Move right on to Voya Financial. I'm pleased to introduce Ewout Steenbergen, CFO of Voya. Since going public in the spring of 2013, Voya has already achieved its 12%-13% ROE target set two years ago, set a new 13.5%-14.5% ROE target for 2018, and bought back over $2 billion of shares, which is meaningfully above at least what I expected. I think probably, I'm not alone in that boat. I'm pleased to introduce Ewout to join me on stage, to talk about the progression story at Voya. Ewout, thanks so much for joining us.
Good morning, Seth. Good morning, everyone.
Ewout, if we could kick off with the ROE plan, it's been impressive progression to start out. In the summer, you moved from a 12%-13% goal to a 13.5%-14.5% goal. How are we going to get there over the next two to three years?
Yep. If you look at Voya's ongoing business, what we like about our opportunity is that this is really a self-help story. The opportunity to improve the ROE is very much within control of management actions we can take to improve returns of our businesses to levels at or above industry levels. It's less dependent on external factors, market factors, as such. We have 20 initiatives defined that we are working on and executing on to improve our ROEs going forward. They're in three buckets. There is margin, growth, and capital initiatives. If you think about margin initiative, think about making our businesses more efficient, digitizing some of the processes, simplifying IT infrastructure, taking expenses out, managing our crediting rates, and so on. Those are all opportunities that are clearly within management's control.
With respect to growth, there's many initiatives where we believe we have more opportunities to improve our commercial activities in the markets. We're expanding some of our distribution reaches in retirement. We have more feet on the streets. There is, for example, in the small mid-corporate area, there's still a large part of the market where today we are not invited for RFPs, and we're really actively trying to really be part of every possible new client that is out there in the market that goes out with an RFP. We are expanding our distribution there in the tax-exempt market as well as in the large corporate markets. We are so far in the mega markets, and we're going down a bit to the large, so let's say the over $150 million market there. The same is within our investment management business. We are expanding distribution.
International distribution, we have been relatively light, so that is where we are acquiring additional capabilities. We have a new team that is selling to insurance customers, mostly P&C and other insurance customers that need general accounts capabilities. We can provide that. There's many initiatives that are going on. Think about our annuities business, our fixed indexed annuities. We have new distribution arrangements with Allstate. The advisor channel network of Allstate are now selling fixed indexed annuities from Voya. We have just announced last quarter a similar initiative with the advisor network of Farmers. There's a lot of things going on with respect to commercial initiatives. The last category is capital. We believe we still can make our business less capital intensive. We are looking at products that are less capital intensive.
On the individual life side, we are mostly only selling indexed universal life, which is really linked to indices and is less having interest rate guarantees. The same on the annuity side. Already for many years, we shifted from the traditional fixed annuities, where there's more interest rate guarantees to indexed fixed annuities, which are all less capital intensive. We're also looking at opportunities to take capital out. Last year, we did a transaction to sell a block of business of individual life to RGA. That was a block of business where we had low returns, and we're freeing up approximately $230 million of capital. Those are all those initiatives. In total, like I said, 20 initiatives. Therefore, we're confident we can bring this ROE up to 13.5%-14.5% by 2018.
Moving to that next leg, I believe that across the three initiatives, it looks more weighted to growth than maybe some of the margin improvements, which were part of the self-help story to start out over the first two years of the IPO. From your remarks, it sounds like increased penetration of distribution and increased client relationships is a big component of that. Voya is a fairly new brand. Obviously not a new company, but a new brand. Could you talk about your conversations with clients and reaction to the Voya brand?
Clearly, we came from a situation with an ING brand that is very strong. We are spending last year and this year approximately $100 million for rebranding, so additional advertisements to bring the Voya name out to the market, both to our distribution partners, plan sponsors, as well as just the retail market plan participants. It's helpful when an advisor is sitting with a retail client, that the retail client is saying, "Yes, I recognize Voya. I've seen their ads on TV. I know who they are," if the advisor is proposing a Voya product. The same for a plan sponsor. It makes it easier if the plan participant knows Voya and saying, "Oh, yes, I know Voya is my administrator for my 401(k) plan and for my 401(k) account." We are measuring clearly the brand awareness. We're tracking with the targets.
We are not so concerned about this transition. It's, in fact, going very well. I would not be able, Seth, to give one example to say, we really lost out commercially because of the brand issue, that because the brand was less well-known, we have seen some reduction in sales in a particular area, or we missed out on a large institutional client because of a brand initiative. I think that transition is going well. I presume everyone is seeing the ads. It's quite often out there. We think that transition is going well.
As you mentioned, one of the attractive elements of the ROE expansion story is it's not as reliant on market factors. Positive equity markets help you. Could you give a sense of sensitivity of your ROE and your ROE goals to market measures? Does the turbulence to start out 2016 put your 2018 target at risk?
