Good morning, and welcome to the Voya Financial fourth quarter 2016 earnings conference call. 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 touch-tone phone. To withdraw your question, please press star, then two. Participants are limited to one question and one follow-up. Please note, this event is being recorded. I would now like to turn the conference over to Darin Arita, Senior Vice President of Investor Relations. Please go ahead.
Thank you, Rocco, and good morning, everyone. Welcome to Voya Financial's fourth quarter 2016 conference call. A slide presentation for this call is available on our website at investors.voya.com or via the webcast. Turning to slide two. On today's call, we will be making forward-looking statements. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of Federal Securities laws, including statements relating to trends in the company's operations and financial results and the business and the products of the company and its subsidiaries. Voya Financial's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties, including those from time to time in Voya Financial's filings with the U.S. Securities and Exchange Commission. Slide two also notes that the call today includes non-GAAP financial measures.
In particular, all references on this call to ROE, return on equity, ROC, return on capital, or other measures containing those terms are to ongoing business adjusted operating return on equity or return on capital as applicable, which are each non-GAAP financial measures. An explanation of how we calculate these and other non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures can be found in the press release and quarterly investor supplement available on our website at investors.voya.com. Joining me this morning on the call are Rod Martin, Voya Financial's Chairman and Chief Executive Officer, Alain Karaoglan, Voya Financial's Chief Operating Officer, and Mike Smith, Voya Financial's Chief Financial Officer. After their prepared remarks, we will take your questions.
Also here with us today to participate in the Q&A session are other senior members of management, Charlie Nelson, Chief Executive Officer of Retirement, Christine Hurtsellers, Chief Executive Officer of Investment Management, and Carolyn Johnson, Chief Executive Officer of Annuities and Individual Life. With that, let's go to slide three, and I will turn the call over to Rod.
Good morning. My apologies, I have a bit of laryngitis. I appreciate your patience. That said, I'm eager to share our progress on our plans, so let's begin on slide 4 with some key themes. During 2016, we continued to execute on our plans to improve our ROE and better position Voya to meet our customer needs. We increased our ROE to 12.3% at year-end, and we're confident that we can achieve our 2018 target of 13.5%-14.5%. Our confidence comes from our growth, our capital efficiencies, and our opportunities to simplify Voya. Let me briefly expand on each of these. First, we remain confident because of the growth that we're generating. During the fourth quarter and full year, Retirement and Investment Management generated strong net flows. Retirement has benefited from our distribution expansion and our increased productivity.
Investment Management has grown in part by developing solutions for our new customers. We also grew in annuities and employee benefits. Second, we remain confident because of the capital efficiencies we produced. These efficiencies have been greater than our initial plan. Finally, we remain confident because of the opportunities to simplify Voya to better serve our customers and to achieve at least $100 million in cost savings through 2018. In addition, our capital position remains strong. At the end of 2016, we had $941 million in excess capital. In the fourth quarter, we entered into a $200 million discounted share repurchase agreement that we mentioned in November. This agreement priced earlier in the first quarter of 2017. We intend to utilize our remaining $633 million share repurchase authorization over the course of this year.
During the fourth quarter, our hedge program continued to effectively protect our Closed Block Variable Annuity capital, and the resources backing the block continue to exceed our regulatory and rating agency requirements. We completed our fourth enhanced annuitization offer during the quarter to further run off the block. In total, we've accelerated a cumulative runoff of $1.5 billion through four enhanced annuitization offers. In January, we launched a GMIB enhanced surrender value offer. This will provide an option to those customers who may find more value in liquidity than the potential income stream of the annuity. This offer period concludes at the end of March, and we will share the results with you during our first quarter earnings call. Moving to slide 5. We reported operating earnings per share of $0.91 for the fourth quarter.
Prepayment fees and alternative investment income above our longer term expectations, as well as a gain associated with the Lehman Brothers bankruptcy settlement, collectively increased earnings by $0.17 per share. For the full year, we reported operating earnings per share of $2.61. There were several items that, on a net basis, decreased earnings by $0.39 per share. The most notable was due to our DAC VOBA unlocking related to our annual review of actuarial assumptions on the models in the third quarter. Finally, our ROE for 2016 was 12.3%, up from 12.1% for the trailing 12-month period ended September 30. Overall, 2016 was another successful year in the transformation of our company. We improved our financial results by helping our customers plan, invest, and protect their savings.
