Jackson Financial Inc. Q1 FY2022 Earnings Call

Good morning, and thank you for joining today's Jackson Financial First Quarter '22 Earnings Call. My name is Austin, and I will be your moderator today. I would now like to hand over the conference to our host, Liz Werner, Head of Investor Relations. Liz, you may proceed.

Good morning, everyone. Before we start, we remind you that today's presentation may include forward-looking statements, which are not guarantees of future performance or outcome. A number of important factors, including the risks, uncertainties, and assumptions discussed in risk factors, management's discussion and analysis of financial conditions and results of operations and business financial goals in the company's 2021 Form 10-K could cause actual results and outcomes to differ materially from those reflected in the forward-looking statements. In this presentation, management will refer to certain non-GAAP measures, which management believes provide useful information in measuring the financial performance of the business. A reconciliation of non-GAAP financial measures to the most comparable GAAP measures is contained in the appendix to the presentation. With us today are Jackson's CEO, Laura Prieskorn; our CFO, Marcia Wadsten; and our Vice Chair, Chad Myers.

Good morning, and welcome to our first quarter earnings call. This morning, we'll review our first quarter performance, reiterate our financial targets, and speak to current market trends. This quarter, Jackson once again demonstrated its ability to navigate volatile markets from the business and capital management standpoint. Our solid operating results reflect the underlying profitability of our healthy in-force annuity book and our ability to deliver sales growth in a fluctuating market through product and distribution diversification. Adjusted pretax operating earnings, excluding notable items, were $463 million for the first quarter, up from the first quarter of 2021. Overall sales increased over the year-ago quarter as lower variable annuity sales were offset by an increase in institutional sales, coupled with growth in two of our newer product initiatives, RILA and Defined Contribution. Total Retail Annuity assets of $242 billion were up slightly from the first quarter of 2021 but down 7% since year-end due to poor equity market performance in this year's first quarter. In addition to the volatility in equity markets experienced during the quarter, we saw a dramatic increase in interest rates. While higher interest rates are a clear long-term economic benefit to our business through lower hedging costs, this can cause a near-term headwind for our statutory RBC positions, which Marcia will explain in more detail. Over the course of the first quarter, we once again took advantage of multiple paths to returning capital and returned a total of $192 million to our shareholders. This consisted of $52 million in shareholder dividends and $140 million in share repurchases, representing approximately 4% of Jackson's outstanding shares, including a $28 million repurchase from Apollo. We remain active buyers of our shares and view Jackson's shares as attractively valued. We are on track to reach our targeted capital return of $425 million to $525 million for 2022. We ended the quarter with nearly $1 billion in holding company cash and cash equivalents and have received board approval for a second quarter dividend of $0.55 per share. Focusing on retail annuity, we saw sales of over $4.8 billion, an increase from the first quarter of last year despite significant market volatility. These strong sales reflect our focus on diversification and contributions from our recently introduced RILA offerings for our recent entry into the Defined Contribution market and our continued leadership in the variable annuity market. We continued to gain traction with our RILA product, with sales nearly doubling from the fourth quarter of 2021. We've seen momentum building since the launch, and we expect further sales growth as product approvals are received from additional distribution partners. RILA has been a stable source of growth for the annuity market overall as it provides a valuable solution to financial professionals and their clients. Early estimates from LIMRA point to another quarter of increased RILA sales, which now account for nearly 15% of annuity sales for the industry. In the first quarter, we saw a return to positive net flows for variable annuities. While recent equity market uncertainty led to a slowdown in VA sales, the market impact resulted in an expected and offsetting decline in VA surrenders. This decline in surrenders directly benefits our VA assets and fee income. The industry's injections have been responsive to increasing interest rates with enhancements to VA living benefit features, providing more attractive products to retirees. As we've mentioned previously, our variable annuity products are making the investment freedom they offer and we are focused on providing a comprehensive fund selection to meet the adviser and client needs. Looking beyond the current period, we believe the opportunity for annuities to meet the retirement income and saving needs of Americans will remain robust. According to LIMRA, early estimates of March industry annuity sales reached a monthly record of close to $26 billion, the highest monthly level since LIMRA began collecting data in 2014. The monthly growth was largely tied to an uptick in fixed index annuities, which we view as a response to rising interest rates and market volatility. While we offer both fixed and fixed index products, we continue to see our best opportunity for growth in the RILA space, given its capital efficiency and favorable risk profile in the context of our large variable annuity block. Expanding distribution remains a strategic priority for Jackson, and we recently announced the addition of a new adviser relationship, Producers Choice Network or PCN. PCN is a subsidiary of Raymond James and provides advisory annuity products over 6,500 financial professionals and fee-based registered investment advisers. We believe our advisory channel is well suited to provide annuity solutions to their clients. Jackson's focus on quality service delivery and technology-driven solutions for ease of business interactions positions us well within this channel. Last month, an independent industry survey showed Jackson leads the industry in the number of variable annuity adviser relationships. We place a high value on our distribution partners and seek to maintain our long history of industry-leading service and support. The first quarter marked a milestone since the beginning of the pandemic with our wholesalers back to meeting in person at full force. Meeting face-to-face enhances adviser engagement and builds product relationships for Jackson and our distribution partners. We see tangible results from our commitment to our distribution partners and see how our service enhances their business. Since 2004, we've been recognized by Service Quality Management or SQM for our exceptional customer service. SQM is the independent organization that benchmarks 500 leading North American contact centers. We also seek to serve advisers and their clients through our industry leadership and engagement, where we are at the forefront of advocating for regulatory change that can result in greater consumer access to retirement solutions. As with many of our peers, we're highly engaged in supporting IRI and ACLI efforts. Most recently, we continue to support Secure 2.0 legislation, which passed in the house, and we are pleased with its focus on retirement savings and income. While the legislation still needs to get through the Senate, we believe the focus on more favorable minimum distribution and potential expansion of lifetime income opportunities are positive developments for the annuity industry. Turning to Page 4. We reaffirm our 2022 financial targets. Jackson has returned capital to shareholders each quarter following our Board's initial authorization last November. As of April 29, we've repurchased 9.5 million shares at an average price of just over $38. This represents over 10% of our shares outstanding at separation. Our shareholder dividend points to a long-term view of Jackson's profitable growth and sustainable capital generation, which supports future capital returns to shareholders. Importantly, our risk management discipline allowed us to navigate volatile markets and maintain a strong balance sheet. We are within our targeted range for both adjusted RBC and financial leverage. Our adjusted RBC range of 500% to 525% reflects solid capital at our operating company and excess capital at our holding company. Our holding company cash position and relatively low leverage provide capital flexibility and a clear line of sight to near-term capital returns. As you will hear later in the call from Marcia, our hedging strategy performed as expected, staying within our risk limits. The change in our RBC ratio from year-end was largely tied to previously disclosed items, including the impact of capital returns and the statutory mean reversion rates. Our capital position is consistent with our balanced approach of supporting growth and capital return, which we first introduced at the time of our separation. At this time, I'll turn it over to Marcia to walk through the numbers.