Obviously, we are also not immune as a company for macroeconomic factors. We think overall the sensitivities are manageable. What you have to think about is the following. A 1% decline of the equity markets is approximately $3 million-$4 million impact on our operating earnings, $3 million-$4 million, and that is post-debt, pre-tax. Post-debt, pre-tax, $3 million-$4 million for 1% decline in the equity markets. In our plan, we have an assumption of 7.5% equity market appreciation, 1.5% dividend income. If you would add that up and over a three-year period up to 2018 in terms of return on capital, unlevered returns, it would be approximately 60-70 basis points if equity markets would stay flat, wouldn't do anything over the next three years.
In terms of rate sensitivities, if interest rates would stay flat from where they were, let's say at year-end, more or less flat over the next few years, compared to our plans, it would be a 1% impact on operating earnings in the first year, growing to approximately 5% impact compared to what is our plan in 2018, so 5% less than our current plan in 2018. That would be closer to a 90 basis points impact in terms of the ROC. That would be the most extreme kind of sensitivity. We have a range of 13.5%-14.5%. We know we have many initiatives that we can take. There's also initiatives we can deal with a low-rate environment. We have still room with respect to our crediting rates.
On average, the book is somewhere between 70, mid 70 to mid 80% at guaranteed minimum rates, so we still have room to maneuver. There are many management actions we can take to offset. Those have not been included in those sensitivities I just provided.
Moving to capital deployment. Yesterday, you reported an excess capital number of $1.1 billion. You also announced an authorization of $700 million. There's a little bit of a disconnect there, obviously, between the authorization and what you view as excess deployable today. Could you discuss how you view the difference in numbers there?
Yeah. First of all, what we are striking to find is a fair balance between confidence in our excess capital position, as well as prudency given the market volatility. $1.1 billion of excess capital we had at year-end 2015, and it's over and above already very conservative standards. The standards we apply to ourselves, 425% RBC, 24 months holding company liquidity, and so on, I would say are all really at the high end of the spectrum of where some peers are. $1.1 billion, we really feel this is real excess capital that's available. We think, if you look at the current share price of Voya, it's highly attractive, obviously, to deploy the excess capital for buyback activities. We think $700 million is a good number at this point in time. If you would express it in the current market cap of Voya, it's approximately 12%.
12% of our market cap is the new authorization in terms of buybacks. As you said in the introduction, Seth, that is on top of $1.5 billion of buybacks we did last year and $800 million of buybacks we did in 2014. If you add it up, including the current authorization, that's a $3 billion buyback over the last period. We still have $400 million remaining. That is a kind of holdback. We want to see how the year is playing out, certainly with the market volatility, later this year, decide on what is the best way to deploy that $400 million. We think that prudent management is appropriate in the current situation. We are managing the business for the long term, in the course of this year, we take another decision how to best deploy that $400 million.
Is there a thought to bringing down those targets? You do mention a 425 targets and two years holding company liquidity. I would agree that is on the conservative ends of the spectrum. As you move forward and actually deploy this excess capital, is there perhaps potential to bring down those targets for the risk buffers?
Not at this moment. If there are changes, facts, and circumstances, we could think about changes in our standards, we think those standards are clear. They are set at the IPO of the company. They have been communicated with all our constituents, the regulators, the rating agencies, and so on. We like where we are. It helped us last year to get the upgrades from S&P, Moody's, and Fitch. We really would like to stick to those targets at this point in time.
One of the areas not in your ROE targets is the closed block variable annuity book. It obviously flows outside. Could you discuss the strength in terms of your total resources that back that business?
Yeah. Total resources, and these are all hard assets that we had available at year-end 2015, were $5.7 billion. We have a book of business of $35 billion, and these are the account values of the underlying funds of those policies. We have $5.7 billion of additional resources to deal with claims and additional capital buffers on top of that in the future. That $5.7 billion are all hard assets. It's built up based on the following components. $4.6 billion are statutory reserves, also called AG 43 reserves. We had $500 million of cash flow testing reserves, and then we had $600 million of additional assets. Additional, we call unassigned assets over and above our statutory requirements. That's how it's built up. It's the same $600 million that we had a quarter ago.
What is very important here is the hedge program, because the hedge program is a very large hedge program that is working in a very tight way, is delivering on the stated objective, and the objective is to offset regulatory and rating agency requirements. This is a closed block already for six years. It's in run-off. Because it's a liquidation scenario, the most important is the regulatory and rating agency capital requirements, because that will determine the real cash capital that has to be put into this book. We hold ourselves to the higher of the two standards because we want to be fine on both bases. The hedge program is performing well. We show that in our earnings deck.
