall, our first quarter results were strong, and I believe the underlying trends of our businesses demonstrate good momentum for achieving our strategic objectives. Now, I will turn the call back to Mark for some concluding remarks. Mark?
Thanks, Anders Malmström. Before breaking for questions, I'd like to be clear on our goals and performance. On slide 15, we summarize our key financial targets. We've positioned the company to maintain a strong balance sheet while delivering disciplined financial growth. We are holding ourselves accountable to deliver 5%-7% compound annual growth in operating earnings through 2020, supported in part by the 30% adjusted operating margin target that AB has publicly reported. With a target payout ratio of 40%-60%, this should result in a pro forma non-GAAP operating ROE in the mid-teens by 2020. We expect to maintain strong capitalization of CTE 98 for the variable annuity business and 350%-400% RBC for the other insurance businesses. Finally, on slide 16, just a reminder of the highlights from the first quarter.
As a newly public company, I'm very pleased to deliver such strong results, driven by continued solid performance across our two principal operating subsidiaries. We are confident that our leading positions in select markets, premier multi-channel distribution platform, and investment expertise position us well to continue to generate earnings growth, maintain financial stability through market cycles, and generate attractive returns and strong cash flows for shareholders. With that, I'll hand it over to the operator to open the call to Q&A.
At this time, if anybody would like to ask a question, please press star one on your telephone keypad. Again, that will be star one on your telephone keypad. Your first question comes from Erik Bass from Autonomous Research. Your line is open.
Mark, good morning. Thank you. I guess the first question, can you talk about the timeframe for potential capital return? Are there any restrictions on when you could begin share repurchases? Do you have a preferred approach between being in the market on a regular basis or waiting to participate in future stock offerings from AXA?
Thank you, Erik. This is Anders speaking. First of all, as we already talked in the S-1, we going to intend to start paying dividends from Q2 on, which means first time will be in August. As we indicated, it will be most probably around $0.13 per share per quarter. We also said that we're going to start using buybacks in the second half of the year. We're going to come back in Q2 with a more detailed plan how we're going to do that, but I tell you it will be in H2, so later in the year from that. We come back in the Q2 earnings call and going to give you more details.
Got it. Thank you. Just to follow up on that, with the 40%-60% of operating earnings that you expect to deploy, I think you're talking about doing that for 2018. Obviously, you won't have paid a dividend in each of the four quarters. Should we still use that as kind of the rough range to size-
Absolutely
total capital deployment for 2018?
Yeah, absolutely. Absolutely. This is the right range. Think about we're going to do 75% this year because basically we're public for three quarters.
Got it. Thank you. If I could sneak in just one more. Over what timeframe do you expect to complete the investment portfolio optimization? Can you provide some more color on just the geography of where the benefits will show up in your results?
Yes. As we already said in the S-1, and I think during the roadshow, this is a three-year program. We've completed about one third of the program, which means on a run rate basis, on an annualized basis, this is a pickup of about $50 million. You're going to see the impact in the net investment income over all segments. I think you can expect the biggest impact obviously on protection solution segment, but it will impact all three segments. We cannot call out the impact of the program standalone because obviously there is an underlying performance yield coming from the joint account that is a pickup of about $160 million on a pre-tax basis. As I said, about one third is implemented, which is on an annualized basis, about $50 million.
Great. Thank you very much.
Your next question comes from Ryan Krueger from KBW. Your line is open.
Hi. Thanks. Good morning. When we think about the difference between net income and operating income, I guess, can you help dimension how much of that you would view as true cash items versus more accounting differences that result from the GMIB business?
Yeah. This is again, Andres speaking. As I said in the presentation, I think the really the right way to look at the business is from an economic point of view. That's what we try then to use operating earning as the best proxy. I know GAAP in the end is what we have to report on, but GAAP doesn't really reflect the economics of the business. That's why we really think the operating earnings is the best way to look at. You see in the reconciliation when we go down from operating earnings to net income, that the impact coming from the VA business is about $212 million. Think about the majority of it is really mark-to-market. I think about $186 million is mark to market and about $26 million is coming from the static hedge program.
You can argue this is a cash item because really for options you pay a premium. $26 million is a cash item. The rest is mark to market for that reconciliation. Again, as I said, I don't think net income is the right way to look at it. It's really the economic view, and we try to use operating earnings as the best proxy to reflect that.