Thank you, Laura. Turning to our results on Slide 5. Our adjusted operating earnings were down from the prior year's quarter. This is due to higher DAC amortization resulting from lower comparative separate account return, lower limited partnership income, and higher expenses. As a reminder, we believe Jackson has taken a conservative approach to the treatment of guaranteed fees within our definition of adjusted operating earnings, as all guaranteed fees are moved below the line with no assumed profit on guaranteed benefits included in adjusted operating earnings. In the first quarter, adjusted operating earnings combined with positive non-operating income resulted in a growing book value even after returning $192 million to shareholders in the quarter. Slide 6 outlines the notable items included in adjusted operating earnings for the first quarter starting with a market-driven acceleration of DAC amortization. As we previously highlighted, the amortization of DAC is a key item for our results given our annuity-focused balance sheet, and operating DAC amortization has multiple components. For clarity, our financial supplement reports these components as core amortization, which is driven primarily by our pre-debt gross profits of the period, and any market-related acceleration or deceleration which results from the pattern of separate account returns over time, as well as the DAC impact from our annual assumption review, which occurred in the fourth quarter. In the first quarter of 2022, there was market-driven acceleration of DAC amortization, resulting in an $81 million increase in DAC expense in the quarter on a pretax basis. This was primarily due to a negative 6.2% separate account return in that period, which was below the assumed returns. In contrast, in the first quarter of 2021, there was a deceleration of amortization, resulting in a pretax $30 million reduction in DAC expense primarily due to a 4.6% separate account return in that period, which exceeded the return. As a result, the market-driven DAC effect was a net negative impact of $111 million on a pretax basis when comparing the current first quarter to the prior year first quarter. In terms of future market-driven DAC acceleration or deceleration for modeling purposes, we have provided additional details on the mechanics of the calculation within the appendix of this presentation, which aligns with the format in our financial supplement. This market-related effect is expected to change in the first quarter of 2023 with the adoption of LDTI under GAAP accounting, and we continue to expect to provide more information regarding LDTI impacts later in the year. Additionally, we would note that the first quarters of both 2021 and 2022 included strong limited partnership income, which is reported on a lag and can vary significantly from period to period. Limited partnership income in excess of long-term expectations was $36 million in the current quarter compared to $144 million in the prior year's quarter, creating a comparative pretax negative impact of $108 million. In addition to the notable items, the first quarter of 2022 had a higher effective tax rate than the prior year's quarter, negatively impacting the period-over-period comparison. First quarter 2021 pretax operating earnings were higher than the first quarter this year, which meant that the tax benefits that were similar on a dollar basis in the two quarters led to a smaller reduction to the effective tax rate in the current period. Adjusted for both the notable items and the tax effects, earnings per share was up 6% from the prior year quarter, primarily due to the reduction in diluted share count resulting from our buyback activities. With the increase in interest rates in the first quarter, we provided insight about the impact of rising rates to the results of our VA business, both immediately and going forward. Slide 7 takes into account our healthy VA book and the corresponding impact from the cash surrender value floor on reserves, which is an example of conservatism within statutory accounting. Our reserves were materially impacted by this floor, both at the beginning and end of the first quarter. Before I go through the items in the table, it is important to note that while rates were up across the yield curve in the quarter, anticipated Fed actions should further increase the short end of the yield curve. Starting with hedging cash flows, our interest rate hedges are focused on protecting us from downward moves in rates which would increase the present value of claims payments that emerge years into the future. These interest rate hedge assets are immediately fair-valued when longer-term rates rise. However, there is a go-forward benefit to future hedge spend from operating in a higher rate environment. This is due to the fact that interest rates are a key driver of hedging expenses, both in the cost of the hedging instruments used to protect our book and the volume of hedging necessary to stay within our risk limits. Because we use a mixture of equity futures and shorter-dated options to protect our business, the cost of these instruments is most directly influenced by the shorter end of the curve with the 3-month treasury being a helpful reference point. Since the increase in the short end of the curve did not happen until