F&G Annuities & Life Q2 2023 Earnings Call Transcript

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August 9, 2023

There are 7 speakers on the call.

Operator

Returns. Our first half results reflect these established and newer capital light strategies and we've generated record gross sales whilst maintaining pricing discipline. Our gross sales were $6,300,000,000 in the first half, up 11% over the prior year. We're on track with our stated goal of growing annual gross sales at a double digit clip. And with net sales of $4,400,000,000 in first half, we are on track with our stated goal of managing net sales retained above the $6,000,000,000 to $7,000,000,000 annual level that continues to grow our retained AUM.

Operator

Next, looking at the quarter's results more closely, we reported gross sales of $3,000,000,000 in the 2nd quarter, a decrease of 3% from the prior year quarter due to lumpy institutional sales with a 9% decrease over sequential first quarter, which reflected a record level of sales boosted by the effects of market volatility and the U. S. Regional bank crisis. Retail channel sales were $2,300,000,000 in the 2nd quarter, an increase of 5% over $2,200,000,000 in the 2nd quarter of 2022. This reflects our 5th consecutive quarter of retail channel sales exceeding $2,000,000,000 driven by continued strong consumer demand for our products.

Operator

Fixed annuities are an attractive solution for consumers given their relatively higher rates, guaranteed growth, principal protection and tax advantaged accumulation and annuitization options. Sales. Our sales mix was consistent across the 3 retail channels, including agent, bank and broker dealer in the Q2 as compared to the prior year. Institutional market sales were nearly $700,000,000 in the 2nd quarter comprised of $500,000,000 of pension risk transfers and $200,000,000 funding agreements compared to nearly $900,000,000 in the Q2 of 2022, solely comprised of funding agreements. Funding agreement activity in the Q2 was driven by FHLB transactions as current market conditions remain challenging for funding agreement backed notes issuances.

Operator

For the 1st 6 months of 2023, this brings our institutional market sales to 1,200,000,000 and with 6 months to go, we are on track with our annual target of $2,000,000,000 F and G's net sales retained over $2,200,000,000 in the 2nd quarter as compared to $2,500,000,000 for the prior year quarter. This expected trend reflects the attractiveness of 3rd party flow reinsurance, which increased from 50% to 75% of MYGA sales in September of 2022. F and G has profitably grown its retained assets under management to a record $46,000,000,000 at June 30 net of flow reinsurance. Adjusting for flow reinsurance, we estimate gross assets under management at $51,000,000,000 as of June 30, that is before the approximately $5,000,000,000 of cumulative new business ceded. Growth.

Operator

Next, turning to our investment portfolio, we continue to have conviction that our portfolio is well positioned to withstand uncertainty in the macro environment and form through the cycle given its diversification and Blackstone's extensive expertise. Our fixed income yield was 4.39% in the in quarter excluding ALTS volatility as compared to 3.93% in the Q2 of 2022. Growth. This reflects our 4th consecutive quarter of maintaining fixed income yield above 4%, driven by relatively higher yields on floating rate assets and new investments given higher interest rates over the past year. Our portfolio is high quality with 95% of to maturities being investment grade.

Operator

There has been no change in our commercial real estate and office holdings from last quarter, which skews toward the lower end of industry exposure. Credit related impairments have averaged 5 basis points over the past 3 years, well below our pricing assumption and remain below that level in the Q2. Overall, our portfolio continues to perform well and is well matched to our clean and stable liability profile. Margin. Our spread based business is a simple one.

Operator

We target a return on assets or ROA above 100 basis points on our AUM. Excluding significant items, we have now delivered our 6th consecutive quarter of adjusted ROA, well above our 100 basis point target, in fact, averaging 113 basis points excluding significant items over the last 6 quarters. Beyond spread based earnings, we are further diversifying into capital light fee based earnings, including flow reinsurance and owned distribution. Growth. We utilize flow reinsurance, which provides a lower capital requirement on ceded new business, while allocating capital to the highest returning retained business.

Operator

Growth. In addition, the strategy enhances cash flow, provides fee based earnings and is accretive to F and G's returns. Growth. Wendy will provide further perspective in a few minutes. We have also been expanding our own insurance distribution holdings.

