We're going to get started here. I'm Mike Kovac , the life insurance analyst at Goldman Sachs, and it's our pleasure to welcome Voya to the stage with us. Voya is a domestically focused, $8 billion market cap, retirement annuity, life and asset management business. Joining me from Voya on stage today is Alain Karaoglan, Voya's Chief Operating Officer, and Mike Smith , the firm's CFO. Alain is responsible for Voya's ongoing businesses, and Mike recently became CFO in November. Prior to becoming CFO, Mike served as Chief Executive of the insurance solutions business at Voya, and since 2009, has overseen Voya's legacy Variable Annuity business, the CBVA. We're going to do today's forum in a fireside chat model.
I want to start with, for Alain, maybe over the past several years since becoming a public company, Voya's focused on repricing, ring-fencing risk, and outlining a strategy for growth to achieve a 13.5%-14.5% ROE by 2018. I want to know if you could discuss balancing some of these priorities and the drivers of it as it relates to reaching those ROE targets.
Thank you, Mike. Good morning, everyone. Thank you for having us. At Voya, we've been on the transformation journey that is really continuing. What we talked about when we first came public in the IPO, which has only been three and a half years ago, is about a legacy of companies that was brought in through acquisitions that weren't integrated, that were punching below their weight. We laid out plan to improve the ROE by 400 basis points to 12%-13% by 2016. We've achieved that by 2014, and we laid out new plans in 2015 to achieve targeted return on equity of 13.5%-14.5% by 2018.
The first step was about getting these existing businesses that were fantastic, that were punching below their weight, to punch at their weight by focusing really on three financial metrics: risk-adjusted return on equity, distributable cash flow, and sales at or above our internal rates of return. These three financial metrics are still in place today. This is how we judge our progress going forward. In 2015, we announced a strategic investment program of $350 million over four years. Really focused on three things, IT simplification, digital and analytics, and cross-enterprise initiatives. It's to continue the journey to simplify the company, to reduce the silo. IT simplification is about reducing costs, but more importantly, enabling the continuing of our digital and analytics and cross-enterprise initiatives.
In the third quarter this year, we've announced our simplicity efforts, which is to take away the complexity within our businesses that has occurred over the years. What we've announced is we expect to achieve at least $100 million of cost savings by 2018. Last year, we had talked about $30 million-$40 million of cost savings by 2018. It's really a continuation of the journey. You would expect us to constantly get better and better at what we achieve. We've maintained our targets of 13.5%-14.5% ROE by 2018, in spite of the very significant interest rate pressure that we've had over the past few years up to our earnings call, which actually was going to cost us another 140 basis points of return of headwinds because interest rates were lower than what we had expected when we laid out the plan.
That's helpful. Actually, on your last point there, interest rates have clearly been a headwind over the last several years to some of the ROE targets, not just at Voya, but across the industry. How should we think about the recent rise in rates, the easing pressure on earnings balance sheet as it flows through the businesses, maybe for both Mike and Alain?
Yeah. The interest rate pressure has been real. The 140 basis points of additional headwinds have been from interest rates and actually equity markets as well. Because if you recall in 2015, the equity market didn't appreciate as one would have assumed on average would appreciate. The recent increase in interest rate has been meaningful. The spot rate is where rates actually were at the end of 2015, but the forward curve over the past year has been at lower levels. If interest rates were to maintain at this level and continue, that will be very beneficial to our plan. We're not changing our returns. If anybody's going to ask, given the change in interest rate, our return on expectation, we still have a couple of years to go. We'll see where interest rates will end up.
It's going to be helpful to our retirement business, which had a very meaningful headwind from interest rate. Generally, it's going to be very helpful to all of our businesses, both ongoing and closed block.
Mm-hmm. I think the only thing I'd add is just on the closed block in particular, it's a very interest sensitive. It's certainly perceived to be, and I think a lot of the change in the recent stock price that you've seen is driven by perceptions of the VA business. We have a significant amount of interest rate hedging position to protect in case interest rates go back down. We have substantial resources to cover the liability in total, and we manage the hedge program to offset changes due to market shocks in those values of the liability. Overall, I think the new interest environment, if it persists, is going to be very favorable and positive for the organization.