If you go to our earnings release every quarter, as you see the effectiveness of the hedge program relative to the statutory liability movement. It's relatively tight in terms of the hedge program. We have, of course, also been very closely monitoring the program over the month of January. The program is designed for markets like this. We have it for markets, downturns, and volatilities. We have interest rate roll hedges on. We have equity market delta hedges on. We have a volatility hedge. We have credit hedge. We have option programs on top of that, very large notionals. If you look at the hedge effectiveness in January, it was, again, from our perspective, doing well according to its stated objective.
If you look at that $600 million of excess assets, we still feel at the end of January, according to the information we have today, that still a significant amount of excess assets is still available there at the end of January.
Looking at the hedge performance over the last, I think you've given 12 or 13 quarters of data, if we look in your presentations. There's been positive hedge breakage, if we add it up cumulatively, of about $1.5 billion. The positive breakage is obviously a good thing, the direction, but the size, to me, seems a little bit large compared to the $5.5 billion, $6 billion of resources you have. Can you help us think about that size of the breakage over the last three years?
Yeah. From our perspective, Seth, if you look to the hedge breakage on a quarter-by-quarter basis, we actually think it's rather low, because every quarter it's somewhere between zero to $100 million. On the size of book like this, that is pretty tight. You have to realize that these are active managed funds that are underneath. You have hedge breakage there. You have the basis risk, how it is called, that you are hedging according to indices, but you have actively managed funds. The indices are not perfectly aligned with what is happening with the funds itself. Also, we are hedging according to two standards. We're according to the statutory as well as the rating agency standards. You're right that you've seen positive breakages over those periods. Unfortunately, we had one quarter last year where the breakage was slightly negative.
I, in fact, said to the hedging team that I was happy about that, because at some point, if it's every quarter positive, it's almost too good to be true. What you should expect is small positive, small negative every period. Again, within a small corridor. We feel very good about the performance of the hedge program over the last period, including the beginning of this year.
You mentioned the $5.7 billion is all hard assets. You also, I believe, have a letter of credit, which is not included in that number, but it is something that you could tap on occasion. Could you describe what may trigger you to tap that letter of credit, and maybe why you would tap the letter of credit?
First of all, I would like to make a clear statement that there was no need for a letter of credit by year-end 2015 or any of the previous quarters. I think the last time there was really a need was the quarter around the IPO of the company. There was no need for that LOC over the last three years. What would be the purpose of the LOC and when do we really need it? There's in fact two reasons and purposes. One is, if markets go down, there might be a discrepancy between the statutory requirements and the rating agency requirements. Rating agencies don't accept the letter of credit. They only look at hard assets. If there is a discrepancy between the two, the letter of credit is only there to satisfy statutory purposes.
Why do we need it for then for a statutory basis? The difference in the way how rating agencies look at the required assets is they look at all of the entities in aggregate. They look at multiple entities in different states. We have captive entities, and they say, "Are your assets in total acceptable according to our rating agency requirements?" On a statutory basis, you have to satisfy for each and every single entity. It might be that in aggregate, we have sufficient assets, but due to geography, one entity might have a small shortfall. The other entity has a large excess. In total, we are fine, but because we want to satisfy each and every entity on a statutory basis, that LOC is needed. That's not because the company in total is short, it's purely to manage geography.
That's helpful. If we move back to the ongoing business and retirement administration, we've heard other peers reference margin pressure in the 401 market. Could you speak to the competitive landscape of what you're seeing?
Yeah. There is fee pressure, there has been fee pressure, there will continue to be fee pressure. It's not undue, it's not irrational, there is always pressure on the fee levels, and rightfully so. Plan sponsors have a fiduciary obligation to make sure that the plan conditions, in terms of fees, are the best and most acceptable that are out there in the market. What is an interesting market dynamic, what we are seeing is that clearly the retirement space is becoming more and more a scale business because you need to have very efficient operations in order to deal with fees, and fees that might be a bit under pressure over time.
You can clearly see that midsize players are having difficulties, and certainly smaller players, to be competitive in this area because you need to have the scale of the operations, your fixed infrastructure, your investments in more lean operations in order to be able to have a positive economic model. The second is where you see a lot of attention is ultimately, this is not a business where fees are making the difference in terms of being a winner from a competitive perspective, it's not. You want your fees to be in line. You don't want to be an outlier in a negative sense. When you are more or less in the zip code of the required fee in terms of being competitive, then it's all about the additional services you can provide to plan sponsors and to plan participants.
There's a very large trend of more handholding of employees to give them more information, more advice, more tools to clearly help employers that employees are more actively participating in those plans. This is a real issue for employers because the participation level so far in plans have been rather low. Employers want their employees to be better prepared for retirement. It's an economic reason for employers as well. They don't want a very old labor force that is not ready for retirement, will stay on, where the, for example, the health expenses go up, where, for example, they cannot recruit new graduates from colleges because the older generation has to stay because they are not ready financially to retire. There's clearly a drive of additional services to increase participation levels, increase deferral levels, and we have more access, therefore, to the end participants than we had before.