Operator

This strategy solidifies relationships with key partners that we have worked with for a couple of decades, while boosting our presence in underserved trill and middle market segments. Importantly, the strategy plays to key experience and expertise within our management team, which helps these companies to accelerate their growth. Over time, F and G will earn a dividend stream from our ownership stakes, providing for higher margins at a lower marginal cost of capital. We value the power of capital light earning streams from these strategic owned distribution stakes, which are expected to be accretive to ROE. F and G is also committed to strong ratings and achieving upgrades over time.

Operator

We remain on positive outlook with AM Best, and we're pleased that Moody's upgraded the financial strength ratings of F and G's primary operating companies to A3 last month, recognizing the financial strength and stability of F and G's business as we execute on our diversified growth strategy. I'd like to thank our team for all that they have done to execute on our diversified growth strategy, having doubled gross AUM before reinsurance and nearly doubled adjusted net earnings excluding significant items since the merger with FNF 3 years ago. Our success would not be possible without them. We have strong momentum as we head into the second half of the year with many opportunities ahead of us to further expand our business, which will ultimately drive margin expansion and improved returns. And we remain focused on delivering long term value to to our shareholders.

Operator

Let me now turn the call over to Wendy Young to provide further details on F and G's 2nd quarter financial highlights.

Speaker 1

Thanks, Chris. Today, I'll provide more details about our financial results and key performance drivers, capital liquidity and leverage position and wrap up with a few additional thoughts on our reinsurance strategy. Overall, F and G's to successfully execute our growth strategy. Starting with adjusted net earnings, for the Q2 of 2023, we reported adjusted net earnings of $79,000,000 or $0.63 per share. Our core earnings per share were $1.03 after adjusting for $0.40 per share of unfavorable significant items that are not consistent period to period.

Speaker 1

These significant items include $0.44 per share for alternative investment return below our long term expectation, partially offset by $0.04 per share of bond prepay income. For comparison, last year's 2nd quarter adjusted net earnings of $155,000,000 or $1.45 per share included favorable significant items of $0.39 per share. Adjusting for these significant items in both periods, 2nd quarter adjusted net earnings increased by 14% over the prior year. I also wanted to highlight that on July 13, 2023, F and G filed an 8 ks to provide investors and analysts with a supplemental disclosure of our 2022 10 ks and 1st quarter financial supplement and investor presentation. This filing revised our prior LDTI accounting standard recast for calculation refinement of F and G's A and E adjustment to remove all market related movements, including the current period for market risk benefit from income.

Speaker 1

We believe this approach to be in line with peers. This change had a modest favorable benefit to adjusted net earnings, which is reflected in our first half twenty twenty three results and we expect to persist in 2023 and future years. Importantly, F and G has generated consistent economics over time. As Chris mentioned, 113 basis points. Now looking at our 2nd quarter results more closely and starting with asset growth, our retained assets under management were $46,300,000,000 as of June 30, up from $45,400,000,000 as of March 31.

Speaker 1

This reflects $1,900,000,000 of net new business asset inflows in the quarter, partially offset by 1.1 of flow reinsurance outflows. With regard to our in force book, this quarter we saw outflows from MYGA products right in line with the past couple of quarters. These are predictable cash flows and expected to be lumpy over time depending on contractual maturity date set at our origination. During the Q2, we also soft fixed indexed annuity outflows for combined surrenders, withdrawals and death were slightly elevated as compared to past couple of quarters, although not concerning given market conditions and notably we continue to experience strong inflows. Our retail fixed annuities comprise 74% of total net reserves and have policy features which serve as a disincentive for policyholders surrender early.

Speaker 1

91% of our fixed annuities are surrender protected with an average remaining surrender charge at roughly 7% of account value and approximately 70% of these policies also have market value adjustment protection. Overall, F and G continues to have positive net inflows. And as a reminder, we benefit from a boost to earnings from higher surrender charge fees and freed up capital from the policy surrenders. And next, turning to our disciplined expense management. Over the past 3 years, F and G has grown, diversified and modernized its business, while more than tripling its top line sales and doubling gross AUM before flow reinsurance.

Speaker 1

We are disciplined in our expense management approach and focus on our operating expenses relative to growth in sales and assets. To help put it in perspective, from 2019 to 2022, We grew gross sales by 43% CAGR and gross assets under management before flow reinsurance by a 21% CAGR. To generate that growth, we needed to make significant investments in our operating platform and personnel costs and other operating expenses net of deferred acquisition costs and expense allowances from reinsurance partners increased by a 16% CAGR. Margin. Looking ahead, we would expect our variable operating expenses, which are roughly about 1 third of our cost base will continue to increase generally in line with our growing in force book as well as gross sales, which are expected to grow at a double digit clip.

Speaker 1

We also expect that fixed operating expenses, which are about 2 thirds of our cost base or approximately $200,000,000 on an annual basis will grow at a single digit growth rate and we expect that our reinsurance expense allowances or the expense reimbursement that are reported separately under our benefits and other changes and policy reserve line item will increase over time as benefit of cash generation through flow reinsurance to 3rd party. All in, we expect that our operating costs will continue to grow as we scale and invest in the business, albeit at a slower growth rate relative to our gross sales and gross assets under management before flow reinsurance and with the benefit from the reinsurance expense allowances, thereby generating operating leverage over time at a continued measured pace. And next, turning to interest expense. Our interest expense has increased to $47,000,000 or 21 basis points of ROA in the 1st 6 months of 2023 as compared to $17,000,000 or 9 basis points of ROA in the first half of twenty twenty two. This reflects 5 $15,000,000 drawn on our new revolving credit facility, which was put into place in the Q4 of 2022 and $500,000,000 senior note issuance in the Q1 of 2023 as planned to support our future growth and liquidity needs.

Speaker 1

Our annual interest expense remains approximately $95,000,000 or roughly a 6% blended yield on the $1,600,000,000 of total debt outstanding. F and G's debt to capitalization ratio excluding AOCI was 23% as of June 30 below our long term target of 25%. Margin. Now turning to our balance sheet. We ended the 2nd quarter with a GAAP book value excluding AOCI of $5,100,000,000 or $40.70 per share with 126,000,000 common shares outstanding as of June 30.

Speaker 1

There is a page in our investor presentation providing an analysis of book value per share. We continue to target holding company cash and invested assets at 2x fixed charge coverage. Our strong capitalization supports growth and distributable cash. During the Q2, we returned $41,000,000 of capital to shareholders, including $25,000,000 of common dividends and $16,000,000 of share repurchases. In the Q2, F and G repurchased approximately 790,000 shares for $16,400,000 at an average price of $20.79 per share.

Speaker 1

Capacity remaining under the $25,000,000 share repurchase authorization was $8,600,000 at June 30, 2023. Following yesterday's announcement of the Q3 cash dividend of $0.20 per share, we view our current annual common dividend of approximately $100,000,000 as sustainable. This translates into a dividend yield of approximately 3%. Based on F and G's recent market capitalization of approximately $3,500,000,000 and demonstrates the underlying strength in our business as well as our commitment to creating value for our shareholders. The dividend is reviewed quarterly and expected to increase over time subject to cash flows, alternative uses of capital and market conditions.

Speaker 1

As our balance sheet delivers with book value growth over time and ample opportunity for future reinsurance program. Let me wrap up with an update on flow reinsurance strategy. As Chris shared last quarter, the ability of our new business platform to generate premium is attractive to 3rd party asset managers, especially those who are not paired with an insurer as a means for them to take on asset growth and generate fees from the flow. To illustrate the economics for F and G, for every $1,000,000,000 of new business flow reinsurance, we free up approximately $75,000,000 of capital to redeploy to the highest returning retained business. This is meaningful and to help put that amount in perspective, that is nearly 10% of the estimated $800,000,000 capital generation from our entire in force block in 2023.

Speaker 1

Importantly, we expect to grow gross sales at a double digit clip while managing net sales to a level that continues to grow our retained AUM. We estimate that we could retain as little as $6,000,000,000 to $7,000,000,000 of gross sales and continue to grow the retained block. In this scenario, as long as sales are well in sets of outflows, we are still growing with net inflows, albeit at a smaller spread, but with significantly less required capital. Within these parameters, during the second half of twenty twenty three, we expect to increase our flow reinsurance on MYGA new business on the current 75% level to as much as 90% by on boarding additional high quality and established flow reinsurance partners. Importantly, MYGA flow reinsurance provides fee based earnings while also generating a higher ROE than fully retained sales.

Speaker 1

Additionally, in contrast to our 100 basis points ROA rule of thumb for fully retained spread based business for reinsurance sales based on current economics, which could change, we would expect to receive approximately 1 third of the ROA with proportionately less or about 1 5th of the capital requirement. We are well into execution of our flow reinsurance opportunities for the second half of twenty twenty three and I look forward to providing further details next quarter. This concludes our prepared remarks and let me now turn

Speaker 2

Your first question comes from Mark Hughes with Truist Securities. Please go ahead.

Speaker 3

Yes. Thank you. Good morning. Good morning, Mike. Wendy, you do Good morning, Ian.

Speaker 3

Wendy, you talk about if you retain $67,000,000,000 that would be sufficient to grow the block, offset outflows. What kind of growth rate are you thinking of when you talk about Grow the Block? Is that just Low single digits or what's the right number?

Speaker 4

I would say it's single digits but on the upper end.

Speaker 3

Okay. And under those circumstances, is there a Kind of a rule of thumb about the capital return or capital excess capital generation if you're Reinsuring 90% of the MYGAs if you're retaining enough to get kind of single digit growth in the block, Did you say your ROA profile improves relative to your capital usage? What does that mean for capital return?

Speaker 4

Yes. So we believe we'll be able to increase The dividend, over time.

Speaker 5

And the only thing I would add to that, this is Chris, is that Right now, new business we're getting at least mid teen ROEs on new business. The economics on flow are pretty meaningfully north of that. So we think this will Show up relatively quickly in terms of its ability to expand overall net spread.

Speaker 3

And then Chris, the sales this quarter still quite strong in absolute terms, but year over year up mid single digits. I think that's probably I think the industry numbers suggest the overall sales growth was somewhat higher than that. Was this just competitive situation? Did you Was the MYGA not quite as attractive this quarter? And again, not to criticize what's a Good growth rate, but what was the dynamic this quarter?

Speaker 5

Yes. So I would say no, nothing It's really changed in terms of competitive environment. There's always pockets of product where Perhaps you're seeing someone be a bit aggressive and you choose not to go chase it. I think for us it's we look across now all of the channels when deciding where to allocate capital. So, no, I would say return targets for us have continued to be quite attractive, but keep in mind, we're also writing PRT business.

Speaker 5

We've got FHLB borrowings, etcetera. We just we go through the process. It's pretty real time of where we want to allocate capital. The quarter over quarter look like it slowed a little bit, but just keep in mind, we had an absolute blowout Q1. Right now our retail business is on a pace to do $10,000,000,000 of sales on its own.

Speaker 5

So now we're feeling like there's just tons of sales opportunity right now.

Speaker 3

Great. Thank you.

Speaker 2

Next question comes from A. J. Hayes with Stephens. Please go ahead. J.

Speaker 6

Rice:] Hey, good morning guys. Growth. Good morning. Congrats on the quarter and thanks for taking our questions. Chris and Wendy, you both called this out during your prepared remarks, but when we look at your normalized ROA where we utilize your long term expected return assumption of approximately 10% on alternative assets and back Got any other one timers, your ROA as you guys said has been over 100 basis points for 6 consecutive quarters now.

Speaker 6

So first off, congrats on that. But can you generally talk to what is driving this outperformance and then whether we should expect this trend of hovering above 100 basis points to kind of continue for the foreseeable future here.

Speaker 4

Yes, that's where we were trying to give some discussion points for you and some modeling help With expanding the reinsurance and the owned distribution, you should see that ROA expand Even above the levels that we're currently experienced. We're seeing spread expansion In the existing business, we've had with the run up in the interest rates, the floaters are performing very well and we In the QFS, A. J, we show a nice exhibit that demonstrates how that has contributed to The NII line, we have had some increase in the cost of funds, but The product margin is basically what's causing that expansion.

Speaker 5

Yes. And the only thing I'd add to that is which we talked about on the call. I mean, we've Grown the top line at a pretty incredible clip. As you know, we've effectively doubled assets and earnings in 3 years when the goal was 5. And look, we've had to make some pretty significant investments in new channels and new technologies to execute upon that.

Speaker 5

But despite that, we're still getting some good expense synergies. In other words, we've grown fixed expenses at a rate well below what we've grown sales at. And I think now we should see more of that going forward. So it's really across the board. Blackstone has done a terrific job working with our investment team in terms of continuing to generate attractive additional spread for the portfolio.

Speaker 5

Product margins, as Wendy said, have been growing. And then as we continue to tightly manage fixed expense growth going forward. It's a good picture. And yes, I would say, it's pretty hard for us with a straight face to say that the goal is 100 basis points We've averaged 113,000,000 and I think there are more tailwinds than headwinds to that. Great.

Speaker 6

Thanks for the color there. Krish, I believe it was you that mentioned you're on track to hitting your goal of achieving institutional sales of $2,000,000,000 to $4,000,000,000 in 2023 here. But could you provide more color here in 3Q? Have you had any more of these lumpy institutional transactions so far during the quarter?

Speaker 5

We have. So we closed one transaction. I'll double check what it was, 170,000,000 or so. Pipeline is good. We continue to like the market a lot.

Speaker 5

There's a lot of activity. We're really selective on what we go after. It's quite an impressive and sophisticated funnel that the team uses to assess even do we even want to bid on a deal. But once we've decided and we've narrowed in on, we like the profile of the deal. We think it lines up well with our line of sight on asset availability and we go after it.

Speaker 5

We've had a really good hit rate, effectively 1 in 4. Despite frankly being one of the lower rated players competing in the market. So we See a lot of upside there. We like the long duration profile of that business. And it's a small but mighty team.

Speaker 5

And so these are assets We talk about expense leverage. We've got a group of about a dozen people leading this effort bringing in billions of sales. So that positive contribution all around.

Speaker 6

Okay. And then just looking at gross sales here, institutional channel has been strong. You expect to achieve that goal that you just previously mentioned there. Retail channel as well has been performing well here. So strong year in 2023 is kind of the expectation where we're expecting.

Speaker 6

Can you to gross sales maybe in 2024. You expect to hit the double digit clip here in 2023. Is that a reasonable expectation again for 2024?

Speaker 5

Yes, I would say it is. We've got new products in the works as well. We're close to entering the Ryla market and I think that's going to open up a lot of avenues and other pockets of distribution for us, which I think will be really attractive. We talked about PRT. I think there's certainly tailwinds there.

Speaker 5

And then retail demand for fixed annuities, you referenced some of the industry numbers is really just off the charts right now. You're looking at crediting rates of 5 ish percent tax deferred with principal guarantees. So I don't I honestly don't see that slowing down anytime soon. And again, for us, it's really we view our most important job on behalf of our shareholders is to allocate capital smartly. And now we've got a new business engine that's cooking along and sourcing premiums from multiple directions.

Speaker 5

So We will continue expect to continue to grow the top line at a double digit. Okay.

Speaker 6

Thanks again and good luck for the rest of the year.

Speaker 3

Thank you. Thank you.

Speaker 2

I would now like to turn the floor back over to Mr. Blunt for closing remarks.

Speaker 5

Great. Look, we're pleased with our overall results despite the uncertainty and volatility in the current macro environment. We think F and G is poised to benefit in this higher rate environment and is off to a strong start in the first half of the year. We expect to expand our business with a focus on further improving our profitability, which we believe over time will drive multiple expansion to deliver value to shareholders. Along these lines, we look forward to discussing our business and emerging growth strategies in more detail at our upcoming Investor Day on October 3.

Speaker 5

Additional information will be provided on our Investors site as we get closer to the event. Thanks for joining us today and we appreciate your interest in F and G.

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Earnings Conference Call
F&G Annuities & Life Q2 2023
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