Our capital position remains strong. We continue to be recognized by third parties for our high ethical standards, our commitment to gender equality, our focus on corporate responsibility, and for being a great place to work. I will now turn it over to Alain, who will give you some details on our actions.
Good morning. Let's begin on slide seven. In 2016, our return on equity and return on capital increased to 12.3% and 10.2% respectively. During the year, we continued to execute on our initiatives and to take actions to simplify our company to create greater value for our shareholders and for our customers. On slide eight, we have provided the underlying drivers that will enable us to improve our return on capital. Beginning with our year-end 2014 return on capital of 9.9%, you can see how each component will contribute to our 2018 return on capital target of 11.5%-12.5%. We are now highlighting cost savings in a separate category, since this will be a significant driver of our return on capital improvement in 2017 and in 2018. Cost savings are expected to add 90-100 basis points to our return on capital expansion.
Capital initiatives were the biggest driver of our returns in 2015 and 2016. The full benefit of the 135-155 basis points will largely be reflected in our return on capital by the end of 2017. Other initiatives, which include growth and margin initiatives outside of cost savings, are expected to increase our return on capital by 80-100 basis points. This category also captures the effect of equity market returns, which have been below levels that were anticipated in our original plan, creating a drag of 30-50 basis points relative to that plan. Although up since November of last year, interest rates are expected to create a headwind of 125-145 basis points. This is an increase from our original expectation of 70-90 basis points. You will note that cost savings and capital initiatives are now the biggest drivers.
Growth remains a core part of our plans. We have begun to see some benefits of our investments in achieving more profitable growth. We expect growth will accelerate once we've completed our strategic investment program and taken further actions to simplify our company. As outlined on slide nine, we are making progress on our $350 million strategic investment program, as well as our efforts to simplify the organization. Most of our initiatives will be more than 50% complete by the end of 2017, with our current plans to consolidate IT platforms at 90% completion. As we shared in November, these collective efforts will enable us to achieve annual run rate cost savings of at least $100 million to be realized in 2018 and subsequent years. Importantly, will allow the company to continue to become more nimble.
On slide 10, we have provided an update on our 2016 growth initiatives and our expectations for 2017. I will highlight a few of these initiatives. In retirement, we achieved an all-time high in full-year net flows amidst a low-rate environment and sluggish industry sales. We increased the number of our client relationships by 6% in a market that was relatively flat last year, according to LIMRA. Through September 30, 2016, Voya was one of the top three companies in terms of new plan growth in plans under $5 million as measured by assets. We expect deposit growth to continue in 2017. In Investment Management, we expect total institutional sales, which were very strong in 2016, to be slightly down to flat in 2017 as certain flows, such as CLO issuances and private equity launch, may not repeat at the same level.
Our retail intermediary sales held up well last year, while a challenging market environment caused industry sales to be down 5% through September 30, 2016. In 2017, we expect retail intermediary sales to be flat to up 5%. Affiliated source sales increased in 2016, partly due to greater partnership between Retirement and Investment Management, as well as strong interest in our target date offerings. We plan to build on this in 2017 and expect sales to be flat to up 5%. In annuities, our sales forecast for 2017 may be conservative, as it assumes the Department of Labor's fiduciary rule is implemented in April. We are assessing the potential effect of last Friday's presidential memorandum to review the rule. Let's take a closer look at each of our businesses, starting with Retirement on slide 11. Retirement's return on capital for 2016 was 8.8%, up slightly from 2015.
We are making great strides in helping our customers achieve greater retirement outcomes. We have invested in new tools for plan sponsors and participants to help them get ready to retire better. In October, we launched the Voya Behavioral Finance Institute for Innovation. This is a new research initiative focused on gaining deeper insights in Americans' financial and retirement planning activities. The institute's work will merge behavioral science with the speed and scale of the digital world. Moving to slide 12. In Investment Management, the underlying operating margin was 28.2%, down from 29.1% in 2015. The year-over-year decline largely reflects lower average asset levels during 2016, particularly during the early part of the year. We have successfully leveraged our strong investment performance to drive sales and net flows. We also have brought our investment expertise to new clients, including expanding in the insurance asset management channel.
