Good morning, and welcome to the FGL Holdings fourth quarter 2017 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 Investor Relations. Please go ahead.
Thank you, operator, and good morning, everyone. Thank you for joining the inaugural earnings call for FGL Holdings. Today, we will discuss our financial results for the fourth quarter of 2017, which ended on December 31st, 2017. You can find the financial information for FGL Holdings on the investor section of our website, fglife.bm. Today's presenters include Chin Chu, Co-Chairman of FGL Holdings, Chris Littlefield, President and Chief Executive Officer, and Dennis Vigneau, 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 revise or 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 FGL Form 10-K that we filed with the SEC on November 16th, 2017. In conjunction with our shift from a fiscal year-end to a calendar year-end, we plan to file our 2017 Form 10-K next week. During this conference call, we may make reference to non-GAAP financial measures that we believe may be meaningful to investors. Please refer to our fourth quarter earnings release and financial supplement that are on the company's website, which contains a reconciliation of non-GAAP financial measures to GAAP. Finally, all comparison comments today will be to the fourth quarter 2016, unless we state otherwise. Now, I will turn the call over to Chin.
Thank you, Diana, and good morning, everybody. As you know, we closed the transaction on November 30th, and I'm pleased to say that the progress and the direction of the company, we're very pleased with both. We're excited about the future, and this experienced management team builds on a very strong foundation of established annuity and life insurance franchise. Today's an important milestone, as is our first conference call, our earnings call since the merger. As you know, in two weeks, we will be updating you again with our business strategy during the March 13th investor day. Amongst the investment thesis of the deal are three things. Number one, strong sponsorship. Number two, the partnership with Blackstone, which yields in a asset management uplift. Number three, the migration to an A-minus rating.
On the first point, we're pleased, as a reminder, Bill Foley and myself are serving as Co-Chairman, and we partner up with Blackstone and FNF, and the combined sponsorship group have invested over $900 million into the transaction. We have worked on populating the board with very experienced and talented individuals and wanted to report that our latest appointment is Tom Sanzone, the current CEO of Black Knight, Inc. Tom is a terrific executive that will add a lot of value to the board. During his tenure at Black Knight, Inc., he has increased the stock price sevenfold and has created significant shareholder value.
On the second point, the asset management uplift and the partnership with Blackstone, I'm also pleased to report, as Dennis will cover, we recently executed a $2.7 billion block trade that will result in a $40 million earnings uplift, taking the yield of that $2.7 billion block 150 basis points higher. This could not have been done without the partnership with Blackstone. This is an example of the things that we can do with Blackstone to continue to increase the portfolio yield of the company. On the third point, the migration to A-minus rating, I'm also pleased to inform the shareholders that since closing, we have received upgrades from three rating agencies, including a two-notch upgrade from S&P. With that, I'd like to turn over to Chris to talk about the company and do a deeper dive into the financials. Thank you, everybody. Chris?
Thank you, Chin. Good morning, everyone. We're pleased to host our first earnings call following the successful completion of the merger with CF Corp. This transaction's transformative in many ways for our company, and we expect to benefit substantially from the world-class sponsorship that Chin discussed. As part of that sponsorship, we will be working closely with Blackstone to improve the overall returns on our investment portfolio. We're already seeing very significant benefits from that partnership. As Chin headlined, we've already completed the first step in our portfolio repositioning by executing a block trade of about $2.7 billion of corporate bonds, which we expect to increase annualized net investment income by about $40 million. Dennis will provide more details on that trade in a minute.
In addition, we are benefiting from much better access and allocations to securities that are offering us additional opportunities to improve our net investment income. By combining our former FGL investment team led by Raj with Blackstone's expertise and resources, we truly expect to meaningfully enhance our investment yield over the next 12 to 24 months. Turning to sales in the quarter. Sales of our fixed indexed annuity products, or FIAs, were $462 million, up 9% from the third quarter, but down from $551 million in the year-ago period. As we expected, 2017 FIA sales across the industry were impacted due to the uncertainty surrounding the DOL fiduciary rule, as well as the strong equity markets, which can reduce consumer appetite for safe money products. Looking at the full calendar year of 2017, our FIA sales were $1.8 billion, down 9% from 2016, but in line with our plan.