I want to dive into that a little bit more later on a segment level basis. There's a lot more going on than just sort of the macro here. Alain, you mentioned early your comments on cost savings programs expected by 2018 to drive $100 million of potential savings. Can you walk us through where these savings are coming from in terms of why now in the business as opposed to in prior periods?
I think that's a very important thought. The macro environment, none of us can control, and things are going to go up and down. There are certain things that we can control. Our expenses, what we do every day, where we focus on energies every day, we can control. Our IT simplification effort is an effort that's going to continue to help us reduce our unit costs, but also deliver us capabilities in digital and analytics that will further reduce our costs, but also help us to provide a customer with an effortless customer experience. We're continuing to focus on these elements that we can control. What we've learned over the year and a half as we were accelerating our IT simplification is we've learned a lot about our infrastructure, what's possible in the new environment, in the cloud environment.
We're further expecting to accelerate what we wanted to do two years ago through the learnings over the past two years, through the continued simplification over the last couple of years. We're bringing our annuities and life insurance business together from a management point of view. That's going to lead to synergies between the two segments. It's going to allow us a better leverage with distributor, having more heft with them as we're talking to them about the opportunities there. On the retirement side, we're still expanding our sales force and our retirement opportunity to continue to grow going forward. What's very important is we're not slaves to the macro environment.
We recognize it, we take account into it, our job as management is to constantly figure out what we can do to continue to improve our unit costs, to continue to provide the right customer outcomes and the right customer experience going forward. What I love about our plan, and I loved it since we went public, is it really depends on us. It's about execution. It's a self-help story with the macro environment being helpful if things continue to turn positive on the interest rate environment.
Any thoughts on the costs in sort of the early years of that at this point, or still too early to tell in terms of the costs of the ultimate savings?
We announced a restructuring cost of $30 million in the fourth quarter. We don't have any new update on that, we'll make sure we'll inform you as soon as we get them.
One of the other big elements for Voya is a capital return story. Wanted to spend a minute on that with Mike, if we could here. At the end of the third quarter, excess capital stood at almost $1 billion as you determined it, you announced $200 million of buybacks in the fourth quarter, another $600 million in 2017. Despite the recent rally, the stock's still trading at 70% of book value. What are your thoughts on accelerating this deployment or sort of finding other sources of additional capital?
First let me frame up the $1 billion of excess capital. I think it's important to understand the timing of that. About $380 million is currently in the holding company. The balance of the $600 million is actually in the operating companies and can be dividended up to the holding company sometime in the second quarter. We don't comment on the timing of share repurchases. I think our commitment throughout under Abel and certainly under me is that we're going to be very prudent in managing our excess capital. We do view shareholder stock buyback as probably one of our better uses of excess capital, particularly when we see the value of the stock below its intrinsic value. We're continuing down the path that we've been on, and I think we'll see how things develop.
Makes sense. Another key area of interest since the election has been on regulatory issues and sort of a number of them as they pertain to the life insurance industry. The first one's on really the Department of Labor update to the fiduciary standard. Can you provide us any thoughts on either conversations you're having with the industry, with distribution partners as it relates to where the DOL heads under new presidential administration?
We hear the same noise and rumors that all of you hear. There's definitely, with the new administration, there's a different view on regulation, and there might be a desire to roll back the DOL fiduciary rule. Practically speaking, how they do it might take some time, and they need to figure it out. There's talk about delaying the rule, there's a process in order to do that, how do you delay the rule, et cetera. We don't know where it's going to end up ultimately. On our end, we're working as if that rule is going to be in place in April and by year-end. We're working with our distributors and internally to make sure that we can comply by the rule. If the rule gets changed, we'll deal with it at that time, and we'll address it at that time.
The cost of addressing that will be incremental in terms of complying with the rule.
if we were in a position where we got to April 2017 and there was either a delay or revocation of the rule, is there anything you would change in terms of how you're managing your business today?
