Jan Weidema - Head, IR Alex Wynaendts - CEO Matt Rider - CFO.
Farooq Hanif - Credit Suisse Robin van den Broek - Mediobanca Nick Holmes - Societe Generale David Motemaden - Evercore Mark Cathcart - Jefferies Ashik Musaddi - JP Morgan Farquhar Murray - Autonomous Johnny Vo - Goldman Sachs Steven Haywood - HSBC.
Good day, and welcome to the Aegon First Half 2018 Results Conference Call. This conference is being recorded. At this time, I would like to hand the conference over to Alex Wynaendts, CEO of Aegon N.V. Please go ahead..
Thank you, Marion. Good morning, everyone, and thank you for joining this conference call on Aegon's first half 2018 results. We would appreciate if you would take a moment to review our disclaimer on forward-looking statements, which you can find at the back of the presentation.
Our CEO, Alex Wynaendts, will provide an update of our key strategic achievements in the first half of 2018, before handing it over to our CFO, Matt Rider, who will you through our financial results. We are now reporting only semiannual results.
We will more extensively go through our presentation, although we will of course leave more than sufficient time for your questions at the end. I will now hand it over to Alex..
Good morning, everyone, and I would like to echo here also Jan Weidema's remarks for all of you joining us and then also appreciative to speak to you. I also like to mention that this is Jan Weidema's first call as our new Head of IR. So let me now turn to our results.
I'm pleased to report that we had a good start of the year both financially and strategically for our company, and this puts us well on track to meet our 2018 financial targets, including expense savings, return on capital and our capital return to shareholders, all of which I will come back to you later.
Let me now provide you with an overview of the most important strategic achievements we have realized since our last earnings call. So in terms of capital, we've made significant progress, improving our Solvency II ratio to 215% and enhancing the quality of our capital. This allows us to increase the interim dividend to €0.14.
In the U.S., we transferred more than 2,000 employees to Tata Consultancy Services, and this is part of our partnership with them to outsource the administration of our Life and Annuity businesses. And this led to significant cost savings in the first half of the year and will contribute to further cost savings over the next few years.
But more importantly, as a result of this, we will be able to focus our resources now on further improving our digital customer facing capabilities. In the U.K., we migrated more than 400,000 retail customers, representing £28 billion of assets from Cofunds to our own platform, confirming our position as the number one platform player in the U.K.
And furthermore, we have significantly rationalized our geographical footprint.
We exited Ireland, Czech Republic and Slovakia, while we expanded our existing partnership with Santander in Spain and acquired the income protection provider Robidus in the Netherlands, clear examples of how we're focusing our efforts towards markets while we have leading positions and sufficient scale to capture growth opportunities.
Finally, throughout the first half of the year, we took a number of actions to further improve our sales and earnings momentum in the U.S. and Asia, and I will cover this also later. So let me now take a close look at the progress we're making on our transformation in the U.K. on the next slide.
As you can see, we completed several major migrations in the first half of 2018. This amount to approximately £85 billion of assets in total and position the U.K. to deliver the committed cross synergies of £60 million.
This includes the data migration completed in May of the Cofunds retail book, which was the largest and most complex of the migrations needed to be completed as part of the overall integration.
As some of you may be aware, after the migration process some advisors and customers have experienced service issues and this was caused by higher than anticipated demand for access to the new system and in turn the compact center. We also decided to release some platform functionality on a phased basis after the migration.
And finally, we experienced some technical issues as one would expect to arise with the process of this scale. Here, however, it's important to stress that at absolutely no point during the migration where there any issues regards to customer or advisor data integrity.
Our team in the UK has taken a comprehensive range of measures to address the service issues and has a structured plan in place to release the additional functionality our advisors and customers are expecting.
As a result of the additional resources we're allocating to the integration program, we incurred £3 million of additional expenses in the month of June and we expect additional expenses to continue until the Cofunds integration is completed.
Migration of the assets related to the Nationwide business is the final milestone in respect to this integration and is expected to be completed in the first half of 2019.
Despite the challenges, we have not seen an increase in withdrawals, which is reflected in our strong net inflows in the UK The result of the net inflow and the continued success of our upgrade program, we have reached a record high £120 billion of assets on the platform.