In 2016, we generated $850 million in net flows, up from $200 million in 2015, through our work with insurance companies. Growth in this channel was driven by strong interest in our U.S. equity, mortgage derivative, and private credit strategies. Moving to slide 13. The return on capital for annuities was 9.8%, up from 9.3% in 2015. In addition to greater distribution reach, we have significantly transformed and improved the profitability of our product line in annuities to require less capital and better meet customer needs. For example, nearly 100% of our annuity sales are now from newly developed products with improved capital efficiency, compared with about 60% in 2015 and 40% in 2014. At the same time, we've been closely managing crediting rate to align with our return targets.
We expect the combination of our annuities and individual life businesses to lead to future synergies, particularly on the distribution front. Turning to slide 14. Individual Life's return on capital increased to 6.6% from 6.2% in 2015. During 2016, we continued to benefit from a number of actions we've taken to reduce capital usage and refinance redundant reserves. We completed the refinancing transaction ahead of schedule, and this provided approximately 15 basis points of benefits in the fourth quarter. The annual run rate benefit continues to be 150-200 basis points. This will be slightly offset by higher reinsurance costs of 25-50 basis points in 2017, as we noted last quarter. In November, we announced our decision to cease sales of term life insurance at the end of 2016.
Focusing solely on index universal life insurance will require less capital going forward, while enabling us to continue offering our customers a valuable protection solution. Moving to slide 15. The return on capital for Employee Benefits was 23.3%. Our loss ratios in 2016 returned to our expected annual range after having been unusually good in 2014 and in 2015. As we look to build upon our in-force premium growth in 2017, we also will continue to remain disciplined with our underwriting and with our pricing. We see several opportunities to continue to improve customer and distributor experiences, as well as lower unit costs by simplifying our operations. In summary, we made solid progress on the execution of our various initiatives, our strategic investment program, and our actions to simplify our company.
As I have noted before, our ability to achieve our plans depends, in large part, only on our continued commitment to execution. Now, I will turn it over to Mike to go over our financial results. Mike?
Today, I will discuss our financial performance for the fourth quarter and full year 2016. On slide 17, we highlight several key items that occurred during the quarter and other items to consider. Prepayment fees and alternative investment income were both above our long-term expectations. Both Retirement and Investment Management benefited from rising equity markets and positive net flows. In addition, Investment Management generated strong performance fees during the fourth quarter. In Retirement, plan participants continued to shift assets from variable to fixed accounts, which partially offset increased fee income and acts as a drag on investment spread and return on capital. In Individual Life, elevated severity affected our mortality results. In Employee Benefits, our loss ratios for full year 2016 were in line with our expected annual range, while our quarterly loss ratios were mixed.
Looking ahead to first quarter 2017, we expect $25 million of seasonal expenses for our ongoing businesses due to payroll taxes and revised upfront recognition of equity compensation for retirement eligible employees. For our annuity segment, administrative expenses in first quarter 2017 will increase by approximately $5 million relative to first quarter 2016. This will be mostly offset by lower DAC amortization due to a reduction in the amortization rate from changing business mix. Moving away from expenses, we anticipate approximately $750 million of retirement tax exempt market net outflows driven by a merger related departure of a case with high guaranteed minimum interest rates. In Investment Management, our 2017 performance fees are expected to normalize as our full year 2016 performance fees exceeded annual expectations by $14 million on a gross basis.
In Employee Benefits, we expect our full year 2017 loss ratios for stop loss to be at the higher end of our annual target range, reflecting less favorable development on business written in 2016. Finally, institutional spread products will be almost entirely run off by year end 2017, and the quarterly results are reported in Corporate. The block is expected to record operating losses in 2017, primarily from corresponding deferred prepayment penalties due to the accelerated runoff. Turning to slide 18. Our quarterly retirement net flows were positive for the fifth consecutive quarter. In corporate markets, we have generated net inflows for 21 of the last 22 quarters. These net flows have exceeded $6 billion over that period. Turning to slide 19. Investment Management source net inflows exceeded $1.5 billion in the fourth quarter and were positive for every quarter in 2016.