Not really. If we step back and think about the impact of the rule on us, where does it impact us in our overall business? If you think about our retirement business, we're in the large corporate market, which doesn't affect it, the tax-exempt market, which largely doesn't get affected. What gets affected a little bit is the small, mid-corporate market. The way we've been going to market, we've been going to market in a way that's already compliant with the rules. The area where we really get affected is our broker-dealer. We have our own distribution. These are the individuals that have to become a fiduciary or avail themselves of the BIC clause and BIC exception. Beyond that, our business, we weren't getting that affected by it before, and we're not going to be that much affected by it going forward.
On the Fixed Index Annuity, which was swept under the rule at the last minute, when we look at our distribution, one of the issues is that a lot of the Fixed Index Annuities are sold through independent agents. In order to avail yourself of the BIC rule, you need to get affiliated with a financial institution, which is either an insurance company, bank, broker-dealer. We sell 65% of our business through financial institutions. Another 15% is through agents that are registered rep, and they can affiliate themselves with institutions. Only 20% of business is sold through pure independent agents. What happens in the Fixed Index Annuity business overall market, and for those who sell through independent agents, these independent agents are really disenfranchised from their ability to sell Fixed Index Annuity.
Now they can get relief from the Department of Labor in order to be able to continue to it. To put it back in context, before the rule, we weren't that affected by it. To the extent that it changed, we won't be that affected by it as well.
Makes sense. The other key area that comes up most frequently is tax reform. Wanted to get your thoughts there as it relates to Voya, knowing that one of the other sources of value at Voya is the large deferred tax asset. How are you thinking about that under potentially corporate tax reform?
Sure. Certainly a lot yet to be learned about what the tax reform will actually look like. If you imagine as some of the proposals have started to outline just a lower flat overall rate, that would have two direct impacts. First, the deferred tax asset would drop roughly pro rata to the decline in interest rate. That's just simply-
Tax rate.
Or the tax rate, excuse me. That's just sort of a mechanical process. The second would be an overall improvement in after-tax operating earnings. I think you can do the math and come up with your own sense of what the relative value of that is. We think overall, a decline in tax rate is going to be a favorable development for us.
Are there tools at your disposal if we see something coming down the pipe where you could accelerate some of the utilization of the DTA? Do you see things internally or not really?
It's a good question. I don't think at this point we're able to give you a lot of guidance on what those things are. We have a pretty significant team that's focused on tax planning and managing our tax position. As we get better information about where things are going, we'll certainly take advantage of the opportunities that are in front of us.
That makes sense. Maybe shifting back to the segments a little bit on an underlying basis. Retirement is the one operating segment that was outlined in the third quarter as maybe not quite hitting the ROC targets that you'd originally outlined. Can you walk us through what's happening there, how maybe the macro environment might actually be helping that today or tools that you have to continue to improve the return on capital there?
Let's step back and think about what has hurt us when we reported our earnings and laid out our new targets on the retirement business of 9.5%-10.5%. It's really three things. It's the interest rate environment that was lower, the equity markets that was lower on an absolute basis than we expected, and the guaranteed minimum interest rates that we have on our contract, where our policyholders can transfer from variable accounts to the fixed account. Given the guaranteed rates and the lower interest rate environment, more were transferring than we had planned for. The most significant impact is the interest rate impact on its own. The overall impact of these headwind costs were going to cost us 250 basis points of return on capital in our retirement business. What are we doing to offset that?
We have a team focusing on the guaranteed minimum interest rate to try and address these issues in the contracts specifically. All of the cost savings, IT simplification, a good portion of that will go to the retirement business. We're still expanding. We expect our revenue to grow in the retirement business. We're expanding in that market. We're working on it. We believe we can get to the targets that we have in 2018. Very importantly, you've heard us say before, 2018 is a point in time. Life does not end after 2018. We expect to continue to improve all of our business and we continue to make up some of these headwind in 2019 and 2020.
To key on one of the things you mentioned there, expecting to grow revenue over that period of time. Obviously, a competitive environment in the retirement space. Maybe you could give us some thoughts on how the competitive dynamics are shaping up, specifically in the markets that Voya wants to grow in today.