Ultimately, that is where you differentiate as a player in the retirement market.
We have microphones at the back. If anyone has a question, feel free to raise your hand. Here we go, in the back left. Thanks. Can you comment on your energy exposure and your credit risk and any sensitivities that you might have to a ratings migration or defaults?
Yeah. Our energy fixed income exposures by year-end were $7.3 billion. 92% of that is investment grade, 92%. The total unrealized loss on that book is approximately $500 million. Unrealized loss for us isn't that much of an issue. We are a buy and hold investor. We can wait until maturity. The key item that you have to monitor and proactively manage is potential downgrades, credit migration, and the impact that might have on the capital requirements, the capital charges. Our team is very proactively, tactically looking at the book, looking at the risk where there is potential downgrades, and managing that in order to make sure that the capital charges are not going up. Just to give you a perspective, that 92% that we had in terms of investment grade by the end of December was 93% by the end of September.
We see hardly any change there in terms of the overall quality over the last quarter. We feel confident about the quality of that book. In terms of our total below investment grade exposure, that was $3.2 billion by the end of the year. That is approximately 3.5% of our total investment portfolio, clearly less than the average of our peer industry. The total unrealized loss there is $100 million. We also feel very comfortable about the quality of that book, and we're not concerned at all. In terms of your question about sensitivity, and this would be the most extreme sensitivity. If there would be a one-notch downgrade of all of our energy holdings across the board, and we would not proactively manage that credit migration, that impact of one-notch downgrade would be 15-20 RBC points less than our current RBC.
Our RBC attainment was 485, clearly, as I said before, over our target of 425, which is a very conservative target. The impact would be if a one-notch downgrade across the board, 15-20 RBC points lower.
You comment on that being a very extreme scenario. This is where you run the risk of talking to a bunch of equity guys about credit events. How do we think about a one-notch downgrade, just in terms of how your investment guys think about it and distribution of probability, all moving down a third of a letter. Where does that fall within sort of the extreme tail risk, or is that a tail risk?
If you first take a step backwards, I think we come out of a period where credit defaults and credit risks and credit risk premium were extremely low. To some extent, you could say we came from a very favorable period, and we see some normalization. The attention is very much to the energy and metals and mining sector, there, the risks are higher. Our philosophy from a risk management perspective is, if you are in a very favorable part of the cycle, you don't want to set your actual credit exposures very close to your limits because you know at the point that the cycle is turning and you're already at your limits, then suddenly you have to act and you have to take actions because then you might very quickly pierce your limits and you have to reduce your exposure.
We keep deliberately, from a risk management perspective, some positive buffer between our actual exposures and our limits in a positive part of the cycle. If we see credit migration going up, we're still comfortable within our overall limits. I think that's where we are, and that's why for us it's important. We are, again, a buy/hold investor. If you are a forced seller in a market like this, then clearly you wouldn't be in a good position, but that is not where we are today.
Just want to pause to see if there are any other questions. Maybe we could just finish up on investment management, a core part of Voya's business, facing pressure from passive approach. How are you combating that, and how do you find your positioning relative to the industry?
Let me give you a few perspectives, overall, my message would be, the discussion about active versus passive is a bit black and white. We think there are pockets of the investment management industry where active management is useful and where you can really have alpha outperformance. Then there are some parts where you're more in a midpoint in terms of active and passive, for example, our target date fund strategy. Let me first go into where do we feel we have opportunities to provide alpha to the market. Our equity teams, very fundamental teams in terms of their approach. There is no particular bias in terms of industry. There's no star kind of managers. It's very team-based approach, bottoms-up. We usually tend to do a little bit less in terms of performance when there is a lot of positive sentiment.
We are not so much into sentiment stocks, but usually from a downside perspective, we do a little bit better when markets turn negative. We have certain asset groups that have very specific capabilities. We have a very strong industry, well-recognized private placement group. We have a commercial mortgage group that is very strong, a mortgage derivative strategy that has one of the best performance in the market, a private equity investor. Those are some of those pockets where we have specific capabilities where we can provide alpha to the market. With respect to target dates, this is really a trend we have jumped upon. It's a very good trend for the retirement space. It fits very well with our overall proposition.
A lot of those plan participants like target dates because you expect the manager to really have a glide path in terms of your risk exposure from now to the point that you plan to retire and to manage that for you. Those target date proposals are usually a mix of passive and active. It's not only Voya-managed. We have a special multi-asset team that picks the best managers in the market, and we like that as well in terms of strategy. It isn't that black and white. We see those pockets, and we think we can really have a good proposition to the market there.
I think you'll get a lot of support in this room in terms of the value proposition of active management. We'll leave it there for now. Ewout, thanks so much for joining us.
Thank you, Seth.