Got it. Thanks. On VA sales, they were down some in the quarter. I know you noted a strong year-ago comparison. Seems like we're starting to see some improvement in overall market VA sales. Can you talk a little bit about your outlook going forward and if you expect to grow VA sales this year?
Hi, it's Mark. I'll take that question. You're right. First quarter 2017 was a particularly strong quarter for us, ahead of the proposed DOL changes, if you remember. Those changes were substantially altered and less disruptive to the industry. As you say, we are seeing some signs of improvement in sales conditions in the VA business since the first quarter end. We're very positive that over the long term, there is significant demand for these products and we're very well-placed with our product range and our distribution reach.
Great. Thank you.
Okay.
Your next question comes from Andrew Kligerman from Credit Suisse. Your line is open.
Hey, good morning. Follow up on that annuity question. As I looked at slide 11 in the net flows, the new products, it looked like the flow of the new product was $579 million this quarter versus $1.14 billion last quarter. Are you seeing more competition in the structured product area? Can you talk a little bit about that and
Yes. Hi, it's Mark. I'll follow up on that. Yes, there is more competition, particularly in the space where we have our SCS product. A number of competitors have come out with similar products in there, a little bit more crowded there. The other point behind that reduction in the net flows on the current product line is the maturities on our SCS that we sold five years ago. Some of that business was planned to mature and come off, and we're starting to see that. I think it's a combination of the two things, the sales being down slightly on a very strong quarter in 2017, and the natural outflows that we expected on the SCS. Also on the competition side, it's two things, isn't it? One, it's the product range you have, but also the distribution capability you have.
You'll see, I think our sales over the last few years are less volatile than some others because we have AXA Advisors and we have distribution relationships broader than just wire houses. I think we're well-placed. Yes, I think there is more competition there.
Got it. At AllianceBernstein, it was interesting, the net flows in taxable fixed income were -$9.6, on the active equity, you were +$2.9, of course, that was great because your net fees were better. That said, I was just curious as to what was driving the pressure in taxable fixed income and the strength in active equity?
This is Andrew St. John from AB. I think that the pressure in taxable fixed income was just driven by the increase that we saw in rates during the quarter. The strength in the equity side, we had actually won two large institutional equity mandates, and one was a value mandate, international value mandate. Those were really what was driving the equity numbers as well.
Do we have a trend going forward?
Well, we had positive active equity flows last year of $800 million. Obviously, that's going against what we're seeing in the industry and against our peers. We're quite pleased with that. Again, not quite sure if that will continue, but time will tell. One thing that's helped us, I think, is that our performance in the active equity space has improved over the course of the past two years. I think we're seeing that in our flows. In fact, one of the large institutional mandates that we did win in the first quarter was actually a client that had left us many years ago and now has come back to us. That was a very good sign.
Great. Thanks a lot.
You're welcome.
The next question comes from Jay Gelb from Barclays. Your line is open.
Thanks very much. Can you give us any perspective on how quickly the AXA parent company may sell down its remaining stake?
Hi, Jay. It's Mark Pearson. Can't give you any more than AXA's already put out, which is its intention to fully exit over the next few years, subject to market conditions. I think, well, I know AXA are out publicly with that. We don't have any more information other than that.
Okay. Next question. It appears, looking at AXA Equitable's current valuation, that the valuation of AllianceBernstein is not really reflected at all in the stock. I wonder if that might drive you thinking at some point as to whether to buy in the rest of AllianceBernstein or perhaps spin it off.
Obviously we can't comment on valuation. That's for the market to set. In terms of our ownership of AB, Jay, it's been 65% under the AXA umbrella for some years now. When we've looked at this topic before, we're aware of financial evaluation, want to do, but by the minorities. We know that there is a very good currency for AB in being listed, both externally in winning mandates and internally with the senior team. In terms of within our portfolio, we really like the business. It ticks a lot of boxes for us. It's low capital intensity. It gives us non-regulated cash flows into the holding company.
Although the businesses are distinct, they're pretty complementary and support each other very well in terms of the funds under the management that AB look after on the life side, and also the seed capital that the life business is able to provide from time to time, to support the strategy. We're happy with where we are now. We will look at it from time to time, I'm sure, but no plans to do so now.
I appreciate that. My final question is, just trying to get a perspective on AXA Equitable sensitivity from an earnings per share perspective on a given move in equity markets or fixed income yields, if you happen to have that.