The environment has been competitive throughout and has continued to be competitive, no more or less so. We have good competitors in the marketplace. What we find is the reason you saw it in some of the net flows in the last year, that we're able to win our fair shares and our expectations to continue to win. The reason is because we provide very good value for our customers, both the participants and the employee sponsors, because we focus on what the outcomes are, for both the participant and the sponsor. Ultimately, what we're trying to do is get people to retire better, is to be retirement ready, to be able to deal with that anxiety of retirement. We have some capabilities in terms of both digital and phone-based access to planning.
We have also nationwide individual advisors that are available to participants if they need it to be helpful. Ultimately, what we can show sponsors and we can show participants is you started at X%, and by being with us and by being your retirement provider, both the participants and the overall population will be better off over time. The competitive environment is still there, good competitors, competitive, we're having very good dialogues with both the employee sponsors and the participants in terms of achieving the right outcomes.
Maybe another market, shifting to the investment management side, where obviously a high-margin business for Voya today. Broadly speaking, how are you navigating fee pressure that we broadly see in the market from move to passive and others? Just sort of your thoughts there.
On our investment management, it is quite a profitable business. Our target margin is 33%-35% by 2018. We've had very strong investment performance in our investment management business through all the categories, on fixed income, equity, Senior Bank Loan. What we said on the third quarter earnings call is continuing. We're having good flows with the CLO that we put in place in the fourth quarter. A private equity fund that we raised. We still find quite a good appetite for our capabilities that we have, whether it's Private Placements, whether it's Mortgage-Backed Securities. We have a good Mortgage-Backed Securities capabilities. Whether it's commercial mortgage loans. We have great performance on our fixed income side as well. We're seeing very good demand for it.
What you're seeing on the institutional side also is a barbelling approach, where for the vanilla stuff, they're willing to go to indexed or something like that. For the categories that require active management and capabilities like the ones that I just mentioned, they're willing to pay the appropriate fees for that because they're looking at total return after fees. We have great capabilities for that. If you remember, Mike, a couple of years ago, we started an effort to offer our capabilities and our services to other insurance companies. That has been very successful and continues to be quite successful.
Makes sense. The other two segments that you discussed early on in terms of the merging as part of the general cost savings within the life and the annuity segment, I wanted to dive into that a little bit more, in terms of what you see as the benefits of merging those two segments today.
By merging the annuities and the individual life business, of course, you're getting some opportunities for synergies, from an efficiency, an ability to reduce our unit costs in both of the segments. In addition, it does give us more leverage and more presence with distributors. If you're going at distributors, you might have the same distributor, but if you're going with individual life and annuities separately, as opposed to going all at once, it gives us more leverage in that. It allows us to focus on the businesses that we want to focus in, the less capital intensive businesses, selling more of these products, and then avoid some of the products that are less attractive. We stop selling term insurance, for example, in that. Ultimately, we still have both segments. We're going to report individual life and annuities separately.
We're going to be able to execute and achieve our plans better, more seamlessly, and with more confidence being together.
One of the other tools in the life segment was improving returns through reducing capital in that segment through reinsurance and through refinancing some of the redundant reserves. Can you provide us any update that you have on either of those and potentially how a rising rate environment might either make that easier or more expensive in some of this?
Just to recap what we've done. We've done two major reinsurance transactions in 2014 and 2015, releasing in total about $400 million of capital and with minimal earnings impact, about give or take $5 million run rate. Those were the If you remember, there was a paradigm that I introduced at our investor day, fix it, sell it, or improve it. This is the sell it piece. The fix it piece is the refinancing that we just announced in our second quarter call, where we're able to take the overall financing cost for about half of our outstanding redundant reserve financing and significantly improve it to the ultimate impact to the life business of 150 to 200 basis points improvement in its ROC, and translating into about 50 to 60 basis points of ROC improvement for the overall company. That last one is still in process.
We expect to get that primarily done this quarter. You'll start to see the impact flow through in 2017 and then potentially increasing in 2018. Interest rates don't have a lot of impact to that specific component. I think it's more about the refinancing market and the level of refinancing costs. I think there are still some opportunities for us to make that more efficient. I think we're predominantly done with the sell it and fix it thing unless the market conditions change.