These results were driven by continued client demand across a broad range of our products and solutions, including fixed income, CLO, and private equity funds. These net inflows have a higher revenue yield than the variable annuity outflows, which are primarily in index-based strategies. Variable annuity net outflows for the funds managed by Investment Management were $908 million, which were accelerated by $338 million due to our fourth enhanced annuitization offer in CBVA. Investment Management, however, retained all AUM related to this offer as the assets go into the general account. As shown on slide 20, our annuities net flows recovered in the fourth quarter, led by continued investment only inflows and a rebound in fixed indexed annuities flows. As rates rose during the quarter, we were able to increase fixed indexed annuity sales while meeting our return targets.
On slide 21, we experienced unfavorable mortality in Individual Life due to elevated severity. We have added reinsurance on larger policies to reduce severity exposure and mitigate potential underwriting volatility. The graph on the left shows that our fourth quarter actual to expected mortality ratio was 99%. This is relative to our expected mortality ratio of 90%. Moving to slide 22. Our fourth quarter loss ratio for Group Life was better than our expected annual range of 77%-80%. The loss ratio increase for stop loss was driven by higher claims frequency. While quarterly loss ratios can fluctuate, our full year loss ratios were in line with our expected annual range. As slide 23 shows, our Closed Block Variable Annuity hedge program continues to focus on protecting regulatory and rating agency capital and is performing as designed. During the quarter, the hedges offset the changes in reserves.
We had estimated available resources of $5 billion, which are entirely supported by hard assets, and statutory reserves of $4.5 billion at the end of the fourth quarter. The change in values from third quarter was largely driven by higher interest rates. The annualized net outflow rate in this closed block was 16.3%, which included a 6.8% benefit from our fourth enhanced annuitization offer. Also during the quarter, we had two items affecting the GAAP results. First, a non-performance risk loss reflecting credit spreads tightening, and second, a loss recognition event, which led to a write down of deferred acquisition costs driven by higher interest rates, which actually benefit the block from an economic perspective and an increase in GAAP payout reserves. These GAAP items did not affect our regulatory or rating agency capital position. Turning to taxes. We are paying close attention to potential changes to corporate tax policy.
While the new administration has not revealed tax reform specifics, we can comment on directional impacts. In a hypothetical scenario in which corporate tax rates fall to 20% without renewal of the dividends received deduction, we would expect our tax rate for operating earnings to be 20%, all else being equal. As a reminder, our current operating earnings tax rate of 32% reflects only one-third of our dividend received deduction benefit as derived from our ongoing businesses. The remaining two-thirds of the benefit accrues to our Closed Block Variable Annuity segment, the potential value of which is reflected by the separate NPV chart on the bottom right of the slide. With respect to the net present value of the projected cash tax savings from our deferred tax assets, our new estimate is approximately $1.6 billion as of year-end 2016.
This is up slightly from last year, primarily due to additional hedge losses from higher rates and the impact of our individual life redundant reserve refinancing. On slide 25, you can see that our regulatory and financial leverage ratios are strong and remain better than our targets. The RBC ratio increased to 493% at the end of December, mainly driven by statutory net income. On the right side of the slide, our debt-to-capital ratio as of the end of the fourth quarter was 24.4%, reflecting lower retained earnings. On slide 26, our capital position is strong. Holding company liquidity stood at $463 million at the end of the fourth quarter. The middle chart shows our excess capital at $941 million, which consists of estimated statutory surplus and holding company liquidity above target. We expect to upstream most of the estimated statutory surplus to our holding company in the second quarter.
We have over $600 million available for share repurchases through year-end 2017, after funding a $200 million discounted share repurchase program in the fourth quarter. The transaction priced in the first quarter. In summary, we continue to take proactive steps to improve ROE and focus on cost management. We have a strong balance sheet and significant excess capital, and our Closed Block Variable Annuity hedges continue to protect regulatory and rating agency capital as we pursue additional de-risking measures. With that, I will turn the call back to the operator, Rocco, so that we can take your questions.
Thank you very much. We will now begin the question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. As a reminder, participants are limited to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Ryan Krueger of KBW. Please go ahead.