Yeah, look, I think as we talked before, I think our business is sensitive to equity markets. I think most of our segments actually have quite a high portion of separate accounts. I think the sensitivity there is pretty obvious. The same is true for AllianceBernstein. We don't give a number on that, but I think You probably can calculate it by yourself because fees are directly linked to equities. Maybe just the sensitivity to interest rate is, on the insurance side, pretty limited. From an earnings perspective, this is more a long-term impact, I think on AllianceBernstein is obviously slightly higher because of all the fixed income in the underlying funds. Yes, we are sensitive, in particular to equity market.
Okay. If at some point down the road, perhaps you can give us the details on that'd be helpful. Thanks very much.
Absolutely. Thank you.
Okay, Jay.
The next question comes from Mark Hughes from SunTrust. Your line is open.
Yeah, thank you. Just a quick follow-up on that question. Is it just the impact on account balances that drives the earnings effect related to market movements? Or are there other fees or revenue items to consider?
Yeah. This is again, Anders speaking. I think it's really the impact on the underlying asset balances directly impacting the fees coming, therefore. As we talked before, our hedging program really tries to immunize all the impact on the rider, which means on the guarantee. There, the impact should be very limited. It's really coming from the fees the interest rate obviously going to impact the yield on the general account, but that's much, much lower. Because that's only for the new money you're going to invest, that's where you're going to see the impact on an interest rate. Yes, it's coming from the underlying asset balance.
compensation expense came in a little lower perhaps this quarter than we might have looked for. Is there any sort of seasonality or one-time items that might have impacted that, or is that the cost efficiency measures?
I think if you look at the expenses overall are slightly up. If you take out the impact from AllianceBernstein, it's actually down quarter-over-quarter, which really goes back to the efficiency measures we are taking at the insurance side. Maybe, John, you want to comment on expenses on AllianceBernstein?
I think at AllianceBernstein, it's just the comp expense was up because of the revenues were so much higher, and you're just applying a comp ratio to it. Just as far as the other expense lines, the G&A expense was flat for the quarter-over-quarter. The promotion and servicing was up, I think just about $3 million. That was really due to higher trade execution expenses at the Bernstein research business because they were trading more market volume. Obviously, some of their trading expenses are variable, and that's reflected there as well.
Thank you.
Thanks.
Again, if anybody would like to ask a question, please press star one on your telephone keypad. Again, that is star one on your telephone keypad. Your next question comes from Suneet Kamath from Citigroup. Your line is open.
Thanks. Good morning. I wanted to start with the AllianceBernstein stake. Our understanding is about 45% of that investment is sitting in a regulated insurance subsidiary. Two questions on that. One, any thoughts in terms of why that is? Second, can you tell us which businesses that asset is supporting?
This is Andre speaking. Look, I think Suneet, you're correct. It's about 28% out of the 65% are owned by the insurance company. The rest of 37% are owned by the holding company. The reason for that is really historical. That's how we could build up the whole ownership structure. The only thing I can tell you about that is that we're actively looking at changing that, because from our perspective, we would like to move the AB shares to the holding company. It's something that it's more complicated than just do it in one single step. That's something we are looking at. When it comes to your question about what kind of business it supports. It's really part of the surplus.
That's the way you have to think about it under statutory, which means the earnings coming out of it provides a statutory surplus, but it's not allocated to a business. Our general account is not segregated to businesses, but the AB shares you can think about as a surplus item.
As perhaps a comment on the RBC impact, if it were to move. I think we've given the market some guidance on that as well.
As you know, because AllianceBernstein is equity, the RBC treatment is pretty high. Even though it's a significant stake, the RBC impact is actually pretty small. If you were to exclude them and we would move up the AB shares from Equitable into the holding company. It's a low double-digit number in terms of RBC points.
Okay. Suneet, a follow-up on that. Just so we should not think about this stake as being included in any of the available resources backing the VA block?
Correct.
Okay. My separate question is just on the free cash flow conversion of 40%-60%. I get that it's an at least kind of number. I guess, given your business mix, especially with the AllianceBernstein piece, I would have thought that maybe that was higher, or should be higher, because the 40%-60% is pretty close to what we see from insurance companies that don't have sizable asset management operations. Is there something that we're sort of missing there, or is it just conservatism?
Yes, maybe I start. This is again, Anders speaking. I think the 40%-60% is really the range we gave when we went out. I think it is a range that we can definitely hit, and I would say if everything works well, we are in the upper end of this range. I think that's what I want to give you. Certainly, yes, I think there is upside there.
