Good morning. Welcome to the FGL Holdings second quarter 2018 earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Diana Hickert-Hill, Senior Vice President of Marketing, Investor Relations, and Communications. Please go ahead.
Thank you, operator. Good morning, everyone. We appreciate your joining our earnings call. Today, we will discuss our financial results for the second quarter of 2018, which ended on June 30th. You can find the financial information for FGL Holdings on the investor section of our website, fglife.bm. Today's presenters include Chris Littlefield, President and Chief Executive Officer, and Dennis Vigneault, Chief Financial Officer. Some of the comments we make during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. We do not intend to update any comments on this call to reflect new information, subsequent events, or changes in strategy. A number of risks and uncertainties exist that could cause our actual results to differ materially from those expressed or implied.
We discuss these factors in detail in the Form 10-K that we filed with the SEC on March 15th of this year. During this conference call, we may refer to non-GAAP financial measures that we believe may be meaningful to investors. Please refer to our second quarter earnings release, financial supplement, and investor presentation that we posted to our website. These documents contain a reconciliation of non-GAAP financial measures to GAAP. Finally, all comparison comments today will be to the second quarter of 2017, unless we state otherwise. Now, I will turn the call over to Chris.
Thank you, Diana. Good morning, everyone. We delivered strong performance in the second quarter and are continuing to gain traction in building our business to generate long-term value. As a reminder, there are a number of key components that we believe will facilitate enhanced growth and profitability over the quarters and years to come. First, we serve a market with very attractive demographic trends, and our products meet the growing consumer demand for safe money retirement products that offer principal protection with the opportunity for interest crediting upside based on market performance. We believe this combination of favorable demographics and index products provides a strong tailwind for our business.
Second, as we've discussed with you in the past, we're positioning the company for additional ratings upgrades, which we believe will accelerate sales growth of our existing business and give us greater strategic flexibility to enter new distribution channels and new businesses. Third, our strategic partnership with Blackstone will continue to allow us to reposition our investment portfolio to improve our investment yields and offer competitive new products. Our core annuity business is a simple net investment spread business, and Blackstone's unique world-class investment expertise has delivered and will continue to deliver increased profitability and returns. Fourth, we have a scalable platform that can accommodate significant growth, both organic and inorganic, without the need to add significant incremental base costs. We previously disclosed that we believe we can add about another $10 billion of assets without a material increase in our fixed costs.
Last, we benefit from the strength of our exceptional sponsorship and experienced board and leadership. Turning to the results of this quarter, our second quarter total sales were $872 million, up 35% from last year, and our first half sales were $1.7 billion, up 17% from last year. Fixed Indexed Annuity or FIA sales totaled $549 million in the quarter, up 21% over last year and up 26% over first quarter. Year-to-date FIA sales were $985 million, up 10%. Our Multi-Year Guaranteed Annuity or MYGA sales were $220 million in the quarter, up 73% from last year and up 55% over the first quarter, excluding the $200 million FHLB funding agreement completed last quarter. During our last earnings call, we noted that we expected a strong second quarter of annuity sales as we saw increasing momentum in each month of the year.
This overall strong sales momentum is coming from several factors. Attractive market demographics I mentioned earlier, strong long-tenured relationships we've developed with our distribution partners, our distribution partners' increasing confidence in our company's future and anticipation of ratings upgrades, our comprehensive competitive product portfolio that meets a range of consumer needs, the successful launch of a new performance-based income and accumulation product series in February, which already contributed 12% of our FIA sales in the quarter. Last, the court ruling that vacated the Department of Labor rule and eliminated the distraction that had been impacting industry sales. Turning to our Indexed Universal Life or IUL business, we delivered $7 million of target premium in the quarter.
As we've mentioned in the past, we like the IUL business because its renewal premiums provide a natural hedge for rising interest rates, it helps diversify our risks and provides us more duration for investment. We expect our IUL business to benefit from higher ratings, which will allow us to expand distribution and attract new advisors. On the international front, our international sales totaled $54 million in the quarter, up more than 60% over first quarter. We believe we have an opportunity to continue to grow our flow reinsurance business at F&G Re and are working on a couple of additional opportunities that could be in place later this year or in early 2019. We've repeatedly emphasized that our first priority is driving profitable organic growth. At our investor day in March, we said we expected our total annuity sales to grow 10%-12% in 2018.