Shifting to one of the businesses we haven't talked about today, the employee benefits side. Been pretty strong returns in that business. Year-end renewals are big. We're approaching those in the next couple of weeks. What is happening from a competitive dynamic there? How should we expect returns in 2017 for the industry broadly versus 2016 and maybe Voya specifically?
The employee benefits business has been a great story for us, right? We've achieved 20-plus % return on capital. We've been able to grow that business quite meaningfully in the past few years. We benefited from a tailwind, right? Medical costs have been lower than we expected in our pricing, led to a loss ratio that we're better than we expected. Great. We've always highlighted that our loss ratio expectations are higher than whatever we're achieving. We're expecting the return on capital to decline. What you're seeing a little bit this year is a return to what we would consider more normal range of loss ratios. The marketplace is being more competitive than it was a year ago. We're still finding quite good opportunities. We're going to be disciplined.
If we have the opportunity to ride the business at the loss ratios and the return that we want, we'll ride it. If we don't have the opportunity, we'll let it go. We're patient. We're able to do it the right way. The great story is we've been able to do both in the past few years. We're getting to a level now that is more normalized. We're in the middle of the renewal season in the fourth quarter. We'll see how it will turn out. The market is a little bit more competitive. Mike, from your vantage point.
No, I think that's right. Look, the outside world observes the loss ratios that the companies are seeing. They know we've had a couple of good years in 2014 and 2015 in particular. That's part of the dynamic that's entering into the pricing considerations. I would say yes, the market's more competitive, but it's not irrational. I think we're very comfortable with the levels of rate that we're generally seeing overall. There are always one-off situations where we walk away and say, how they got there, we don't know, but generally the pricing levels are fine. The employee benefits business also has a growing voluntary book and a fairly stable group life book. Those are, I think, additional sources of return that we're excited about, and particularly the growth in voluntary and the rates that we're seeing there.
Wanted to shift and spend a couple of minutes here on the CBVA, on the closed block of Variable Annuities. Mike, having spent a considerable amount of your time looking at that.
Yeah.
Maybe for you, how have the current environment, maybe even over the last month or so, potentially shifted the way that you're thinking about that block on a go-forward basis? Maybe start at a high level. We can dig into some additional thoughts. Some of the things we definitely want to think about are the capital within it and potential capital releases down the road.
Broadly speaking, we've got significant resources supporting this block. As we announced on the last call, while we target CTE 95 on a rating agency basis, we're at CTE 98. Our hedging strategy is aimed at protecting that level against market movements, both interest rate and equity markets. We've been very comfortable for the last, ever since the IPO, we've consistently reported solid hedge performance, and we think that's going to continue to perform well for us. At the same time that we've been managing the block, and we're comfortable to manage it for as long as we need to given the resources that we have, we've been looking at ways to run the business off more quickly. That's come through a variety of enhancement offers where we've gone to customers and said, "Would you like to take your income stream sooner?
We'll give you a little bit extra to do that." We've also recently filed a buyout opportunity. That's still in process, but that would ultimately allow someone to surrender for the entire value of their account, plus some extra. That's still to be determined, and as I said, we're in the midst of the registration process, so I can't comment a whole lot further on that. As it relates to the current environment, we certainly welcome the increase in interest rates. It's a positive development for us. We're adjusting our hedges accordingly. As the markets move, the sensitivity of the various metrics does change. We'll make modest adjustments to our hedges. Nothing too significant. It's normal course.
Finally, as it relates to strategic options, which I think is where you were really trying to go with the question is, interest rate increases make it more likely that we're going to be able to find some kind of broader de-risking opportunity. I do think rates need to probably go up a bit more before the opportunities are going to be particularly attractive. We'll continue to watch the developments in the equity market or the equity and interest rate markets. We are very comfortable with where we are now. We think the resources are more than adequate. We think we're well protected from a hedging perspective, and if we can find a way to strategically accelerate the runoff of that risk, we'll take advantage of that if it's economic for us to do so.