This is a little bit better than the overall industry sales in the independent channel, which decreased by about 10% for 2017 according to LIMRA. With respect to our outlook for 2018, LIMRA's estimating that FIA sales will increase 5%-10%, and we're targeting the high end of that range. Although the outcome of the DOL fiduciary rule is uncertain and the equity markets are continuing to perform, we currently believe that we'll be able to deliver low double-digit growth in FIA sales. That said, FIA sales in the first quarter likely will be below our targeted run rate, but we expect to ramp those up through the remaining three quarters. Sales of multi-year guarantee annuities, or MYGAs, were $161 million in the current quarter, up from $197 million last year.
We believe that we have great opportunities to grow our MYGA business going forward as Blackstone helps us source shorter duration, higher spread assets that we need to back these liabilities. Our fourth quarter total annuity sales were $623 million, down 4%. For the full calendar year, annuity sales were $2.5 billion, a 6% decline, with the uptick in MYGA sales offset by the lower FIA volume. Shifting to indexed universal life, or IUL, our sales in the quarter were $7 million compared to $17 million last year. We expected the decline as we focused on the quality of new business and exercised pricing discipline to achieve our profitability targets. IUL sales totaled $36 million in 2017. We like this business a lot. The IUL business continues to be in the fastest-growing segment in life insurance. It helps us diversify our risk beyond credit.
The renewal premiums provide a natural hedge to inflation as they're invested as interest rates rise. IUL also gives us more duration in the portfolio. We expect double-digit growth in IUL sales this year and believe there's even more opportunity for growth upon an upgrade in our ratings. Going forward, we want to emphasize that we intend to maintain our bottom-line orientation and pricing discipline across our business. We'll focus on achieving or exceeding our new business profitability targets. In fact, we were able to exceed those targets in 2017 and plan to achieve or exceed them again in future years. Lastly, while we focus on organic growth as our top priority and top three priorities, I feel good about our growth prospects, but we're also pursuing opportunities on the M&A front. We stand ready to move forward for the right opportunity.
Obviously, we're not able to predict if or when the potential transactions will occur, but it is something we will continue to keep our eye on. Now I'll turn the call over to Dennis.
This is the operator. Please stand by. We seem to have lost our connection with the speakers.
Good morning.
Please go ahead.
Apologize for that delay. Thank you, Chris, and good morning, everyone. Today I'll focus my comments on the following areas: the adjusted operating earnings trend, purchase accounting, tax reform, and the overall performance of the investment portfolio, and a few comments on capital and liquidity. Beginning with a discussion of the adjusted operating income trends that are reflected on page eight of the presentation that was posted to our website last evening. I will note that we are showing the fourth quarter standalone and the full year results for 2016 and 2017. We have, where helpful, put the periods on a comparable basis to best demonstrate the trends in each of those periods. First, the reported adjusted operating income in the fourth quarter of 2017 was $39 million, which compares to $41 million in the fourth quarter of last year.
There were notable items in both periods impacting adjusted operating income, which are shown on the chart net of intangible amortization and after-tax as follows. In the fourth quarter of 2017, there was a $5 million unfavorable adjustment for higher intangible amortization due to normal equity market fluctuations, partially offset by some DAC unlocking. There was also $1 million unfavorable actual to expected mortality within the single premium immediate annuity product line. The $41 million of reported AOI in the fourth quarter of last year included two items. First, a $2 million favorable actual to expected mortality for the SPIA product line, and $2 million favorable net investment income from some bond prepayments. Considering these notable items, we would view the underlying performance as $45 million in the current quarter and $37 million in the last year fourth quarter, or approximately 22% growth in overall earnings.
The trended details of these notable items can be found in our quarterly financial supplement. Turning to the full year performance. In 2017, the reported AOI was $184 million. That compares nicely to $174 million in 2016. Again, both periods include some notable items with similar drivers. After considering those items that were positive in both periods, we view the underlying earnings trend to be $169 million in 2017 and $141 million in 2016, or year-over-year growth of about 20%. The key drivers of our earnings performance for the business continue to come from net underlying asset growth, which was 7% year-over-year when you exclude the effects of the merger and purchase accounting, expanded net investment spreads, and ongoing disciplined expense management. The overall underlying effective tax rate for 2016 was 35% and 33% for 2017.
Again, 2017 results there is before considering any of the impacts of purchase accounting effects of the merger. I will speak more to our view on taxes looking forward in just a moment. We ended 2017 with a run rate on adjusted ROE of about 12%. This performance reflects the full-year adjusted AOI of $169 million I just mentioned, divided by the post-merger ending common equity of $1.5 billion. A complete reconciliation of these trends can be found on page 26 of the presentation. Let me just give you a few thoughts on purchase accounting and what the primary impacts of that were. Following the merger, we implemented purchase accounting whereby all balance sheets amounts were reviewed and adjusted to reflect the adjusted book value as of the opening balance sheet date of 12/1.