Hi. Thanks. Good morning. My first question was on the 2018 ROC target of 11.5 to 12.5. The slide mentions by the end of 2018. I just wanted to clarify, I guess, if that's a distinction from the prior guidance, I think which was just for full year 2018.
Yes, Ryan. Thank you for the question and the clarification. Yes, it's full year 2018.
Okay, it's still full year.
Yes.
Got it. Okay. On CBVA, the amount of statutory resources in excess of the reserves declined by about $500 million in the quarter. Is it fair to say that you would expect generally to have less resources in excess of reserves when interest rates rise because the economics are more sensitive to interest rates than the actual statutory reserve moves, so we should expect generally a greater gap between the two when rates are low and a smaller gap when rates are high?
Ryan, this is Mike. Good morning. Thanks for the question. I think generally, yeah, that you're thinking of it the right way. Just to give it some perspective, the reserves at the end of the third quarter were $5.3 billion. No, reserve of $5.3 billion, resources were $6.3 billion, and we dropped to reserves of $4.5 billion and $5 billion as of the end of the fourth quarter. The way to think about that is really in, I think, three buckets, right? There's the liabilities, there's the hedges, and there's the underlying assets. The change in liabilities is generally offset by the change in the hedge, as you can see on the slide. The value of the assets is adjusted as interest rates move up and down because those are marked to market in that example. That led to the decline in the margin.
More importantly, we're focused on managing to the CTE 95 level. As we said, we're more than sufficient at CTE 95.
Thanks. I guess last quarter, I think you said you were at CTE 98. Is that still where you are now?
We did say that, and we are still sufficient at CTE 98, but we do not target that, and there will be quarters where we fall above and/or below that level. We're comfortable with CTE 95. It's consistent with our ratings and has served us well thus far.
Our next question today comes from Erik Bass of Autonomous Research. Please go ahead.
Hi, thank you. I had a question for Retirement. How quickly should we start to see spreads benefit from the rise in interest rates? How much further would rates need to rise to offset the headwind from spread compression?
Charlie will take that, Erik.
Good morning, and thank you. Our forecast and plan assumes the forward curve essentially at year-end. It has embedded in it the rising rates. Rising rates and spreads certainly impact things relative to the duration of the portfolio and the time and the amount that any rising rates would come in. We've got to balance that with our crediting rates, once the crediting rates potentially get above a guaranteed minimum interest rate. In short, all things being equal, rising rates above the forecast is going to be good. How impactful depends on so many factors that it's tough to provide some specific guidance on that relative to an increase. Relative to overall, in terms of how we think about it, we're going to continue to manage our general account liabilities with agility to balance, I think, relative to the overall market, environmental, and our business metrics.
Just thinking about it in total, difficult to forecast, but certainly in total, a good thing if it gets above our forecast.
Got it. Is there a rate to think about where the drag would disappear? I know some companies have talked about a 10-year Treasury rate of 3% or higher would eliminate the drag on spread compression. Is there sort of a shorthand way to think about that for you?
Maybe just to give you some context on the overall impact on rate on the company. The original plan, we had an expectation of interest rate headwind of 70 to 90 basis points. Today, what we're highlighting, it's 125 to 145 basis points during the period. What has happened, obviously, during 2015 and 2016, we have been investing in this lower rate environment, and that you don't make up until the duration of your assets mature. What we've done in order to offset that impact of interest rates, what you've seen us is focus on cost savings and capital initiatives to offset the impact. Despite the headwinds of the interest rates and the equity market, as I mentioned, will cost us close to 50 basis points because equity markets haven't appreciated as much as our plan.
We expect to still achieve the original plan of return on capital of 11.5%-12.5%, or an ROE of 13.5%-14.5%. Mike, maybe you want to talk about the portfolio yield versus new rate and where does it stand today, and that may give you some additional perspective.
I think the other way to think about this is the degree of erosion in the portfolio rate as we put new money to work, that continues so long as the new money rate is below the overall portfolio yield. Right now, we're putting new money to work at around 4%, give or take. The portfolio rates vary from business to business, but think of that as in the high fours. We'd need spreads to widen a bit and/or the Treasury to go up in order to get to the place where we're at sort of a neutral position. I think if you think about it in those terms, to the extent others are guiding around three, that's probably not a bad benchmark, but it's not quite that easy there. You have to think about spreads, too.