later in the first quarter, we did not receive a meaningful benefit in our first quarter hedge spend. If the Fed continues to raise rates as expected through the balance of the year, we would anticipate further increases in the 3-month rate to benefit us through lower option premium expenses and improve cost of carry on any future contracts. This benefit should begin to emerge in the second half of this year. The volume of hedging required is positively impacted by the longer end of the curve, which is materially out. Our VA living benefits focus on GMWB rather than GMID. Because of this GMWB focus, claims payments that result from lower equity markets will emerge years into the future and cannot be monetized immediately. The increase in the longer end of the curve that we've seen year-to-date helps to reduce the hedging payoff needed to offset the corresponding long-duration liability impact of equity shocks. When you consider the statutory impact of higher rates, it is important to note that Jackson is impacted by the combination of floored-out reserves and fair value accounting for interest rate hedging assets. When reserves are impacted by the CSV floor and therefore cannot be reduced, increases in rates that drive losses on hedge assets do not have a liability deduction offset, leading to lower statutory total adjusted capital in the current period, which is the numerator of the RBC ratio. However, the reduced hedge spend discussed earlier is not an immediate benefit but instead emerges over time, benefiting future capital generation. Required capital, which is the denominator in the RBC calculation, can potentially immediately benefit the RBC ratio when rates rise, partially offsetting the negative immediate impact of declining capital. Taking all of these items into account from an RBC ratio perspective, we have a near-term negative impact when longer rates rise, our go-forward benefit on the volume of hedging required when longer rates rise, and a go-forward benefit on the cost of hedging instruments when short-term rates rise. I will touch on this again later in the presentation when I walk through the components of the current quarter change in our adjusted RBC ratio. As a contrast to that, under GAAP accounting, the impact of increasing rates is more consistent between the immediate and go-forward impact because FAS 157 reserves are sensitive to rate movements and are not subject to a floor, there is an immediate liability reduction offset to hedge losses from rising rates. As shown on Slide 17 in the appendix from the presentation, we expect that GAAP results will benefit from the same reduced hedging costs we noted earlier, and we would expect to see a reduction in the expected impact from LDTI implementation at Page 5. Slide 8 illustrates the reconciliation of first quarter 2022 pretax adjusted operating earnings of $418 million to pretax income attributable to Jackson Financial of nearly $2.4 billion. This provides an illustration of how rising rates benefit GAAP earnings right away, as I just discussed. As shown in the table, the total guaranteed benefits and net hedged results was a gain of $782 million in the first quarter. As we've noted, net income includes some changes in liability values under GAAP accounting that we consider to be noneconomic and therefore will not align with our hedging assets. We focus our hedging on the economics of the business as well as the statutory capital position and choose to accept the resulting gap below-the-line volatility. Starting from the left side of the waterfall chart, we see a robust guaranteed fee stream of $764 million in the first quarter, providing significant resources to support the hedging of our guarantees. These fees are calculated based on the benefit base rather than the account value, which provides stability to the guaranteed fee stream and protects our hedge budget when markets decline. As previously noted, all guarantee fees are presented in non-operating income to align with the hedging and liability movement. There was a $1.5 billion loss on freestanding derivatives, which was driven by losses on interest rate hedges during the quarter as a result of rising interest rates. This was more than offset by a $1.8 billion gain on net reserve and embedded derivative movements, which were also driven by higher interest rates. Now let's look at our business segments, starting with Retail Annuity on Slide 9, where we continue to see healthy sales trends. We are pleased to have had strong levels of retail sales, which included defined contribution sales of $540 million. We generated positive net flows for Variable Annuities, fixed indexed annuities, and RILA as well. Our sales without lifetime benefits increased from 31% in the first quarter of last year to 33% in the first quarter of this year, and we expect this percentage may vary somewhat over time based on market conditions and consumer demand. Growing our fee-based advisory business remains a focus for us. And while sales of these products were down 22% from the prior year quarter, we continue to see significant long-term growth potential from this business. Our total annuity market share highlights our consistent presence in the market, our strong distribution relationship, and disciplined approach to pricing and product design. We