With our strong sales performance through the first half, we're updating this guidance and believe our total annuity sales will grow 15%+ this year. Most importantly, we remain disciplined in our pricing and have continued to exceed our new business IRR targets while delivering this growth. While we've delivered strong sales growth year-to-date, we expect to see additional upside once we're able to secure targeted ratings upgrades. We believe that we are already getting some of that lift now in anticipation of those upgrades, but we do expect some additional lift from new agents promoting our products because some agents cannot or will not sell products from companies without at least an A-minus rating from AM Best.
Moreover, in addition to increased sales in existing channels, a ratings upgrade to A-minus would also allow us to expand into new channels, in particular regional banks and independent broker-dealers. We are in the process of building the foundation and leveraging existing relationships to access these new markets. While we're pleased with the progress we're making to expand our distribution footprint, we currently do not expect to generate sales through regional banks and independent broker-dealers until sometime in the second half of next year. With respect to M&A, we've been evaluating a robust pipeline of opportunities and are taking a disciplined approach to evaluating targets with a focus on areas we know well, life insurance and annuities, and on deals we believe will be accretive for our shareholders.
Given the deep M&A experience of our board and management team, we're very confident in our ability to execute our acquisition strategy as accretive opportunities arise. With that, I'll turn the call over to Dennis to discuss our results in more detail.
Thanks, Chris, and good morning, everyone. Today, I'll focus my comments on the following: Adjusted Operating Income, including any areas where results were impacted by purchase accounting. The overall performance of the investment portfolio and progress on our reposition. An update on where we are with tax reform. Lastly, I'll wrap up with some thoughts on capital, liquidity, and ratings. Beginning with Adjusted Operating Income on page 13 of the presentation, I'll note that we have put all periods on a comparable basis to best demonstrate the trends across each period. Adjusted Operating Income available to common shareholders in the quarter was $58 million, or $0.27 per share, compared to $42 million or $0.20 per share last year, a 38% increase year-over-year.
Although part of our overall core business performance, we had some notable items in the period within Adjusted Operating Income that are worth pointing out. In the second quarter of 2018, we had $6 million net favorable earnings from three items. A $5 million net favorable adjustment from better actual to expected mortality in the Single Premium Immediate Annuity line. This product line, by its very nature, and given the average age of the policyholders, will have variability quarter-to-quarter. We also had $4 million favorable earnings from bond prepayment income, which was partially offset by $3 million higher expenses for some project costs. The $42 million of AOI available to common shareholders in the second quarter of last year was impacted by a net favorable $1 million from two items.
First, $2 million favorable adjustment from better actual to expected SPIA mortality, which was partially offset by $1 million higher project cost. The trended details of these variable items can be found in our quarterly financial supplement. Stepping back at the half year mark, we reported $119 million of Adjusted Operating Income available to common shareholders or $0.55 per share year-to-date. This is up nearly 50% compared to $80 million or $0.37 per share in the first half of last year. Although we can see quarterly fluctuations in earnings such as I described earlier, we are confirming our previously discussed AOI outlook of $1.10-$1.15 earnings per share, as we expect the second half of the year to benefit further from the portfolio reposition uplift. One update regarding a technical accounting matter.
In the quarter ended March 31, 2018, the company adopted the new accounting standard related to the classification of debt and equity securities, which was effective 01/01/2018. Under this accounting standard, the change in fair value of equity securities is now recorded as net realized gains or losses on investments in the income statement instead of prior inclusion as a direct adjustment to equity or AOCI. In the current quarter, we identified 21 securities that required reclassification from fixed maturity to equity on the balance sheet and recorded an immaterial $21 million or $0.10 per share year-to-date unrealized loss. Again, unrealized loss in GAAP net income. This reclassification had no impact on the $119 million of Adjusted Operating Income available to common shareholders or $0.55 per share year-to-date.
Importantly, the corrections did not result in a misstatement of any of the company's previously issued financial statements and were adjusted for all periods and presented in our 10-Q to be filed later today. I'll now turn to the investment portfolio performance for which we have provided additional information in the presentation. Overall, the portfolio is performing quite well. Average assets under management total $25.2 billion at June 30. Reflecting an increase of $4.8 billion year-over-year, which included $1.4 billion of net asset flows over last year. Average AUM also increased $1.2 billion from purchase accounting impacts and the inclusion of a combined $1.9 billion of assets for F&G Reinsurance and FGL Holdings. The purchase accounting or PGAAP mark-to-market is a non-cash adjustment which will amortize as a reduction to net investment income over the remaining asset life.