On the next slide, I would like to highlight the overall gross deposits we achieved across the group during first half of the year. While not all our fee businesses are performing fully to expectations, we nonetheless generated an 8% increase in gross deposits to €64 billion in the first half of the year.
This increase was a result of strong inflows in our asset management business, in particular into the Dutch mortgage funds, fiduciary management inflows in the Netherlands related to the general pension fund, Stap, and the continuous strong performance from our Chinese joint venture, AIFMC and Aegon Asset Management.
We generated net deposits of €3.9 billion in the first half of 2018 as a result of our strong gross deposits, which more than offset €7 billion of net outflows in the United States.
These net outflows were primarily driven by 3 large contracts losses in the 403(b) retirement business, mostly relating to Mercer acquisitions in the medical care provider space. In these M&A related cases, Transamerica was not the plan provider for the acquiring company.
As the outflows are related to M&A activity, we do not expect these outflows to lead to a trend in the retirement plan business. Revenue-generating investments increased slightly compared with yearend 2017 to €825 billion. The strengthening of the U.S. dollar more than offset the sale of Aegon Ireland.
I would now like to briefly take you through our Life and Accident & Health sales on the next slide. This is Slide 5. New Life sales amounted to €422 million, a 2% decreased on a constant currency basis. This movement was primarily driven by lower term life and indexed universal life sales in the U.S. as a result of increased competition in the market.
This focus on profitability is reflected in our improved MCVNB margin for life products, which increased to over 6% in the first half of 2018 and confirms our commitment to our strict pricing policy.
In Asia, we saw lower sales in our High-Net-Worth business due to higher interest rates, which drove up the cost of premium financing for customers, in addition to strong competition in the market. These drivers more than offset the continuous success of our critical illness product in China.
New premiums for Accident & Health and General Insurance sales decreased by 48%. This is caused by product exits and lower supplemental health sales in the United States.
As we announced at our 2016 Analyst and Investor Day in New York, we have exited the affinity, direct TV and direct mail distribution channels as these channels and associated products no longer fit strategically with our wealth and health platform.
And for this reason, we expect to have our stop loss sales to continue declining significantly over the second half of 2018, leading to material benefit to capital generation, and which Matt will explain later. I would like to now outline our plans to improve our sales performance in our largest market, the U.S., on the next slide.
In recent years, sales in our U.S. business have been impacted by headwinds such as the Department of Labor fiduciary rule for variable annuities and low interest rates driving down profitability of life products. In addition, Accident & Health sales declined following our decision to exit certain distribution channels that are no longer core.
With many headwinds subsiding, we have been very active in terms of taking actions to accelerate sales in the U.S. First, we've launched several product enhancements in the variable annuity business to improve the competitive position of our offerings.
This includes the addition of investment options on our living benefit rider, Retirement Income Choice, and adjusting the rider fee and withdrawal rates on our Retirement Income Max rider. These enhancements have led to an increase in our variable annuity market share and gross deposit, which increased by 13% compared with the second half 2017.
And we're continuing to see positive sales momentum to the start of the second half 2018. Second, we want to drive further growth in our Retirement Plan business by increasing revenues by providing managed advice directly to our customers. All of the new retirement plans sold this year have managed advice as an option.
And we are working hard to increase the retention rate of in-force customers and generate higher fees. Third, we will further expand on our best-in-class life combination product offerings to continue meeting the evolving needs of our customers, and at the same time, we're enhancing our term life products with new rates and adding living benefits.
In addition, we see good momentum in our indexed universal life product that showed 24% sequential growth in the second quarter.
And fourth and finally, we plan to further grow our Accident & Health businesses by broadening our distribution relation through cross-selling these products with our retirement plan offerings as part of our wealth and health strategy.
Working with our partners, we are developing a single digital customer administration platform that will seamlessly integrate our employee benefit and retirement products. This platform will enhance the enrollment experience for our customers, while ensuring proper positioning of our products.