expect these attributes to support the growth of our recently launched RILA product for which we reported $199 million in sales in the current quarter. We view this as an important product launch, capturing the economic diversification benefit between RILA and a traditional living benefit variable annuity as well as capital efficiency through RILA account value growth alongside our large healthy in-force traditional variable annuity blocks. Looking at pretax adjusted operating earnings on Slide 10. We are down from the prior year's first quarter. This was primarily the result of the notable items I detailed earlier. While earnings were down, we received a benefit from a modest increase in variable annuity account value from the prior year due to positive market returns over the trailing 12 months. We have built up $305 million of account value on RILA since our launch in October. Because of the early age of our RILA book, surrender activity would be minimal, such that sales lead to an immediate buildup in account value. We have a similar dynamic on our fixed annuity and fixed index annuity book. These account values are minimal after taking into consideration the business reinsured to a theme, but they did also grow during the period due to positive net flow. Our other operating segments are shown on Slide 11. We reengaged in institutional sales late last year, and this continued in the first quarter of 2022 with $975 million in sales and $316 million of positive flows. We see the value of the institutional business is broader than just GAAP earnings as it provides diversification benefits, is cost-effective, and helps to stabilize our statutory capital generation. Our pretax adjusted operating earnings for the institutional segment of $23 million during the first quarter of 2022 was up from $10 million in the prior year quarter due to the lower interest credit in the current period. Going forward, the earnings should largely track the account value. Lastly, our Closed Life and Annuity Blocks segment reported lower adjusted operating earnings compared to the prior year, reflecting lower levels of limited partnership income. Absent future M&A activity, the earnings for this segment should trend downward as the business runs off over time. Slide 12 summarizes our capital position as of the first quarter. As Laura noted, we delivered $192 million of capital returned to shareholders during the quarter, which is a strong start to our targeted capital return of calendar year 2022. Since returning this capital to shareholders, we've maintained cash and liquidity of nearly $1 billion at the holding company, which is substantially above our minimum liquidity target. As a reminder, the minimum liquidity target was meant to provide a cushion for holding company expenses. The excess over that amount provides us with a substantial cash buffer to support our capital returns beyond our 2022 targeted return. Our total GAAP leverage was at 21.2% at quarter end, down from 22.9% at year-end and within our 20% to 25% target range. We believe that this range provides us the financial flexibility to navigate potential market volatility as well as the future accounting impact of LDTI. Jackson National Life Insurance Company reported a total adjusted capital position of $5.4 billion, down from $6.6 billion as of year-end. This was the result of the $600 million remittance to Book Life in March, hedging losses from higher rates that were fully offset due to floored-out reserves mentioned earlier, as well as an increase in non-admitted deferred tax assets. Our estimated adjusted RBC ratio at the first quarter is within the 500% to 525% target range and is down from 611% at year-end. The majority of movements accounting for nearly 70 RBC points resulted from three notable items. The first is the previously disclosed change in the mean reversion parameter or MRP, which was effective January 1, 2022. One of the go-forward benefits from higher interest rates is a reduced MRP impact in future years. For example, if rates stay at or near current levels, we would not expect an MRP impact in January of next year. Tax-related items primarily increasing non-admitted deferred tax assets for a second negative impact. As a reminder, we expect to realize the benefits of our gross statutory deferred tax asset over time; but because of the admissibility rules, we cannot admit all of that in our current reported capital position. Lastly, our adjusted RBC position was reduced by the $192 million returned to shareholders during this quarter. The remaining decline from year-end was primarily due to hedging results, which included both the higher hedging costs resulting from elevated equity market volatility and the immediate negative impact of higher rates mentioned earlier. However, as noted, higher rates are a benefit to future hedging costs and would provide a partial offset to any negative impact from potential future equity market declines. It is important to note that our hedging performed as expected during the quarter, keeping us within our risk limits throughout this period of volatility. In summary, we are within our adjusted RBC ratio target range, continue to operate within our target leverage range, and have robust holding company liquidity. And with that, I will turn it back to Laura.