GAAP earned yield on the investment portfolio was 4.4% for the second quarter and up 21 basis points sequentially. This level is approximately 60 basis points lower than the 5% pre-merger yield in the second quarter of 2017 and reflects the net impact of PGAAP, partially offset by the year-to-date lift for reposition. It's important to note that on a statutory basis, which is not impacted by PGAAP, the economic yield remains above 5%. It's also important to note that this yield will continue to rise as we further reposition the portfolio to enhance investment income and earnings. I'll provide an update on that reposition in a moment. Total asset purchases during the quarter totaled $1.5 billion at an average yield of 5.65%. Purchases were primarily in structured securities such as CLOs, ABS, and mortgage-backed securities. Through the partnership with Blackstone, we are accessing attractive high-quality assets.
On a year-to-date basis, including the $2.7 billion block trade in Q1 and net new business asset flows, we have purchased $5.2 billion of assets at a weighted average NAIC rating of 1.7 and an average book yield of 5.2%. Overall, we're seeing meaningful benefits on new money flows and generating higher risk-adjusted yields than we have achieved historically. Net investment income was $282 million in the quarter, up $25 million or 10%, growing from higher net asset growth and bond prepayment income, partially offset by $18 million of premium amortization. The after-tax non-cash impact of this amortization was $11 million or $0.05 per diluted share. Net investment income was up $19 million sequentially or 7% due to new business growth and $13 million from the block trade in February.
The underlying quarterly net investment spread is stable for all products, with recent periods at 208 basis points, which was adjusted from pre-merger levels of 250 basis points due to the PGAAP impacts I spoke of. Net investment spread for all products increased 20 basis points on a sequential basis due to the lift in net investment income. For our core product, FIA, we have historically achieved a steady net spread of 300 or better basis points, now reset to 254 basis points in the current quarter, again, reflecting the impacts of purchase accounting. These impacts are non-cash and spreads will continue to rise back to historical levels as we reposition the investment portfolio, driving further earnings and ROE expansion. To that end, I'm pleased to share some details on the progress we're making to boost the yield on the portfolio.
As I mentioned, we expect the $2.7 billion block trade we executed in February to provide $40 million of annualized net investment income lift, with about $33 million of that to be realized in 2018. Secondly, with respect to structured products, over the next few quarters, we will continue our rotation out of approximately $4 billion-$5 billion of relatively lower-yielding public corporates, structured assets and munis, and migrate into higher-yielding structured assets, primarily CLOs, mortgage-backed securities, and other asset-backed securities. Overall, we expect this phase to deliver an additional annualized lift of about $60 million-$75 million of net investment income once completed, with a partial year $20 million uplift projected for the second half of 2018. We continue to favor structured assets as an alternative to public corporates. These assets provide attractive yields, enhanced credit protection, and floating rate upside relative to corporate public bonds.
We have about 13% of the portfolio on floating rate assets today. These assets are good for overall ALM and cash flow testing and also provide important flexibility to manage the portfolio irrespective of the rate environment. With a rising rate environment, it allows us to also pick up a little bit more spread on the in-force block. To put it in perspective, on the floating rate portfolio, every 25 basis points increase is worth about $3 million of AOI. This will grow as we shift a significant portion of the additional $4 billion reposition to this asset class. Our CLO partner is Blackstone Credit, part of Blackstone, the credit business, again, within Blackstone. They have in excess of $100 billion in assets under management and are one of the largest and most successful managers of CLOs globally.
Our focus is on high-grade NAIC 1 and 2-rated CLO debt tranches, which are generally floating rate in nature. GSO has a 20-year track record managing these types of assets and has outperformed the market with an average annual default rate of just one half of 1%, well below the 2.9% industry average. Likewise, GSO has a higher average recovery rate relative to the industry. Lastly, we expect GSO to provide us with industry-leading scale and scope across this asset class and drive a tangible advantage going forward. Our partner on real estate and debt investing is Blackstone Real Estate Debt Strategies, or BREDS. As you know, Blackstone is the largest real estate private equity firm in the world, with real estate assets under management of $120 billion. Within Blackstone, BREDS oversees $15 billion of investor capital and is part of their world-leading integrated real estate platform.
BREDS has not had any realized losses since the strategy's inception in 2009. BREDS oversees our existing CMBS portfolio, as well as the execution of additional CMBS, RMBS, REIT, and commercial mortgage loan trades for the portfolio repositioning. Finally, with respect to alternative assets, this program is well underway as we grade towards a target funded allocation of 5% of the overall portfolio in 2020. This allocation will be across a wide range of assets, including private equity, real estate, credit, and multi-strategy type assets. Blackstone is the largest alternative manager in the world, with a 30-plus year proven track record of deal flow and competitive risk-adjusted net returns throughout all economic cycles. At the half-year mark, we are well into the sourcing of commitments for this alternative asset class with much more to come.