Notable items included an increase to the book value of our investment portfolio by $1.2 billion to equal it to its current fair value. This gain is a non-cash adjustment, which we will amortize as a reduction to net investment income over the remaining asset lives. Following the merger, the unfavorable impact of this premium amortization was $3 million net of offsets and after-tax, or about $0.01 per share unfavorable for the month of December. Again, non-cash in nature. We also wrote off our existing deferred acquisition cost asset, or DAC, and established a new intangible for the value of business acquired. As required, the actuarial assumptions underlying our reserves in all product lines were evaluated as of the opening balance sheet date and ultimately strengthened by approximately $970 million. Lastly, a $470 million goodwill asset was established. Let me turn to tax reform.
As we all know, U.S. tax reform passed in late December. The net unfavorable impact for FGL Holdings was $131 million after tax, or $0.61 per share. That's simply due to the revaluation of our net deferred tax asset, given the reduction in rates. This write-off resulted in a reported GAAP net loss of $102 million for the month of December. We have removed the net impact of that deferred tax asset write-down from our adjusted operating income. In light of tax reform, we expect the initial GAAP effective tax rate, or ETR, to be about 20% for 2018. The ultimate rate will depend on where final guidance from the U.S. Department of the Treasury turns out. Should that guidance end up as a net calculation on offshore affiliate reinsurance transactions, our tax rate would be lower and in the 10%-12% range.
Near term, we are assuming an ETR of 20% that I just mentioned. Having said that, we are also, in parallel, implementing actions to maintain flexibility for the international platform to ensure that we have no exposure to BEAT tax during this interim period. At the same time, we are working on third-party opportunities which would not be subject to BEAT in order to leverage the international platform and reduce our overall effective tax rate to 15% over time. Let me turn to the investment portfolio performance and share some thoughts. For comparison purposes, I will discuss certain key metrics on a full-quarter basis, although the reported results were split as of the transaction date of 11/30. Average assets under management were $24.7 billion at 12/31. This reflects an increase of nearly $4 billion over the sequential quarter from a couple of items.
First, the $1.2 billion increase from purchase accounting mark-to-market I just mentioned, the inclusion of $1.9 billion of assets for the Front Street Re repurchase and excess cash at our holding company, and as well, about $0.8 billion for net sales and other items. GAAP earned yield on the investment portfolio was 4.2% for the fourth quarter and for the full year 2017 on a post-merger basis. This level is approximately 70 basis points lower sequentially from the 4.9% pre-merger yield because it reflects the yield reset for the higher average assets under management, which has been adjusted for the merger and purchase accounting effects I just mentioned. It is important to note that on a statutory basis, which is not impacted by purchase accounting, the yield remains unchanged at 5.1% for the quarter.
It is also important to note that this yield will begin to rise as we reposition the portfolio with Blackstone to enhance investment income and earnings. Next, asset purchases during the quarter were approximately $1.1 billion at an average yield of 4.73%. For the full year 2017, the average purchase yield was 5.1%. Asset purchases during the quarter primarily included investment-grade corporate bonds and structured securities. Net investment income was $266 million in the fourth quarter, up 2% sequentially and up 11% over the fourth quarter of 2016. That exceeds our net asset growth, demonstrating spread improvement year-over-year. Net investment income in the current quarter was also reflective of a $7 million impact to market premium that I mentioned earlier, or the $3 million unfavorable to the bottom line.
Quarterly net investment spread was 201 basis points for all products after the PGAAP effect, but consistent on an underlying basis at 244 basis points, excluding the PGAAP reset. For our core product, FIAs, net spreads were 267 basis points, including PGAAP, and consistent at about 300 basis points, excluding that PGAAP reset. Again, these impacts are non-cash in nature, and spreads will begin to rise again back to those historical levels as we reposition the investment portfolio. That'll drive earnings and our ROE expansion. To that end, I'm pleased to share some further details on the progress we've made with Blackstone to lift that portfolio yield given the block trade. As we mentioned, there were $2.7 billion of low-yielding bonds which were immediately reinvested into a comparable $2.7 billion book of higher-yielding public corporate bonds. The average yield on the sales were 3.47, and on the purchases were 4.97.