Perfect. That's helpful. Just one quick clarification. On the $25 million of seasonal expenses in the first quarter, is that $25 million of higher than previously expected expenses, or are you just alluding to the typical seasonal pattern with higher expenses in the first quarter?
Thanks for giving the chance to clarify. That's versus 4Q. It's an increase relative to 4Q. Typical seasonal pattern.
Our next question today comes from Suneet Kamath of Citi. Please go ahead.
Thanks. Good morning. I wanted to go back to page eight, where you provide that walkthrough, or sorry, that ROC walk. If I look at this slide that you gave us at the Investor Day a couple of years ago, it looks like that growth bucket that you used to call out was 150-180 basis points of improvement. Now it seems like cost savings are higher, capital's higher, and this other bucket, which I'm assuming encapsulates the growth, is lower. Maybe you could just tell us what's going on in terms of the differences in that bucket in particular.
Thank you, Suneet. In that bucket, it relates to the comments that I just made earlier. The level of interest rates being lower than what we had expected in the plan. What does it mean? As you know, we are very disciplined, for example, in our fixed indexed annuities. Therefore, as interest rates decline, we will lower our crediting rate and adjust our cap rate to reflect the spreads that we can earn. The same is true when interest rates go up. Some of the growth opportunities within the annuities business have moderated from our original plan. The equity market return is in that bucket as well, and that's going to cost us, as I mentioned, 30-50 basis points of return on capital.
When you think about the growth opportunities, the lower macro environment is affecting it meaningfully, and especially since now we've had two years that have passed with a macro environment out of the four years that has been below that. The other thing that I want to emphasize is how we adapt to these environments. We're not a victim of that environment. This environment changed, we've adapted, we've adjusted our plan, we're going to achieve the same expected returns that we expected at that time. That's what we're really trying to do with the organization overall. We're simplifying our IT infrastructures. We're digitizing our processes.
That's going to allow us to be more nimble and going forward, to even be more adaptable in order for us to adjust to any changes in the environment from wherever it may come from, and that's true overall and for each of our businesses.
Yeah, I got it. I guess the annuity business is already sort of at your target. Is any of the slowdown in growth affecting the retirement business?
Absolutely. Some of that is affecting the growth in the Retirement business. Some of that growth affects, obviously, both the Retirement business and Investment Management business on the equities portion of that.
Okay, got it. My follow-up is just on the capital. It looks like the gap between your excess capital of $941 and your current share repurchase authorization of $633 million is pretty big. You'd mentioned that you plan on sending most of that $941, I guess, up to the holding company. Any thoughts on the pace of buyback? I know you like to be pretty consistent quarter in and quarter out, but just given how strong the excess capital is, any thought to increasing the pace of share purchases?
Suneet, it's Rod. Thanks for the observation and frankly, the comment that we've been consistent. You've heard me refer to it regularly. I think we're very good stewards of capital. By way of example, we've returned $2.9 billion since we've been a public company in share buybacks, and we're going to continue that philosophy. We're going into the year, we feel very good about the financial position, and you'll see us use good judgment as the year unfolds. There's a lot in play as we go into the year with the new administration. We're cautiously optimistic as a result of what we're hearing, but we are listening and learning as we go. I really want to underscore the point that Alain made.
We, I think, have demonstrated great agility in responding to the environment that we're presented, and that's why we feel so good about the balance of our plan through 2017 and 2018. You'll see that reflected in our share buyback activity in addition to all the other decisions we're making. I just would add one other element to what Alain pointed out. Certainly, the equity markets, as he said, over the last two years, have affected our retirement business and investment management. But if you look at the net inflows that we had in the full year of 2016, as well as the good management we've done in our indexed products in terms of flows, we feel very good about how that is boding well in terms of our broad distribution platform as this economy continues to improve. Blake, anything to add?
Okay, thanks, guys.
Our next question comes from Jimmy Bhullar of J.P. Morgan. Please go ahead.