Thank you, Marcia. While current market volatility presents challenges that impacted this quarter's results and has continued into the second quarter, our experience managing through many different market environments has prepared us for today. We remain committed to maintaining profitable growth, meeting our capital return targets, and delivering value to shareholders. At this time, we'd like to open up the call for Q&A and turn it over to the operator.

Our first question is with Thomas Gallagher of Evercore.

First question is more of a mark-to-market expectation for hedging as we think about Q2. I heard everything you said about Q1 and the differential with what happened to interest rates and the floored-out reserves. But if I look at, at least so far what's happened quarter-to-date into Q2, I would imagine the equity hedge gain component would outweigh the interest rate negative mark, just looking at this, the magnitude of the equity market decline, and I would expect that whole issue with floored out reserves would actually become a positive in Q2. First question, does that sound directionally right? And second one, if that is right, could you share with us some kind of sensitivity in sizing of if there is expected to be an RBC gain in Q2?

Thank you for the question. I'll turn it over to Marcia to get us started.

Sure, Tom. From what you've noted, it seems logical that with the markets down, we would benefit from our equity hedge position. However, the ongoing rise in interest rates in the second quarter is likely to result in negative marks on our interest rate hedges, similar to what we experienced in the first quarter. Overall, this situation probably favors the results of our equity positions in relation to our tax position. Additionally, there will be impacts from both equity and interest rate movements during this period, depending on how the quarter progresses. As of now in the second quarter, these factors will affect the required capital calculation, potentially leading to an increase in the capital requirement due to equity movements. This increase would be somewhat offset by benefits from higher rates, but the impact of the floor is limited as we move further out. The effects of our reserves substantially contribute to our numerator position regarding reserves, though their impact on required capital is somewhat diminished as this is calculated over a longer term.

Got you. So is it fair to say you add all that up, and again with the caveat being if the markets were to close, where things are today, would you expect to have positive RBC build in the quarter? Or is it too involved to really determine that at this point?

There are many factors at play, and it will depend on how they interact. Overall, we expect some additional pressure on the RBC in the second quarter, but as previously mentioned, we anticipate some positive developments in the latter half of the year due to Fed actions affecting short-term rates, which will benefit our overall hedge spending. As for the second quarter, we are not yet halfway through, so there are still many variables to consider. We need to think about interest and equity rates, as well as the level of volatility and how it will contribute this quarter regarding the hedge fund. We've noticed slightly lower volatility so far this quarter, which is a positive sign, but it remains at a heightened level.