We expect this to result in higher participation, increased revenues and a competitive advantage in the market. We're confident that these actions will drive sales growth in the future across our chosen markets in the U.S., and we will provide you a comprehensive update on our U.S.
business at our Analyst and Investor Conference in New York on December 6th. On the next slide, I would like to briefly discuss the progress we've made in turning around our Asian operations.
Since 2015, we've made a number of decisions to further simplify and unlock the value of our Asian businesses and continue to evaluate businesses that are underperforming for strategic options.
In our High-Net-Worth business, we took steps to improve the capital efficiency of the business, including redesigning our products to reduce the new business strain required. And as a result, this business delivered a return on capital of 10% in the first half of 2018 and will upstream regular dividends to the group.
We expect a dividend of $25 million this year after the $200 million that was paid in 2017. China, we reached breakeven in 2017 and continue to grow as we focus on our successful critical illness product, which has achieved annual sales growth of 30% per year since 2015.
In the second half of 2017, we took the strategic decision to place our direct marketing activities in Asia into run-off. The focus is now to accelerate the release of capital from the business as it runs off. In India, we're looking to further grow our successful digital business.
This includes exploring a range of options to develop and expand direct-to-consumer proposition. Finally, in Japan, we continued to face a low interest rate environment, which has resulted in though sales environment that has prevented Aegon Sony Life from reaching the necessary scale to make it a viable business.
We're therefore reviewing all available options, including our exit of the joint venture. Let me now briefly highlight some of the actions taken in the first of 2018 to further optimize our portfolio. I'm now turning to Slide 8. I'm pleased with how we are continuing to make -- to further improve our geographical footprint.
This progress builds on a strong track record of optimizing our portfolio to reallocate our resources towards markets in which we have a leading position and sufficient scale to capture growth opportunities.
In the first half of the year, we completed the divestment of Aegon Ireland and today we announced the divestment of our businesses in the Czech Republic and Slovakia, €455 million. This latest transaction guarantees continued customer service, offers new opportunities for employees and is in best interest of our shareholders.
The sale is expected to improve the group's solvency ratio by 1 percentage point and will result in a book gain of approximately €80 million when the deal closes in the second half of 2018. In the United States, we continued to make progress on reducing capital allocated to our run-off businesses by divesting the last block of our U.S.
life reinsurance business to SCOR. The transaction will close in the second half of the year and will result in a one-time capital benefit of $50 million. In the Netherlands, we reached an agreement to acquire Robidus, the leading income protection service provider, for €105 million.
This acquisition will strengthen our position in the important income protection market and supports our ambition to grow our fee-based businesses.
And in Spain, we continued to build upon our existing partnership with Santander by expanding our joint venture to now include the business related to the Banco Popular franchise, which Santander acquired in 2017.
Since the original partnership was formed in 2014, premiums have grown on average by 12% per year and new life sales have nearly doubled with a focus on protection products. Over the same time period, we have received €87 million in net remittances from the partnership.
This success underscores the strong foundation that will enable the expanded partnership to keep growing, particularly as banks insurance distribution accounts for approximately 70% of all sales in the Spanish markets. In total, expanded partnership in Spain will increase our potential client base from 10 million to over 40 million customers.
And also in the first half of this year, we took the decision to restructure our own business in Spain as it is currently loss making. We will improve profitability through rationalization in distribution, expense savings and more effective claims handling. Aegon's own businesses in Spain consists of Life, Health and Pension Products.
These products are distributed through two main channels, brokers and agents and directly to customers through its digital platform, which supports our partnership with Santander. And this gives me confidence that our combined operations in Spain and Portugal will achieve an attractive return on capital in the medium term.
I would now like to conclude the strategic part of the presentation by addressing our 2018 financial targets on the next slide. As you can see on Slide 9, we made very significant progress in the first of 2018 and this means that we are on track to deliver on our targets by yearend 2018.
Our total annualized run rate expense savings increased to €325 million in the first half, which keeps us on track to reach the full €350 million target by yearend. At the same time, the growth of our business and a successfully implemented expense savings program together with the expected benefit from the U.S.
tax reform supports our confidence in achieving our return on equity target of 10% at the end of 2018. Finally, I'm pleased that we are today announcing an increase in our interim dividend to €0.14 per share.