By its very nature for this asset class, cash fundings will lag the investment commitments in the pipeline. At this time, we have approximately $250 million of funded alternative assets and are building a robust pipeline of commitments to achieve $1.5 billion of cash fundings in 2020, or the 5% of AUM, as I mentioned. Overall, once completed, we believe the shift to alternative assets will add approximately $145 million of annualized net investment income lift. In summary, our partnership is progressing well. The opportunities thus far are exceeding our original yield expectations and go beyond the in-force portfolio reposition opportunities. As I noted earlier, we are also seeing meaningful benefits on new money flows at higher risk-adjusted yields than we have achieved historically. Additionally, we are sourcing enhanced asset flows for our MYGA product line.
Let me provide a few comments now on where we are with tax reform. As I mentioned on the first quarter call, we expect our effective tax rate to be about 21% for 2018, and we are tracking close to that estimate at 20.7% on a reported AOI year-to-date basis. We continue to await clarification from tax and treasury authorities on the topic of the gross versus net for affiliated reinsurance issue. You will recall we made a tax planning election to have our Bermuda-based affiliate company treated as a U.S. taxpayer. This election will maintain flexibility for our international platform to ensure no exposure to BEAT. If the BEAT interpretation results in a gross calculation, we would recapture this affiliated business from Bermuda, and again, have no exposure to the BEAT tax.
If BEAT ends up as a net calculation, we would release the previously recognized expense at 21% and resume new business reinsurance. We expect to get guidance in the fourth quarter of 2018, we'll update following that. Separate from BEAT, we are working on third-party strategies and opportunities to grow our international platform. These strategies should reduce our overall effective tax rate to 15% over time. Let me wrap up with a few comments on capital. We finished the second quarter in a strong capital position with an estimated RBC ratio of about 485%. This includes the expected adjustments due to tax reform. The effective tax reform, as you know, only applies to the RBC calc, as the rating agency proprietary capital models are pre-tax. Looking ahead, we are managing capital to fund new business, maintain RBC at greater than 450%, and to secure ratings upgrades.
With regard to liquidity, you'll recall from our last earnings call that in April we issued $550 million or 5.5% senior notes due in 2025. We used a portion of the proceeds to repay in full all of the outstanding combined debt between the senior notes and credit facility and contributed the remaining additional capital to our insurance subsidiaries to fund growth. Lastly, readily deployable capital is approximately $400 million, comprised of insurance company surplus, available debt capacity, and holding company assets. In summary, since the merger closing, we have good momentum in executing on our strategy and delivered another very solid quarter. To recap the indicative outlook provided for 2018, we see top-line annuity sales at or above 15% annual growth while achieving our profitability and capital targets.
Our AOI expectation remains in a range of $235 million-$245 million, or EPS of $1.10-$1.15 per share, and assumes a 21% AOI tax rate. As previously mentioned, we expect to maintain RBC at greater than 450%. We do view this as a transformational year following our merger transaction and are focused on achieving these objectives. With that, I'll turn the call back to the operator to begin the Q&A.
Thank you, sir. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If your question has been addressed, you may withdraw from the queue by pressing star then one. Your first question will be from John Barnidge of Sandler O'Neill. Please go ahead.
Thank you. My first question, ratings upgrade. I know you guys have talked about that. Do you have any update on maybe timing for that?
Good morning, John. This is Dennis. Yeah. What I can say at this point, is we've had very good ongoing dialogue with all of the rating agencies. We did have our annual updates with S&P and AM Best earlier in the quarter. We would expect them to go through their rating committee processes sometime in late third, early fourth quarter, and we'll have a specific update to provide after that. In terms of how we're feeling about it, we feel as though the business is very well-positioned for a ratings upgrade. The capital levels, as I mentioned, are, we think, exceptional. We're very strong. Operating performance has been well above the rating agencies' expectations and what we have reported to them or shown them relative to our operating plans. At this point, I think we are very well-positioned.
We'll see how it plays out, and we'll report back once we hear.
Great. Thanks. I know you have a small long-term care block that was non-core when the Front Street Re acquisition closed. You've talked about disposing of it. Any update on that or kind of what the market looks like for such a transaction? There was a transaction announced last week, so I thought maybe the market had been unlocked a little bit.
Yeah. Good morning, John. It's Chris. We continue to explore our options with respect to that business. Again, we do have parties that are interested and are continuing to work towards seeing if there's a transaction that would allow us to exit that business in a way that is in the shareholders' long-term best interest. We continue to evaluate it. There definitely are parties that are interested in the block, and we hope to have more update on that in the back half of this year.