That's really helpful. And then just relatedly, if there is a little bit of incremental RBC pressure in Q2 and you were to dip below the 500% to 525% target range. Can you just remind us your views on sustainability of all 5x in common dividends, if you were to drop below that, and at what level you might have to reconsider capital return plans?

Sure, Tom. I think a couple of things to put out as a reminder, that we see the 500% to 525% as a target range. I think we've communicated earlier in some situations that we don't see the end of that being a bright line that indicates switch flips and we would turn things off. So we're comfortable, too, that, that also target that we set, considering normal market conditions. These conditions have been somewhat unique, and we would take that into account as well. But I don't think we see anything at this point that would change our capital return plans for the year given the market volatility and the conditions we've seen. And we wouldn't necessarily see an immediate change in our view, should we get below 500%.

Our next question is with Suneet Kamath of Jefferies.

Great. Just going back to Slide 12. Can you help us with that last bullet, just in terms of sizing those two impacts and a higher cost of hedges from market volatility and then the negative impact on interest rates? Can you just help us sort of dimension or quantify those two impacts?

Sure, Suneet. This is Marcia. I'd say they're roughly similar in size, not tilted heavily in one way or another in terms of how those two played into the results for the period. They were both impactful. It's the level of volatility that we had and needed that translated to in terms of our hedge spend being higher is something that was significant, but both of these are kind of, let's say, kind of similar size, I think, in terms of what they impacted in the quarter.

Got it. And then I guess when we think back to that slide where you talked about the benefit from higher rates, I think was Slide 7, is there any way that you can help us size kind of the impacts of some of these things? There's the immediate impact, which we obviously saw in the quarter, but then you have this go-forward impact that looks positive across the board. But just order of magnitude, is there any help that you can give us with that?

I can't provide a specific quantification at this moment since it likely depends on the path forward. However, to give you some insight into the components, our equity hedging strategy includes both futures and options. As interest rates rise, we may see a shift where a current cost associated with future carry could potentially switch to a positive outcome, depending on where short-term rates land. Throughout the year, this could transform from a negative impact to something neutral, or even shift to a positive contribution. Regarding options, the main factors affecting their cost will be interest rates and volatility. An increase in rates is beneficial, and if volatility stabilizes, that would enhance the advantages we gain from our options hedging strategy.

Okay. My last question is regarding your supplement, where you report statutory operating earnings of $1 billion and statutory net income of $1.7 billion for the quarter. I would like to understand the difference between these two figures. Additionally, what do you consider to be a sustainable level of statutory earnings that you believe you can achieve on a quarterly basis?

Let me begin with the first part. The difference between the operating earnings and the net income on a statutory basis mainly comes from realized gains and losses. It's important to note that these are realized and not the unrealized components, which would account for a significant portion of the interest rate hedge losses over the period since we relied more on swap disruptions than treasury futures. This aspect likely represents the largest difference on the statutory side when considering realized gains and losses.

And on the sustainable stat earnings?

Yes. In the past, we've indicated that this will vary from period to period. However, on an annual basis, we've mentioned earnings that are expected to range from approximately $700 to $900 million. The key resource to look at would be the projections we provided in Form-10, which offers insights into how earnings may develop over a five-year span under different market conditions, as it is certainly influenced by market sensitivity.

Our next question is with Alex Scott of Goldman Sachs.

The RBC ratio, I mean when I find what the overall including holding company cash RBC ratio just for the operating company. I come out to around 450 RBC still a lot of years. And I just wanted to find out what is the process like with the regulator in getting extraordinary dividends. The reason I think people are a little more sensitive here just has to deal with a more limited ordinary dividend capacity. And so when we get to the end of the year, I mean, what sort of the requirements on the regulatory end to get an extraordinary dividend, right? Does that need to be up above a certain level? How do I think through the way that conversation goes to the end of the year if the RBC ratio hasn't gotten higher or maybe it's even gone a little lower?