You mentioned, obviously, that the rise in rates is helpful, but that maybe needs to rise a little bit more in order to find additional sort of capital coming into that space today. What level do you think we need to get to? Is it 3% on the 10-year, 3.5%? If we stay here, are we okay?
I want to be careful and not draw lines in the sand because the expectation then is as soon as if I say it's 3, then at 3.01, it's where's the deal, right? I do think that we need to get probably north of 3 before it becomes reasonably doable. We'll have to see. It needs to get in that range probably before we'll see an opportunity. We are always looking for ways to reduce the risk.
One of the other ones that you highlighted that is in fact in place today is the enhanced surrender offers that have been going on for a number of years. Understanding that one's sort of still in progress, what is the timeline for that in terms of when you should be able to give us more information and when you ultimately expect to start seeing some of the impact on the economics?
The most recent offer that's completed now, that was an income-enhanced offer on our 2003 block. That's about half of the overall GMIB business, a little bit over, I think. We'll have a complete update for you on the fourth-quarter call. Assuming the filing and registration process proceeds as we expect, we should be able to give you an update on the enhanced surrender buyout as well.
Thanks.
I think, Mike, it's important to put it in perspective, right? When we closed that block, the size of that block was $47 billion. Today, it's $34 billion. We had 600,000 policies. Today, it's 330,000 policies. We made very good progress in chipping at the block. Now, having said that, $34 billion is still a large block. If you think of potential one transaction, there are not a lot of players that can absorb such a large block. We have to think about it in pieces, et cetera, as we think through it. We've made very good progress in terms of dealing with the block and shrinking it over the past years. Mike has done a phenomenal job at it.
Understood. I want to leave a couple of minutes here. If anyone has questions in the audience, raise your hand. We have a microphone in the back, right up to the front. One coming.
Hi. Going back to the closed block, just broadly speaking, so that I can get my head around it. Is it fair to say that right now the hedge is in the money and the underlying isn't? Theoretically, when you put it on, you were flat, I'm assuming. Which one's in the money, which one's out, and kind of how close are you to being at parity? Broadly speaking.
I think the way to think about our hedging program is that we've got a capital and/or reserve amount that we're solving for, and we're trying to offset the changes in that capital or reserve as the markets move. The in the money, out of the money is not really the way we think about it. We think about it more in terms of do we have enough resources to cover the liability? That's what we measure our success on, and we've demonstrated a consistent track record of that.
We had one more up in the front.
Hi. You mentioned before that a potential reduction in the corporate tax would have two consequences: one, the DTA, and one, just obviously the ongoing business. The question was asked whether you can accelerate the DTA usage somehow to take advantage of any timing arbitrage before it actually happens. The question I have is on the tax rate itself for the ongoing business. Obviously, the law has not even been proposed yet, but I'm assuming you've run some analysis on your business saying the tax rate goes to 25 or maybe 20. Do you have an idea as to how much your tax rate would go down or how much your earnings would benefit from that? Just assuming some level that we can use.
Well, I mean, the effective tax rate is 32%, right? I think to the extent the gross tax rate goes down, then I think you can adjust it ratably from that. Well, it depends on other characteristics and what other deductions may or may not be allowed, right? It's a little bit about the definition of taxable income as well as the tax rate. If the definition of taxable income is shifting, then I think it gets a little more complex. We're certainly monitoring what comes out, and when we get an actual proposal on the table, then we'll start really analyzing. I think right now it's really hard to speculate because the field is just so wide.
If you look everything else being equal, yes.
Yes
It's a one for one benefit.
Yeah. If nothing else changes, it's straight math.
Mike, you mentioned earlier there's about $600 million of excess capital in the operating insurance company. Is that $600 million incorporated in the 98% CTE on the closed block, or is that excluding the 98% that you're currently at?
It's a good clarifying question. The VA is not included in that excess capital. That's all related to the ongoing business. The CTE95 is separate from that.
Thanks. Well, we're just out of time here. Join me in thanking Voya for their time today. Thanks a lot, Mike.
Thank you.
Thank you.