Great. My last question. Growth in the quarter, is there any way to size the driver from an improving operating environment for the industry versus ownership overhang going away versus increased partnership on the distribution side? Thank you very much.
Well, yeah, John, I think your question is where do we see growth coming from? I think you're going to see record FIA sales in the second quarter. I think across the industry it's up pretty significantly. We're definitely seeing an increased momentum in the sale of the product. I think the product continues to win in the marketplace with the principal protection and the upside crediting versus the VAs and other savings product alternatives. Just general confidence in the overall story of the company. I think people are back to recruiting. They know that the future is no longer uncertain. They understand the story. They understand the financial strength and the growing momentum that we're having, they're building and recruiting behind our company. I think we're seeing a lot of real positive momentum there.
Great. Thanks for the answers.
The next question will be from John Nadel of UBS. Please go ahead.
Hey, good morning. Thank you for taking my questions. I'm looking at slide six, and I'm thinking about operating income and operating EPS first half versus the outlook for the full year. I just wanted to make sure, should we be looking at that on a core basis, ex notable items, to judge your achievement of the full year or should we be looking at that on a reported basis?
Yeah. John, it's Dennis. Good morning. As I mentioned in my prepared remarks, we do have a few of our legacy lines of business that have variability quarter to quarter. We view the reported earnings as all-inclusive. There is that variability quarter to quarter. We don't typically plan for severe mortality in any particular quarter. We know we'll have some. You should view it on a reported basis going forward.
Okay. Then also, just a quick question on the bond prepayment income. When you call that out, Dennis, is that the actual amount received in the quarter, or is that just the amount above what you believe is a more normalized level?
That's the absolute dollar amount of what we've received. Again,
Yeah
Some of that is really just driven by the quality of the assets that we buy. Again, that tends to be lumpy and variable quarter to quarter.
Yeah.
It's reflective, and it's a part of the operating performance.
Understood. Everybody's generating some. Last question. On statutory capital, your statutory book value declined a little bit quarter-over-quarter versus 1Q. I guess I was a little surprised by that given I think you injected some of the debt proceeds into the Iowa company. I think that was $125 million. Can you talk about the moving parts in statutory capital this quarter?
We did put $125 million into the Iowa operating company quarter-over-quarter. I'll check that number and get back to you.
Okay.
I want to validate that number got into the QFS. I'll follow up.
If I could sneak one more in just for Chris. Things we continue to hear is that competition for deals or transactions is much greater for smaller transaction sizes. A lot of capital chasing after deals, a lot of firms chasing after deals. A little bit less so with larger, more complicated transactions. Are you seeing that, and how do you respond to that in terms of thinking about the outlook for M&A for F&G?
I think it really depends on the particular liabilities that are being offered and the blocks of business that are being offered. We've seen decent-sized blocks of business without a lot of competition. We've seen some with much more competition. It's really varied by the block that's being offered. I think we're very confident in our ability to be able to leverage both the offshore structure that we have with F&G Re, as well as the investment expertise we have to bring value to deals. We're going to be disciplined, and we're not going to be chasing things that aren't supportive of us delivering a 15% ROE to our shareholders over time. That's how we think about it. There's definitely competition, we're going to continue to be disciplined.
We do think that we're going to be in position to be able to execute on some transactions over the course of the next year or two. That still remains to be seen. That's probably how I would describe it at this point.
Okay. Thank you.
The next question will be from Kenneth Lee of RBC Capital Markets. Please go ahead.
Hi. Thanks for taking my question. Just one on the Fixed Indexed Annuity sales and how they could be potentially helped by a potential ratings upgrade. Maybe wondering if you could outline how quickly potential benefit to sales might be felt. Presumably, there could be an instant boost to sales within the existing independent agent channel, but wondering how long it would take to establish new relationships, expand the distribution reach within the independent channel. It sounds as if the timeframe for expanding to regional banks is probably not going to happen until the second half of next year. Wondering if that's going to be contingent on any kind of ratings upgrade as well. Thanks.
Okay. Yeah. With respect to the ratings upgrade, I do think we're getting some of that volume now. I do think people are beginning to be comfortable selling and recruiting to F&G based on the positive outlook for ratings enhancements. Once the actual ratings upgrade occurs, and if it occurs, it's probably going to be felt late in the quarter following the upgrade. You get the upgrade, and then people get attracted, you train them on the story, and then they begin to market and sell the product. It's probably a couple months after you actually get the upgrade that you'll see some additional boost in the overall sales. With respect to the regional banks, absolutely. Regional bank and the IBD channel is dependent on a ratings upgrade.