The average duration on the entire portfolio was lengthened by about a half year to take advantage of recent widening in yields and spreads at the longer end of the curve. The annual net investment income lift is $40 million, as well as 20 basis points of lift on the overall portfolio. Again, this is just the first leg of significant shifts to come in our portfolio over the course of 2018 and 2019. The partnership with Blackstone is progressing very quickly, and the opportunities have thus far exceeded our original expectations. We look forward to delving deeper on those opportunities and how they will emerge at our upcoming Investor Day. Let me wrap up my prepared remarks on the quarterly financial performance with a few thoughts on capital. At year-end, we had a strong capital position with an estimated consolidated statutory RBC ratio of 500%.
Readily deployable capital is approximately $500 million, and that's comprised of both surplus and available debt capacity, well within what's available under our ratings constraints. Finally, we were pleased to see S&P Global upgraded the financial strength of our insurance company two notches to triple B in December, and we will continue this dialogue with all of the agencies to position ourselves for future upgrades to come. Looking ahead to 2018, a few thoughts on our key assumptions that are summarized on page 17 in the supplemental presentation. Chris already covered where we're headed on the sales front, so let me turn to where we're headed on the portfolio reposition, which occurs in three phases, the first of which I just covered. The next two phases involve shifts in both structured products and alternative assets.
First, with respect to structured products, we intend to take that allocation to approximately 30% of the overall portfolio by mid-2019. We like the enhanced yield and floating rate upside opportunities in this asset class. With respect to alternative assets, we intend to build this portfolio to approximately 5% overall allocation. This process is already underway, and we expect to complete it by the end of 2019. One more thought on 2018 and the investment portfolio. As you think about where the yields could go as interest rates rise, for every 25 basis point increase, we would expect a $5 million lift in AOI. As I mentioned earlier, we've assumed a 20% tax rate for 2018 and are working to bring that rate down to 15% through third-party opportunities. That effort will take a few quarters to work through, and we'll give you an update later this year.
Lastly, overall for the insurance operating companies, we are targeting to maintain at least a 450% RBC, which includes any residual impacts from tax reform adoption and in support of an upgrade to A- from AM Best in the future. Before we go to Q&A, I just want to note, as Diana previously mentioned, that we will file the 10-K next week after we wrap up final reviews. Thank you. With that, let's go to questions.
Thank you. At this time, if you would like to ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question today will come from Jimmy Bhullar of JPMorgan.
Hi. Good morning. I had a couple of questions. First, just your views on acquisitions, appetite for deals, and just what the competitive environment is for deals in the annuity market and whether you'd be open to using stock for deals at the current share price.
Yeah. I think I would say in terms of opportunities for deals, it's fairly active. There's definitely some opportunities that we are evaluating, obviously you don't know how to time those. I think obviously we would like to see the share price appreciate before we would use the shares equity for consideration, we feel that we have enough deployable capital to look at some really nice opportunities, particularly to grow that offshore business.
On index annuity sales, it seems like you're expecting sales to be weak in the early part of the year. Can you go into details on what's driving that, and how your view of your sales has changed given tax reform, and I guess, the lower competitive advantage you might have versus domestic guys?
Right. I think with respect to first quarter sales, obviously, we're still not done with first quarter. I would say just at a high level, January was a little light, and we generally see that in January with some seasonality right after holidays. We did see a very significant pickup in submitted applications, though, in February. I think it's more about just a little bit slow start in January that's going to impact that first quarter as we build momentum throughout the balance of the year. With respect to tax reform, again, I think that remains to be seen. We believe that the industry will largely try to retain some of that benefit as we try to boost capital levels on the balance sheets, and some people think it'll be priced into the product, and that remains to be seen.
We're planning on being able to retain a significant amount of that drop in the income tax rate and preserve that for ourselves.
Okay. Thank you.
The next question comes from John Barnidge of Sandler O'Neill.
Thank you. Congrats on your first quarter as a company. Given the rise in rates so far this year, have you seen any increase in surrender activity yet?
Hey, good morning, John. This is Chris. We haven't really seen any uptick in surrenders at all. We have seen nothing that is beyond what we've seen historically. I think the rates would really have to move up very significantly and quickly for us to be able to see that. The only other thing I'd keep in mind is we have a fairly young book of business with very strong surrender charge protection. We haven't really seen that much of an impact from the rising rates.
In general, a rising interest rate, especially gradual rises like this, is a very good thing for the industry and for the company as it increases our net spread.