Sure. Historically, most of our dividends over the last decade have been extraordinary in some form, whether it's from the Jackson National Operating company or its immediate parent up to the ultimate parent. This has been a regular topic with the regulator. It's also important to note that the regulator's perspective differs from ours; for instance, when we refer to 450 on a regulatory basis, they see it as 900. We have not faced challenges in distributing extraordinary dividends in the normal course with a well-capitalized company, which we definitely are. Therefore, I don't see this as a significant concern for us.

Okay. And then the second question was just these scenarios that everybody provides them it's kind of crazy that we have to ask before now. But we're all trying to understand what a significantly higher rate environment, combined with a materially lower equity market, what the net of that means as we think through the cash flow scenarios, we're all trying to sort of look at the different ones and maybe got one from another and add it to another scenario and it's off, right? So I was just if you could help us think through that. Have you updated that kind of scenario and looked at it yourself, like could you even help us think it through directionally positive or negative when we think through the net of those two things.

Sure, Alex. I understand the difficulty of trying to combine different scenarios because there are many interactions involved. I appreciate that challenge. When considering the assumptions we made in our Form-10 disclosures and projections, those were based on rates in the forward curve at the end of 2020, and we anticipated a 7% annualized total return on equity. Since then, from that point to the end of the first quarter, rates have significantly increased compared to our assumptions. We expected to reach a certain rate by the end of 2025, but we are well ahead of that expectation. Regarding equity returns, if you look at the returns over the five-quarter period leading through 2021 and into the first quarter of 2022, we achieved an annualized return of approximately 18%, which exceeds the 7% assumption in our projections. While we haven't officially updated those projections, considering our current position, we can logically infer that both rates and equities—despite some decline in equities this year—are favorable compared to what we disclosed in our Form-10. I hope that offers some context for your analysis of our previous disclosures and how recent events have changed our current outlook.

Our next question is with Erik Bass of Autonomous Research.

I was hoping you could provide some more color on how the cost of hedging moved over the course of the quarter and where it sits today.

Sure. Marcia, again. Thanks for that, Erik. So we definitely saw higher hedging costs over the quarter. I think that's consistent with what we've said in the past that under periods of high volatility, we spend more in some cases that leads to spending more than that guarantee fees that we collect in the period. But if that's necessary, that's what we do in order to protect the balance sheet. So I think what we saw transpire in the first quarter of the year was exactly that elevated cost of hedging. So we did spend a greater amount than what we had taken in, in terms of guarantee fees over the quarter for this period similar to what we've seen in the past; we've had other periods like that where volatility is particularly high. And then naturally, when volatility settles down, the way it typically does for some period of time, that relationship can reverse, and we would then expect to be in a position where our hedging budget will be fully covered by the fees that we collect.

Got it. And I guess, just curious, I mean, as you mentioned earlier, kind of for hedging costs, think of the 3-month treasury, which has started to move up. So I would assume that's a positive from where you ended the quarter, and equity volatility is still high, but I don't know if that's kind of where it sits relative to your normal expectation. So I guess I'm wondering, as we sit today, are you in a better position than you were in the first quarter?

Yes. I think we are. The movement up in the short rate, as you noted, happened pretty late in the first quarter. So not enough time to kind of be much of a benefit for that quarter. But as you say in place now as we moved into the second quarter, and we've seen a little bit of moderation in the volatility so far in the second quarter. So I think both of those are moving us in a better direction in getting us a better relationship between our hedge costs at least quarter-to-date relative to our fees.

Got it. And then could you provide a little bit more color on how your hedging performed in Q1? And I know you said in general, it performed as expected, but I wonder if you could give any more color on sort of the pieces in particular. Did you see any impact from basis risk in the quarter given kind of the big moves in the market and some underperformance of active managers?

Yes. I guess touching on the basis risk point. We do have periods of time where we have basis risk movements that are either positive or negative, tend to see a little bit more basis risk in periods with higher volatility. And we did have a little bit of a negative basis risk result in our first quarter. I think not as significant as we've seen in periods past. But we did have a little bit there. We often have seen, though, that basis risk over time tends to kind of mean revert. So when we have periods of negatives, we tend to have periods of positive that occur as well in the following periods that allows for a kind of mean reversion. So that was quite manageable. I think when we just look at how the hedging performed and how we evaluate it, we tend to say that the best way to evaluate our hedge effectiveness is just through the lens of our risk limits and how the hedging is protecting our business relative to our limit, some of which are on a statutory basis. And so that is why we sometimes have an additional hedge spend to protect the debt. I think we referred to that in the past as our kind of macro hedge to protect our statutory sensitivities against the risk limits that are set out in a statutory framework.