That's the first thing that has to happen, is we need to get the ratings enhancement at least to an A minus from AM Best before we'd be able to access those channels.
Got you. Then in terms of wondering what's sort of like the level of sales, annuity sales that the company could support based on internally-generated cash and still keep RBC ratios relatively unchanged?
I'm sorry, could you repeat that question?
Just wondering what the level of sales that F&G could generate on an annual basis and still keep RBC ratios relatively intact.
Yeah. I would say we could comfortably, and we'll come back with a more refined answer, but we could comfortably generate another billion-plus sales and remain very comfortable within our capital availability.
Got you. Thanks.
The next question will be from Pablo Singzon of J.P. Morgan. Please go ahead.
Hi. Good morning. I had a couple of questions about F&G's non-FIA liabilities. The first one is the cost of crediting on non-FIA liabilities is higher than FIA liabilities. I was wondering, can you please give some color on what products are driving that gap, and do you expect a different scenario over time, whether due to the blocks natural runoff or any other actions you might take?
Yeah. Pablo, can you repeat your question?
Sorry about that. The first one was the cost of crediting is higher on non-FIA liabilities than FIA liabilities.
I got it. Yep.
Yep. Just some color on what products are driving the gap.
Yeah. We've got a blended group of historical products in there. First of all, we've got MYGA, we've got SPIA blocks as well. We've got some traditional life ROP, and that all gets blended into those crediting rates. Those aren't rates they sort of get set when you put that business on the books. Whereas FIA, you're continually managing crediting rates on the in-force book as well as repricing new business. The historical book is just a more static crediting rate than what we have on the FIA by their very nature.
Okay. Are there any significant runoff to think of in the next couple years? I think your MYGAs might be beginning to run off in bulk in 2019 or 2020. I just wanted to check if that's the case.
Sure. Great question. I'll take MYGA first. As we think about MYGA, the last big tranche that we had that came in in sort of a lumpy fashion, as you recall, we at one point were a little more episodic in terms of putting MYGA business on the books. We did have a tranche back in the December fourth quarter timeframe of 2013, probably about $700 million-ish, somewhere in that range that was brought on at that time. That's a five-year product that'll be coming up for renewal here in December. What I will say is we have a very good track record and very stable policyholder behavior of being able to manage those renewal events quite successfully and retain the majority of those assets.
Oftentimes, we not only renew assets for one re-up, but we also get a percentage of those MYGA assets re-upped for a second renewal at the 10-year mark. It's not at a level where it's anything that we're concerned about. We've got very stable policyholder trends, and just given the middle market focus that we have across our customer base, they tend to just be stable and not rotate out as much as other customer bases do. We feel good there. Really, since then, we've had much smaller and more predictable quarterly MYGA sales volume come on more in the one to $250 million range in any given quarter. That's not certainly anything that as we look forward, we'd be expecting big chunks of AUM to run off in any particular quarter. On the other blocks of business, the biggest one is Single Premium Immediate Annuities.
We do have this sort of a bifurcation within that block of liabilities. We've got a slice of a couple or $300 million of impaired risk, higher-aged annuitants. That's where some of the quarterly volatility comes from. The average age on that block of business is over 90 years. Again, that's about $300 million. There's some lumpiness there, but again, it's $300 million in total reserves. As that runs off, that typically generates income as we go forward. Again, I look out in the future and things look pretty manageable and pretty steady as she goes in terms of those other blocks and their runoff.
Okay, thanks. My second question is also MYGA-related. You suggested that you expect MYGA sales to pick up as you basically support higher crediting rates and better yielding assets. How should we think of spread margins in MYGAs compared to FIAs? Also, just in terms of their overall profitability, are the two products comparable, or is one really meant to subsidize the other? Thanks.
Sure. The way to think about MYGA versus FIA is in nominal dollars, you have a lower spread, but you invest about half the capital behind a MYGA product that you do in FIA, or even slightly less than half. The more important metric that we focus on is the relative return per dollar of capital. Historically, and as we look ahead, we are at least putting MYGA business on the books at equivalent lifetime returns as FIA. In most years, we're putting it on at a higher IRR than our FIAs, which we tend to target in that unlevered 13-plus range, and we've been historically outperforming those unlevered IRR targets over the last three, four years.
Thanks for answering.
Which puts us up over mid-teens on a levered basis.
Thank you.
The next question will be from Andrew Kligerman of Credit Suisse. Please go ahead.