Okay. Around M&A, you mentioned you'd like the share price appreciation before using the stock to fund the deal. Does it seem reasonable enough to assume that some of your earlier deals may be more focused on block transactions as opposed to whole outright companies?
We are open to both block transactions as well as outright acquisitions of companies. The stock is only one, as you know, of two elements in terms of capital to do the deal. We have significant shareholder support. We also have deep-pocketed strategic investors as well. We are open for business in M&A. We are evaluating, as Chris says, a number of prospects. Our focus, obviously, is on the organic business. We think this is a company that has a strong foundation and organic growth, increasing the portfolio lift, increasing the sales velocity are important. M&A is also very important. Our focus is on organic. If there are M&A opportunities, we can do it even at the stock price because we have excess capital right now, we have strong shareholder base, and we have support from our key strategic investors.
Great. Thanks. My last question, I think, would be, do you think you're seeing other opportunities for further portfolio reposition enhancement beyond maybe the 60-70 basis points?
Yeah. Hey, John. What I would suggest is we're very focused on those first three buckets, one of which we just completed, next on structures. I think it's too early to call. We continue to work through. As we migrate through the year and as the rate environment does shift, I think we'll see opportunities come our way, and we're going to be very quick to respond. That's the beauty of having Raj and his team move over and become part of Blackstone. We've got a much larger army on the ground. Our ability to get immediate exposure to the right deals and the best deals as they develop, and even before they hit the street or the broader public market, cannot be overstated here. It is a powerful tool that we didn't have before. It's going to make a meaningful difference in our earnings.
Thank you. I'll re-queue.
We have no additional questions. Mr. Barnidge, would you like to continue?
Sure. I'll fire away. The final phase of the DOL rule is delayed 18 months to mid-2019. What is your expectation for how it maybe shakes out? How do you see the regulatory landscape having changed since the FGL acquisition was first announced back in May 2017?
Hey, John. This is Chris again. Yeah, I think while the full implementation of the DOL rule was postponed until July, the impartial conduct standards were implemented in June of this year. Those are what we've been working through, and obviously, you've seen other states take action and looking at best interest standards, and the NAIC is looking at some sort of form of best interest standard. I think it's hard to predict right now where the DOL will come out on the fiduciary rule, and that's been complicated by the fact that the SEC has also publicly announced that they are going to take a view on the fiduciary rule. There's a lot happening on that right now.
I think our working assumption is we are going to be working through and managing through some sort of best interest standard for some time, which we think is going to be manageable and be able to work through the states and the NAIC and whatever comes our way on the DOL. I don't think there's a big impact from when the deal was announced in May. It's something I think the industry is well prepared for and managing through, even though we are sort of seeing this short-term disruption as the distribution partners are looking at their business models and figuring out how do they become an FI and what does their recruiting strategies need to look like for their producers.
Okay. Tax savings in the industry. Do you have any indication yet, like maybe a gut feeling, whether savings are being competed away into the product or maybe retained by manufacturers?
I think it's too early. I think it's really too early. The tax savings really only started in January, so I think it's too early to tell.
Okay. Are there certain types of products maybe currently not in the company's wheelhouse that you're looking to grow? Also, I think my last question would be, can you talk about pathway to growing the reinsurance operation?
Sure. I think the pathway to growth on the insurance operation, we've begun some efforts on that before the deal was even announced. If you think about the business that came over from HRG, the Front Street Re business, they already had begun to build some third-party reinsurance relationships which we had cultivated for a long period of time, and our former chief actuary, John O'Shaughnessy, has a very strong relationship with a lot of those partners. We look at being able to leverage those relationships for additional business throughout the course of this year, as well as planting seeds with a number of other companies. We think there's a real good opportunity for us to write some flow reinsurance with those partners, as well as look for opportunities to partner with them to do other reinsurance deals.
We think it's strategically important to us, and we think that we're going to be able to make some good traction on that in 2018, some very good progress with accelerating progress through 2019 and 2020.
Thank you very much.
This concludes our question and answer session. I would like to turn the conference back over to CEO Chris Littlefield for any closing remarks.
Yes. Thank you very much. Thanks all of you for listening today. We are off to a terrific start, and I think we've demonstrated that through our results, through executing on the block trade, definitely are running very fast to continue to improve the performance of this business. We look forward to sharing our further plans and strategies with you at the investor presentation on Tuesday, March 13th. Look forward to seeing you there, and thank you again very much for your interest in our company.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.