Okay. Just the last one, just on the capital, just to follow up. Is there any excess capital that you would point to, either in the insurance subsidiaries or elsewhere? Your 40-60 is obviously based on the earnings that you generate. Just want to make sure, maybe there's not a piece of excess capital that is not contemplated in that 40-60.
Yes. The 40-60 is really the guidance we gave you over the next couple of years. Now, when it comes to capitalization, I think you heard me talking about CTE 98, which is really the target capitalization for VAs, and then for non-VAs, we target between 350% and 400% RBC. Now, if you take that together, you end up at an RBC ratio of about 550 points. Now, as you pointed out, in the S-1, at year-end 2017, we were at about 650 RBC points. If you incorporate the VA recapture, which adds another 50 points, you're close to 700 points. Now, obviously, we're going to pay out the dividend during this year out of the insurance company, but we also generate earnings. With that, I think we are in a good position above our target capitalization.
Keep in mind, there's the impact of the tax reform that has to be reflected at some point once it's final. Also the NAIC reform is coming. I'm not afraid of it. I think we are in a good position there. From that perspective, I see maybe some capitalization above our target range. This is all reflected that we can solidly perform our range we gave you on the 40%-60%.
Okay, thanks.
Your next question comes from Alex Scott from Goldman Sachs. Your line is open.
Good morning. First question was just on the hedge effectiveness. I get that US GAAP accounting makes it a bit difficult for us to assess hedge performance using US GAAP numbers, and that's part of the reason it's below the line. Could you shed some light on this hedge effectiveness metric you gave us? Am I right to interpret 94% hedge effectiveness this quarter in a quarter where equity markets are moving in an okay direction and interest rates moved up? Does that mean that the 6% breakage was actually a positive this quarter?
Yeah. I would say, think about it as a volatility measure when we talk about hedge effectiveness. Basically, what we measure here is on a 12-month trailing. It's a 12-month trailing ratio where we measure the movement in liability versus the movement in our hedged assets. The liability is really the economic liability, is how we manage our program. Every month, you have liabilities up and down, you have hedges up and down, and then you take the difference, and you take this ratio and have a 12-month rolling average. By that, the number is always below 100. Even so if it's a gain or it's a loss, it's always below 100 because you can never be above 100. I wouldn't say it was a gain or a loss this quarter, Think about it as a volatility measure, as I said.
I think overall, we were actually pretty flat for this quarter on an economic base.
Okay, thanks. Just on the NAIC capital reform, can you provide an update at all just based on, I think the NAIC recently put out some recommendations of their own, as opposed to, I think previously it was mostly Oliver Wyman stuff. Is there any additional clarity that you got from reviewing that and any update on the direction of it?
Yeah. As I said before, I think overall, I think we are in a good position now. As you pointed out, the NAIC came out with their detailed report. We're still going through the classification, so I cannot give you any update from that perspective. I hope I can give you that at the Q2 call. My understanding is that the NAIC is going to put it final, I think, in their August meeting. After that, obviously we then have to do the final calculation. As I said, I think we're in a good position there. The NAIC reform goes in the right direction. It's a much more economic framework which supports the economic hedging we're doing. From that perspective, we're fine. From an assumption, policy or the behavior assumption setting, I think we, as well, we think we could be in a good position.
Overall, we support that initiative. I think it goes in the right direction. It supports economic hedging. Quantification, I have to give you once we have the final regulation is done on the numbers calculation.
Okay. Maybe if I could sneak one last one in. Just in terms of seasonal considerations, is there anything you'd highlight thinking about going from Q1 to Q2?
No. Look, I think the quarter was, from a market perspective, it was a benign quarter from that perspective, slightly down, obviously. I think the biggest change is really coming from all the restructuring elements we've done in Q2. I think we increased the AB ownership at the AXA Equitable Holdings level from 48% to 65%. I think that has the biggest impact. Also the debt issuance that took place in Q2. You're going to see all of that reflected in Q2. I think Mark talked about the sales. I think overall, I think really the maturity will be coming from the restructuring.
Okay, thanks very much.
Welcome.
Again, if anybody would like to ask a question, please press star one on your telephone keypad. Again, that would be star one on your telephone keypad. I have no questions in queue at this time. I turn the call back over to Kevin Molloy for closing remarks.
Okay, thank you, Michelle. Thanks, everyone for joining us this morning. As always, if you have any follow-up questions, please do not hesitate to call or email. You can reach us at 212-314-2476 or through email at ir@axa-equitable.com. Thank you, and have a great day.
Thank you, everyone. This will conclude today's conference call. You may now disconnect.