Hey, good morning. Just following on that MYGA question, of course, you mentioned on the call and in the press release that you were able to get enhanced asset sourcing capabilities from Blackstone. Curious, what are the crediting rates that you're offering out there on the product today?
Sure. Our most current offering, and it's been this for probably the last 90 days, is 375. We do have substantial number 1 share in the independent space. We are not currently the highest rate. I think the highest rate out there today is about a 4% crediting rate. We're getting nice volume flow. Differential between our 375 and four, and that's on a five-year product, just to be clear. We're not seeing any tangible slowdown on the volume we're getting. We've been keeping our rate steady at that 375. We adjust it monthly as needed and based on the volume that we're looking to get. Most importantly, it is all about achieving the target margin.
At any given point, you've seen this in various quarters, we'll adjust pricing if we can't get the margin, and we'll adjust pricing downward, and take less volume to get that margin back up. We're pretty disciplined. Currently, the environment looks pretty good, and volume has been fairly steady.
Makes a lot of sense. Chris, I think I heard you mention that in the M&A area, you're interested in life insurance as well as annuities. Any particular type of product area that you're more focused on? Are they the more UL interest sensitive stuff? Is it term?
Hi, Andrew. No, there's been a number of different life blocks that have been offered. We're probably interested in things that are probably not more term and on the other areas of life where we think we can bring some advantage to the block, whether that's COLI or BOLI or other different blocks that may be offered. That's kind of the things that we're looking at. We wouldn't be particularly interested in a large term block unless we really thought that there was an opportunity for us to achieve the targeted returns and get to help us demonstrate and deliver a 15% ROE. We're just not seeing term as a way to get there at this point.
You're seeing a lot of opportunity out there in that area?
I would say there's a decent amount of opportunity. I think there's much more opportunity on annuity blocks. There have been definitely some life opportunities available as well.
Got it. Lastly, on your targeted 15% tax rate over time, could you give us, and I know there's a lot of negotiation and just work with regulators to get to a tax rate, when would you logically think you could get to a 15% tax rate without being held to it? Things change over time, when do you think you could get there?
Yeah, this is Dennis. I think the way to envision our path to a 15% is, I'd dimension it in two ways. First, in terms of organically getting there, the types of things that are going to be supportive of that are the flow reinsurance deals that Chris mentioned in building volume there. We do have some nice opportunities in the pipeline. If it were just left to the organic growth, I think that's a multi-year effort to get down to the 15%. What we're pairing that with are opportunities to do block reinsurance M&A type transactions into our offshore platform, whether that is Cayman or Bermuda, both of which are zero tax rate jurisdictions. As we think about our M&A pipeline and how we would structure those block reinsurance deals, that's the way we're thinking about it.
That effort will accelerate meaningfully as we close those opportunities. We are confident as we work through the pipeline that we will land transactions. I can't predict when, but as we bring those transactions on, it will probably take just to size it roughly, given the size of our balance sheet today at about $25 billion. We're sitting here at a 21% tax rate. To reduce that by five or six points, you'd have to put somewhere between $5 billion and $7 billion or $6 billion-$8 billion of assets in a transaction in one of those offshore or combination of transactions in one of those offshore platforms. There is a pretty steady pipeline across a variety of potential deals out there that could readily get you to that level of assets if we were to successfully close one. That'll take time.
I can't predict when the transactions will close. We are actively working, and we'll update you as those transactions develop.
Very helpful. Thanks, Chris and Dennis.
The next question will be from Ryan Krueger of KBW. Please go ahead.
Thanks. Good morning. First I wanted to follow up on taxes. In terms of moving assets offshore potentially, is the primary method going to be potential M&A transactions? Are you still also considering more of a kind of trade with other counterparties as a way to get assets offshore?
We are considering, again, depending upon where tax reform goes and the opportunities that recapturing the currently ModCo business offshore and then doing additional reinsurance transactions with other third parties. Those activities are still under exploration. I don't have anything to report that's nearing completion, but sort of a combination of that, the block M&A that I talked about and the organic flow deals that we already have in the pipeline. It'll be a combination of all three that come together to get that tax rate down.
Thanks.
As well, I know there are a number of other strategies as it relates to dealing with BEAT, should it end up in a gross calculation. We are exploring those. Again, I don't have anything specific to report on, but there are a number of strategies out there. You've heard others in the industry refer to them. We're evaluating those very same strategies, and there is potential for a fourth leg of this strategy to come to fruition and allow us to accelerate the reduction of the tax rate. I'm very confident that the combination or any combination of these three or four ideas will, over time, drive down that tax rate and start leveraging, to a greater degree, that offshore platform.