Hi, good morning. First I had a question on just the medical stop loss business. You'd had, obviously, very strong earnings and better than expected generally over the last few years. If you could just talk about what's causing you to be a little bit less optimistic and what's causing your view of margins to be lower than what they've been before. Is it pricing more or loss experience or competition? Also comment on how trends were in the market, both in stop loss and just employee benefits in general as you went through renewal season for this year.
Thank you, Jimmy. As you noted, we've had truly spectacular results in our employee benefits business, and in particular, in stop loss. That's reflected in the loss ratios and the return on capital that we've been achieving in that businesses. We've been pointing since 2014, 2015, that these were great earnings, but we expected the loss ratio to get in line with our expected targets because this is where we're pricing the business at, and this is what we expect the environment to lead to. The fact that our profitability is better, also our competitors' profitability was better during these years, the clients also are seeing that profitability there is better, and it's normal to adjust pricing to reflect the loss ratios that are better than anybody expected. Essentially, this business has some cyclicality. You're seeing that reflected in 2014, 2015.
2016 is getting back to within our target range, that's what we're expecting in 2017 to be at the high end of our target range. We're going to remain disciplined on our underwriting, on our pricing, and if the market gets too competitive, if the market is less attractive, we're going to be willing to shrink business.
Just on your slide on the macro headwind from rates and the equity market, how much of that is really the equity market versus rates? Because the market's actually been fairly good the last several years. I think three of the last four have been over 10% total return on the market. 2015 was the only sort of weak year. How much of that is really rates or has the market done worse than your assumption as well?
Yeah. On slide eight, you could see the headwind from interest rates, which is 125-145 basis points of return on capital. While the equity markets have increased, they haven't increased in line with expectations of 7.5% that we had at the beginning of 2015. That lower than expected appreciation cost us 30-50 basis points by 2018. Obviously, some of it will depend as to what happened in 2017, 2018. If beginning of 2018, the asset level go back to where the plan was originally, that will help overcome some of that. It's-
That-
Both that have affected.
I'm just trying to understand, because the market was up more than that. Are you talking about your own performance within your funds, or just average daily balances? What is it that you're referring to?
Yeah. We had expectation of market appreciation from 2014 to today, and the market actually has not-
Okay. Got you
appreciated as much as our assumption of 7.5% that we had laid out at the time of the Investor Day.
Got it. Thank you.
Our next question today comes from Yaron Kinar of Deutsche Bank. Please go ahead.
Thank you very much. I actually want to maybe continue on this last question's path. If I look at the interest rate impact and equity market impact, all in, you get to 150 to 200 basis point drag relative to the Investor Day expectations. I think last quarter you talked about roughly 140 basis point drag. Just given the move we've seen the market and equity rates and interest rates this last quarter, I'm just surprised to see that that headwind has increased by that much over a quarter.
Yaron, thank you for the question. The 140 basis points last quarter was additional drag. It was not absolute drag. What we're showing here is the absolute drag. What we talked about, it was 140 on top of what we had expected.
Okay. That's helpful. With regards to the CBVA and the CTE 95, CTE 98, I think last quarter you talked about roughly $400 million buffer above CTE 95. Is it fair to think that, as interest rates rise, you don't need the dollar amount to get to CTE 98 buffer shrinks?
Yaron, this is Mike. I think the short answer is it will come in a little bit, but the major effect will be the overall reduction in CTE 95. Certainly, rates going up is a great thing for the block and will ultimately lead to a better result in terms of ongoing cash flow and so on. I think that's a good thing. The gap between CTE 95 and 98 will largely be driven more by time effects. As the block shrinks, as the amount of CTE 95 itself shrinks, then I think you can think of it as a proportional reduction. The dollars will go down, but the relativity will be probably about the same.
Got it. That's very helpful. Thank you.
Our next question comes from Seth Weiss of Bank of America. Please go ahead.
Hi. Good morning. Could you update us on the statutory capital that's currently backing the closed block institutional spread business?
Seth, we'll have to get back to you on that one. I don't have that number right at hand, but we'll look it up.
Okay. Thanks.
I don't think it's a large number, but we'll get that for you.