And if I could sneak in one last one. Just given the increase in interest rates, are you considering making any changes to your hedging program to lock in some of the benefit?

I mean I think what we would say is our main focus when we're setting our interest rate hedging position and just the risk profile of the business. So we don't typically make tactical moves or make stuff on them direction of travel with rates or equity. So we'll just be updating and resetting our hedge positioning as needed, the way we would typically do in a dynamic fashion when we look at the risk profile of the business. But with respect to interest rate risk, a lot of that is really connected to how much we might think we have benefits payments to make in the future, which is really on a first-order basis driven by what the equity markets do. And then that kind of has a follow-on to determine how much hedging we need on an interest rate basis. So we're going to be focusing on those as usual and making adjustments as we need to.

Our next question is with Ryan Krueger of KBW.

I guess, first, can you help us think about how far away your reserves are from, I guess, not being floored anymore or maybe like what the dollar amount would have been as a benefit from an offset standpoint if they work forward.

Sure, Ryan. We haven't specifically quantified what our results would have been without the floor, but we finished the quarter with a significant floor in place. As we progressed through the quarter, we might have created some additional reserves while navigating the more substantial market downturn in the middle of the quarter. However, by the end of the quarter, we returned to being floored. The difference between the floored and potentially unfloored reserves is quite notable from a reserve perspective when assessed at CTE70. It's also essential to recognize that under VM-21, both the CTE70 and CTE98 measures are relevant. We have experienced instances, similar to the end of the third quarter, where flooring influenced long-term scenarios impacting the CTE98 tail. This substantial flooring can shift mainly due to market declines, which allows any additional reserves to reflect in our results when they typically wouldn't increase as significantly if we weren't floored under our market decline scenarios.

Got it. When you calculate CTE98, do you project all of your future hedging costs within that? Can you provide more details on how you approach that? I know some companies have taken different strategies, and some have implicit CDHS to better align with market movements. Could you share how you handle this?

Sure. Our CDHS is focused on our kind of core equity hedging and macro hedging, which might be done for equity purposes or, in our case, also the interest rate hedging is not considered within the CDHS. So with the calculations under VM-21, you have to actually do a blend of projection basis that includes only your in-force hedging and then another one that includes benefits from rebalancing with your CDHS to blend those two results together. So our calculation would do that with respect to all of our core equity hedging that would be reflected in there. So we're not capturing future rebalancing of an interest rate hedge position within our CTE98 or CTE70 calculations.

Our next question is with Alex Scott of Goldman Sachs.

I wanted to ask a follow-up about the current cash flow. I was considering the equity aspect, and I understand that equities have increased since the last projection. Can you help us think about the direction of equities? They have gone up, but they also reached much higher levels. I believe there are benefits related to them, right? So, would those benefits have been higher prior to the decline? If we consider the equity scenario to be better, should we assume that's the case? Or could there be a negative impact from the fact that equities increased before they were marked down and then subsequently decreased? Do you see what I'm getting at?

Yes, I understand. It's true that some benefits might include an annual step-up feature if market conditions support an increase at that time. If the market goes up and then down, and policies reach an anniversary during a high market period, certain increases to their benefit base can occur. This serves as a partial offset to overall rising equity results. However, it’s only a partial offset and wouldn't completely counterbalance the effects because the underlying assets under management and our fee revenues benefit from market growth. Considering the market's strong performance since we made those Form-10 disclosures and consistent gains throughout 2021, we haven’t encountered the extreme conditions necessary for significant impacts from policies that may have ratchets during peak market periods.

And I would just add to that, too, that when the ratchets happen, you also ratchet up the fees at the same time. And so what we see through time is that we don't actually spend all the fees over a long period of time. And so you'd actually expect a net benefit going forward from that net ratchet.

That concludes our Q&A session. So I would like to pass the conference back to the management team for any closing remarks.

Thank you. We thank everybody for joining us today and look forward to your participation in our next quarterly call. Thank you.

That concludes the Jackson Financial Inc., first Quarter '22 Earnings Call. Thank you for your participation. You may now disconnect your line.