That's helpful. Thanks. When we look at the ultimate investment income uplift that you expect versus the 2018 uplift, which was helpful, how should we think about the DAC amortization offset that would come through? Just trying to dimension how that would actually impact your bottom line.
As we uplift the portfolio, and as part of our annual DAC reviews and assumption reviews, which we undertake like most in the third quarter. As that yield begins to come through, we'll take the resulting new future yields in the portfolio, and we'll factor that into our unlocking of, to the extent there is any of the DAC impacts. In general, as that portfolio uplift is realized, and all other things being equal across the various and numerous assumptions that we review each year. Uplift in yield will generally have a favorable impact on DAC amortization as it drives enhanced future expected gross profits. Therefore, your DAC is amortized over a broader base of expected future income. It would be a positive. Again, we undertake that in the third quarter.
That work's already underway, we'll have a full report of at least what the current year's impact is on next quarter's call.
Would there be a rough K-factor type of offset as well, just normally as you generate more income that would come through, separate from what you're talking about?
Yeah. Exactly. That's where the positive comes from. The K-factor would adjust down, therefore, every dollar of revenue that's coming in, you're amortizing a lower percentage K-factor. That's where the lift comes in. In the third quarter, we'll go through the annual assumption setting. A natural part of that, there's always, to the extent there's a current period catch-up for previously recognized to sort of catch the book up, that comes through in the third quarter. We'll talk more about what that impact is once our analysis is complete, and then we can give some insight as to what we view that K-factor and the profitability going forward next quarter.
Okay, great. Thank you.
The next question will be a follow-up from John Barnidge of Sandler O'Neill. Please go ahead.
Thank you. There's a large public writer of annuities on the market. Given improvement in your share price over the last couple of months, does that change the economics or make it easier to make acquisitions of size or kind of change your thinking around your M&A strategy? Thank you.
Yeah, John. I think we're probably not going to comment on any specific opportunities that are out there. Obviously, we look at valuations pretty closely in deciding whether or not to execute on a transaction. That's probably all I would probably be willing to say on that, other than we're going to remain disciplined and pay only what we think an asset is worth. Make sure that it's accretive to our shareholders and supportive of a 15% ROE.
Thank you.
The next question will be a follow-up from Pablo Singzon of J.P. Morgan. Please go ahead. Sir, your line is open. You may be muted on your side.
Hi. Can you hear me now?
Yes, sir. We can.
Yes, we can hear you, Pablo. Go ahead.
Thank you. I just wanted to follow up on expenses this quarter. It seems like there was a sequential uptick. Would you consider the amortization normal this quarter? Also, the same question for just general operating expenses.
Well, in terms of the operating expenses, I did note we absorbed about $3 million after-tax expenses related to various strategic projects.
That went through the bottom line. In terms of amortization, there's always a bit of fluctuation from quarter to quarter, depending upon the margins that come through across the various product lines. Nothing out of the ordinary that I would note, and I would just consider it normal quarterly fluctuation.
Okay. My next question was about your offshore reinsurers. I believe they're currently not rated now. Do you think that would be an impediment in growing your business there and using those vehicles to bring down your effective tax rate? Are you working to get those entities rated? Thanks.
Yep, great question. We are in the active process of working with the rating agencies to get those entities rated. The benefits of that are, I think, pretty clear. As we grow those businesses, it'll make us a more attractive partner to do business with. We have had some success, even though those companies are not yet rated. Not only in the flow business that we are bringing on the books each quarter, but also in building the pipeline. We are actively working on that, and I would expect coming out of this year's annual rating agency review cycle, at various points as they complete their process and go through committee, you'll start to see those ratings for those offshore companies come online.
Thanks.
Ladies and gentlemen, this will conclude our question and answer session. I will now turn the conference back over to CEO Chris Littlefield for closing remarks.
Yeah. Thank you very much. To conclude, we're very pleased with our second quarter results and how we're executing to position F&G for the future. We're making substantial progress on the strategy we set forth at our Investor Day in March. We've delivered strong sales growth buoyed by the robust demographic tailwinds, which we think will continue. We've secured ratings enhancements and believe we're well-positioned for future additional enhancements. We're moving forward with our portfolio repositioning and generating increased investment yields. Our profits and our ROE have increased significantly, and we're on track to exceed our sales plan while achieving our new business profitability targets. We appreciate your interest and investment in our company and look forward to updating you again on our progress on our third quarter call. Thank you.
Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect.