Earnings Call Transcript - AEG Q3 2021

Operator, Operator

Good morning, everyone, and thank you for joining this Conference Call on Aegon’s Third Quarter 2021 Results. We would appreciate it if you could take a moment to review our disclaimer on forward-looking statements, which you can find at the back of the presentation. With me today are Aegon CEO, Lard Friese; and CFO, Matt Rider, who will take you through the key points for this quarter. Let me now head over to Lard.

Lard Friese, CEO

Thank you, Jan Weidema. Good morning, everyone. We appreciate that you are joining us on today's call and we look forward to updating you on our third quarter results. In my part of the presentation, I will take you through the strategic highlights and through the progress we have made on our strategic assets. Matt Rider will then go through the details of the results and our capital position. He will also summarize the actions we have taken to further strengthen our balance sheet and to manage the financial assets. Finally, I will conclude the presentation with a wrap-up, after which we will open the call for a question-and-answers. So let's move to slide 2. In the third quarter of 2021, we continue to drive our transformation forward by delivering on our financial and strategic commitments. And I am encouraged to see this reflected in our results. These results are supported by the benefit from expense savings initiatives. And we remain on track to deliver on the three-year target of €400 million expense savings. In our strategic assets and growth markets, we are benefiting from the growth initiatives that we have implemented. And our asset management business extended its track record of over nine years of positive third-party net deposits. We saw an improvement in performance across most of our businesses. This was offset by adverse claims experience in the US with COVID-19 and a higher average claim size being the most important drivers. As a consequence, the operating result decreased by 16%. We expect the impact from COVID-19 to abate over time. In addition, we want to reduce the volatility and mortality experienced in the US and are looking at management actions to mitigate this. In the third quarter, we remain proactive in managing our financial assets. We launched a lump-sum buyout program for certain variable annuity policyholders, which was well-received by customers. Moreover, the guarantees on the remaining variable annuity portfolio are now being fully hedged against equity and interest rate risk. Furthermore, we have almost fully executed our plan management actions to reduce interest rate risk in the US, which has led to a significant reduction in our interest rate exposure. In our long-term care business, we have already achieved approval for more than US$300 million worth of rate increases. And consequently, we have increased our expectations for the rate increase program to US$450 million, underscoring our track record of actively managing this business. Our balance sheet remains strong and in line with our disciplined capital management framework. The capital ratios of all three main units are above their respective operating levels, and our group Solvency II ratio increased to 209%. We've also strengthened Aegon’s approach towards corporate sustainability. Last week, we announced Aegon’s group-wide commitment to transitioning our general account investment portfolio to net-zero greenhouse gas emissions by 2050 with an intermediate goal set for 2025. This further underpins our concrete action plans to create lasting value for all our stakeholders. Lastly, we continue to work together with the Vienna Insurance Group to close the divestment over our businesses in Central and Eastern Europe. VIG is continuing its constructive dialogue with the Hungarian Ministry of Finance to clarify possibilities for a positive conclusion of the acquisition. Let me now give you an overview of where we stand with the execution of our operating plan.

Matt Rider, CFO

Thanks, Lard, and good morning, everyone. Let me start with the financials on slide nine. Our operating results decreased compared with the third quarter of 2020 to €443 million. Increased fees from higher equity markets and positive contributions from growth were more than offset by adverse claims experience in the U.S., which was mainly attributable to COVID-19 and a higher average claim size. Our balance sheet remains strong, with the capital positions of all our three main units firmly above their respective operating levels and the group Solvency II ratio at 209%. Cash capital at the holding decreased to €961 million as anticipated and now sits in the middle of the operating range. The decrease reflects the payment of dividends and use of cash for additional deleveraging. Since mid-2020, our gross financial leverage has reduced by €700 million and now stands at €5.9 billion. This puts us on track to meet our target of reducing our gross financial leverage to €5 billion to €5.5 billion. We have also made good progress on the reduction of our economic interest rate exposure in the U.S. We have now almost fully executed the interest rate reduction plan that we announced at the Capital Markets Day, by lengthening the duration of our asset portfolio and expanding the forward starting swap program. Together with the expansion of the dynamic hedging program for variable annuities, and favorable market movements, this has led to a 75% reduction in the targeted interest rate risk since the third quarter of 2020.

Lard Friese, CEO

Thanks, Matt. So the takeaway from today's presentation is that we continue to drive our transformation forward by delivering on our financial and strategic commitments through a disciplined execution of our operational improvement plan and active management of the enforced business. Adverse claims experience aside, the operating results developments are encouraging and supported by the disciplined implementation of our operational improvement plan. We have reached important milestones for our financial assets that Matt just laid out. We are benefiting from growth initiatives in our strategic assets and growth markets. And we have committed to net zero greenhouse gas emissions targets by 2050. In summary, I'm satisfied with how we continue to deliver on our financial and strategic commitments. And I would like to open the call now for your questions. In the interest of time, I kindly request you to limit yourself to two questions per person. Operator, please open the Q&A session.

Andrew Baker, Analyst

Great. Thanks, guys. Thanks for taking my questions. So, first roughly on capital generation. First specifically to the third quarter. Seems like there's quite a lot of moving pieces, are you able to give an update on your view of the normalized run rate? So I guess the comparable number to the previous €318 million pre-holding company costs that you provided and maybe just talk through some of the moving parts of the quarter? And then secondly, related to the medium-term view, when can we expect an update to the €1.3 billion 2023 target? And then can you also just confirm whether that included an assumption for a 15 basis point reduction in the UFR? And if so, can you just remind me what the impact of that was? Thank you.

Matt Rider, CFO

Yes. I can outline the operating capital generation guidance for the full year. In the third quarter, the operating capital generation, after accounting for holding and funding expenses, was €327 million. When you add back those expenses, the operating capital generation comes to €390 million before holding and funding expenses. We experienced some challenges on the mortality side, while there were benefits on the morbidity side; adjusting for those effects adds approximately €60 million to the run rate. Additionally, there were some favorable adjustments to consider, which roughly amount to €50 million. This results in a clean run rate for the quarter of around €400 million. Looking toward the end of the year, the year-to-date operating capital in the business units, before holding and funding expenses, is about €1.1 billion. From this, we can estimate the fourth quarter run rate, subtracting around €40 million for COVID impacts and approximately €10 million for the effects of dynamic hedging, which will affect future operating capital generation. This puts us around the midpoint of the €1.4 billion to €1.5 billion range discussed last quarter, and we plan to maintain that guidance moving forward. I hope this information is helpful.

Michael Huttner, Analyst

And thank you very much. And can you talk a little bit about the take-up rate expectation, which you're seeing where we are now at the end of October or actually mid-November in terms of take-up? And what kind of impact this could have in terms of RBC, I think at September the 8% was 3.5%. And I was trying to gross it up, but I'm not very good at math. And then the other question is on the morbidities. I understood from your comments €23 million in Q3, including a €16 million of reserve releases. And we kind of done with morbidity benefits, or is there potentially still more to come, or is the €300 million pricing you've spoken about when will we see that in the numbers? Thank you.

Matt Rider, CFO

Yes, let me first address your question about the take-up rate. The take-up for the lump sum buyout program was 8% through September. As of yesterday, it stood at about 14%. However, it's important not to extrapolate this going forward because the program concluded at the end of October, with a significant portion of the take-up occurring towards the end. Right now, the take-up is around 14%. We plan to extend the offer until the end of January 2022, allowing the take-up to increase, although at a slower pace compared to the initial phase of the program. Regarding morbidity, we are still seeing benefits, but admissions to long-term care facilities are rising back to pre-COVID levels. We released part of the IBNR reserve in the third quarter and will release the remaining $44 million IBNR reserve gradually until the second quarter of next year. Concerning rate increases, we have surpassed our expectations for long-term care price increases, currently exceeding €300 million, and we aim for a target of €450 million, with €100 million reflected in our premium deficiency reserve by year-end. The remaining amount will be recognized over time, impacting capital generation. As for the RBC impact, the overall program has contributed a 3.5% improvement to the ratio, based on the 8% take-up rate. We anticipate further enhancements through January, which will be evident in our RBC ratio by year-end and into the first quarter of the next year.

David Barma, Analyst

Hi. Good morning. On US variable annuities, just to come back on that in light of your high expectations for the buyouts take up rate in your comments made on fee increases in some contracts. Can you remind us what you expect for the run rate capital generation on that lines please? And then secondly, on US mortality, so quite high in the quarter, and I assume that splitting COVID-related from the rest is a bit difficult, but any color on underlying trends would be helpful there? And also you say you want to take actions to reduce the sensitivity to mortality, how do you plan to achieve that? Thank you.

Matt Rider, CFO

Yes, so on the VA run rate capital generation. In the last quarter, we had said that we would reduce operating caption by about $50 million, as a consequence of implementing both the lump sum buyout program and the dynamic hedging. And that we would be in a range of $250 million to $300 million operating caption on an annual basis, and we're retaining that. So we came in pretty much exactly where we thought we were going to be. So the number is $250 million to $300 million on an annualized basis. Maybe on the mortality in the US, I mean, the way that we really think about this is that we did have you could say the impacts of direct and indirect COVID claims that represented about 1.5 of the adverse experience that we saw in the border. So if you work in US dollars, we had $111 million worth of adverse mortality experience. Part of it was directly related. So that, you know, that's the case where I think it was $46 million of that was related to COVID deaths, where we get a claim in and we get a death certificate, and it's written COVID-19 as the cause of death. But as I said in my opening remarks, we're also seeing elevated claims from things like respiratory illnesses, which are guiding us saying that there is a portion of other claims that are not directly COVID-related, that are more indirectly related. And then if you add those two components up, then it's like one half of the total amount of the deviation. The other part of it is we did have an increase in the overall average claim size during the course of the quarter, which contributed to about one quarter – one-fourth of the overall for mortality experience. This is just what I would call normal average size claims deviation. We did see a number of higher face amount contract claims that came in during the course of the quarter. You asked the question around management actions. And indeed we are going to try to take some steps here. This is typically done through reinsurance and we will be looking at that to minimize or to reduce the amount of claims volatility in terms of case size.

Robin van den Broek, Analyst

Yes. Hi. Good morning, everybody. Thank you for taking my questions. The first one is on remittances, year-to-date you perhaps close with €500 million, give a little bit when we look forward, before it's more of an interesting quarter when it comes to remittances. So given your RBC ratio is also at the very healthy level, but what should we expect there versus your target. And I was also wondering if you could include in that comments kind of regulatory movements that we can still expect? Are these assets are just changing? And changes are finally coming through in Q4? And secondly, I guess, Lard since you first started the CEO, you haven't had much opportunity to travel and visit the business units, but over last few months, I assume you had some opportunities to do so. And I was wondering if you want us to share your experience from that? Thank you.

Matt Rider, CFO

Yes, as a quick reminder, our guidance for gross remittances for 2021 was in the range of €600 million to €700 million. We aim to link our cash dividend to our sustainable free cash flows. As you may recall from last quarter, we raised our interim dividends by €0.02 per share, indicating our expectations for future free cash flow. We now expect the minimum gross remittances for the full year to be around €750 million. Additionally, regarding regulatory changes, there is a change in the risk-based capital factors for certain asset classes in the US. This results in a negative impact on credit and a slight positive impact on real estate, giving an overall expected decrease of about 10 percentage points on the US RBC ratio, which will be reflected in the fourth quarter results.

Lard Friese, CEO

Absolutely, I’m more than happy to share this with you. Thank you for your questions, Robin. I began my role as CEO during the pandemic, which limited my opportunities to meet people face-to-face. However, over the past month, especially after the summer, I spent several weeks in the U.S. with our new management team. One noteworthy observation I made is that everyone is eager to see Transamerica regain its status. Transamerica was a market leader in the U.S. but has lost market share recently, so our goal is to enhance its performance. I fully support the new team as we develop various strategies to improve this business and accelerate its growth. The positive takeaway from my discussions with distribution partners is that Transamerica is a strong brand, and there is a widespread desire for it to return to the top ranks. Additionally, I believe it's important to mention the new team we've assembled, including Will Fuller as CEO and Chris Ashe as CFO, along with other key appointments. We've brought in new talent, such as Matt Keppler as Head of Financial Assets, who are all highly experienced professionals I’ve worked with previously. It's encouraging to see how this team is fitting in and working to enhance value creation within our variable annuity offerings, while also clearly differentiating between financial assets and growth products, leading to improved focus on the business. Despite the challenges posed by the COVID pandemic, I’ve been actively engaging with our sales teams across both the retirement and individual solutions sectors in the U.S. I recently spent time with our financial distribution partners and will be returning to the U.S. next week to further discuss growth strategies with Will. I truly enjoy spending time with the teams and working to enhance our business, and I also took the opportunity to focus on our operations in the UK. Overall, I find great satisfaction in working hard to drive improvements within the company.

Farquhar Murray, Analyst

I have two questions. First, regarding the inflation hedge that was implemented, can you clarify if there will be any associated costs going forward, especially in terms of capital generation? Second, about the offer take-up, should I consider the RBC ratio established at the 8% level as the take-up you had at that time? I believe you mentioned some sensitivity, but I assume it's a few additional points on top of that since we are moving from 8% to 14% or something higher. Is that correct? Thank you.

Matt Rider, CFO

So, yes, on the inflation hedge in the Netherlands, what's the impact on capital generation negligible. On the take-up rate in the US? Yes, the take up rate was 8%. I think we did the math on that to say that 8% relates to about 3.5% on the solvency ratio a little bit over €70 million in capital generation. It was struck at that moment, so that we would anticipate further positive impacts as that goes forward. One thing I would mention is that you remember that we did take a charge of about €560 million related to the combination of the lump sum buyout program and the dynamic hedging. But on that one, we anticipated further movements in these kind of things. So you're not going to see that continue to bleed in over time. So we've taken all the impacts for any future take-up rate improvements, all in this quarter.

Operator, Operator

Thank you, operator. This concludes today's Q&A session. On behalf of Lard and Matt, I thank you for your interest. Should you have any remaining questions, please do get in touch with us Investor Relations. We're happy to help. Have a good day and thank you for participation in today’s call.