Okay, thank you. If we look at the sensitivities to regulatory capital on page 23 at the bottom side there of the chart, those have changed a good deal, especially the equity market sensitivity since what you presented last quarter. I know markets have changed, but if you could just help us think through what that change means and from an economic perspective versus a regulatory capital perspective, how to use this disclosure.
Look, I think as markets evolve and as the degree of moneyness changes, you're going to see some shifting in this. That'll be one effect. A second will be the relative amount of hedging that we've got in place. We did make a modest increase in our interest rate hedges during the quarter. That's part of the impact that you may see on the interest rate exposure. I think the main way to think about this is that as markets move, there'll be this instantaneous change in the relative capital levels. As equity markets go up, as interest rates improve, the overall value of the business is improving. I think to the extent we're thinking in terms of a broad economics, I think you want to think about it in that way.
The point of this disclosure is just to give you a sense of instantaneous shocks. The economics are probably more in line with the, you can think of some of the cash flow disclosure we've given as giving an indication of that and the overall level of CTE 95 and reserves. As that goes down, that's a good way to understand the economics. We have the number back on your first question. The ISP is a little under $500 million.
Okay. Thanks a lot. Just to the second question, in terms of the asymmetry here on regulatory capital and interest rate moves, negative move kind of boosting the immediate impact. That's the same dynamic, going back to Ryan Krueger's question, in terms of looking at the gap between available resources and stat reserves. Is that right? I just want to make sure I'm thinking about the economics and accounting all in the right frame of mind here.
Hey, Seth, I'm sorry, we just had some difficulty there. Could you repeat that question? Thank you.
Oh, yeah. Just in terms of when you look at the immediate impact to regulatory capital, where interest rates falling causes a boost up in regulatory capital, you don't get the calendar effect. That goes back to Ryan Krueger's question in terms of the gap we see between available statutory resources and statutory reserves. Is that right?
What you're seeing, if rates go down in the regulatory capital, that's purely a benefit of the hedging positions, right? I think the difference between the sensitivities there.
I'll take it offline from there, that's helpful. Thanks a lot.
Our next question comes from Sean Dargan of Wells Fargo Securities. Please go ahead.
Thanks, and good morning. I just was wondering if you could give us an update on any potential CBVA solutions with the rise in the 10-year since the last time you talked about it. Just wondering if there's any change in the willingness of potential counterparties to do a partial or complete transaction.
Good morning. It's Rod Martin. Certainly, the rise in interest rates is a very good thing for our customers, for Voya Financial, and frankly, for the optionality associated with this. That continued rise will help. We continue to be very open to a range of conversations associated with this. As you would expect, we're not going to comment as we are going through that journey. We are encouraged about the direction of interest rates. We've said repeatedly, interest rates on this book matter. We certainly experienced that with you in the context of what we went through in 2016. If you think about something that's 3% or better, we think that creates a good bit more optionality and potential interest in part or potentially in full for the market, and we will keep you posted.
Thank you. If I could just ask a question about the below-the-line losses associated with the fixed indexed annuity product. The way I understood the basis risk in hedging that product was being under-hedged in a strongly rising equity market. Can you just explain the mechanics of what happened in the quarter?
I don't think we would describe it as under-hedged. I think the difference here is really one of timing and accounting. The way we hedge this business is we buy instruments for the guaranteed period that has been set. Every year, we reset the cap rates, we reset participation rates, and we buy instruments to offset that. They're usually one-year instruments, and so the change in the value of those instruments is accordingly driven by that. The liability, however, requires us to project forward what crediting rates will be and discount that over the lifetime of the contract. It basically creates a mismatch that will work its way out over time, in the end, it settles out, but it's just a timing differential. It's not an economic exposure or concern.
Okay. Thank you.
This concludes our question and answer session. I'd like to turn the conference back over to Rod Martin for any closing remarks.
This is Mike. Just one correction. There was a miscommunication on our end. The answer to the question earlier about the amount of capital related to the ISP, the liabilities are just under $500. The capital is about $20 million. Apologies for that misstep. Thank you.
As we look ahead to 2017, we're focused on continuing to execute our plans, manage what we can control, and achieve our financial targets. We have strong businesses, clear objectives, and a commitment to take actions that will benefit both our shareholders and our customers. We look forward to continuing to share our progress with you. Thank you and good day.