By paying a sustainable and growing dividend, we will meet our target to return €2.1 billion of capital to shareholders for the period 2016 through 2018.
Overall, the first half of the year was one for us to be proud of as we continued to execute on our strategy, deliver on our financial targets and help our customers achieve a lifetime of financial security. I will now turn it over Matt so we can talk you through our strong first half results, before we take your questions together. Thank you.
Matt?.
Thanks, Alex, and good morning, everyone. I'm on Slide 11. I like to first take you through our financial highlights, starting with our earnings. During the first half of 2018, underlying earnings were impacted by the weakening of the U.S. dollar year-on-year, while on a constant currency basis underlying earnings increased 10% to €1.1 billion.
The continued successful execution of our expense savings program, which I'll cover in more detail shortly, resulted in a €34 million uplift to underlying earnings in the first six months. As you can see, results were impacted in the first half of 2018 adverse mortality in the U.S.
The current half year included €55 million of unfavorable mortality compared with €34 million in the same period last year, driven by higher claims frequency, reflecting higher than expected seasonality.
In the Netherlands, the shift to higher yielding assets is part of our illiquid investment strategy and growth of the bank resulted in a higher investment margin, while the Non-Life business benefited from a one-time provision release of €22 million related to the Disability business.
In addition, strong performance fees in Aegon's Chinese asset management joint venture, AIFMC, together with improvements across all business lines in Asia due to business growth and strong investment yields further contributed to the increase in underlying earnings in the first half of 2018.
Let's now turn to Slide 12, so that I can provide you with a quick update on our expense savings program. As you can see, we have achieved annualized run rate expense savings of €325 million since we initiated the program in 2016.
In the first half of 2018, annual run rate expense savings increased by €45 million, driven mainly by cost synergies in our Dutch insurance and U.S. life businesses. We expect to implement additional initiatives in the second half of 2018 to achieve further expense savings and to reach our expense savings target.
One other item of note is the reduction in core operating expenses following the divestment of UMG in the Netherlands, which resulted in a decline of €85 million year-over-year. We of course do not count this decline towards the expense savings target for the group.
On the following slide, I would like to walk you through our net income development for the first six months of the year. As you can see, net income was €491 million, a decline of 46% versus the same period last year.
This decline compared with the first half of last year was a result of realized losses, other charges and a one-time tax expense, while fair value items were benign despite volatility in the broader market. Realized losses totaled €67 million in the first six months of 2018 and were primarily related to the sale of U.S.
treasuries as part of ongoing asset liability management in the Americas. Other charges amounted to €294 million, mainly driven by the book loss on the sale of Aegon Ireland of €93 million, together with restructuring charges related to various expense savings programs in the United Kingdom, Spain and in the United States.
The restructuring charges in the U.S. of $119 million were slightly higher than prior guidance of $100 million due to timing and are expected to be $30 million to $35 million in the second half of the year.
In the UK, the restructuring charges were €40 million, which includes expenses for the Cofunds, institutional and retail migrations and the BlackRock part 7 transfer. In Spain and Portugal, we incurred restructuring expenses of approximately €19 million that are part of a strategic plan to improve the profitability of our own business there.
Additionally, other charges included total assumption review and model update charges for the group of €7 million, which includes €32 million related to the annual assumption review and model update in the United States. The majority of the charges are driven by an assumption update for old age mortality in the Life business.
These charges were mostly offset by €27 million of positive assumption changes and model updates in the Netherlands. Finally, income tax amounted to €201 million, with an effective tax rate of 29% in the first half of 2018. This is higher than the expected tax rate going forward due to a one-time tax expense in the U.S.
On the next slide, I will give you an overview of how our long-term care business has performed in the first half of 2018. As I indicated at our webinar in June, we completed our IFRS assumption review for our Long-Term Care business in the first half of 2018, which led to no material changes to our assumptions and thus no impact on our results.
When looking at our assumptions in the aggregate compared to our own best practices and our own experience, we are quite comfortable with where we sit today. That notwithstanding, we will be completing both cash flow testing and premium deficiency reserve testing as part of our annual statutory review process in the second half of the year.
Our actual to expected claims experience of 97.5% on an IFRS basis in the first half of 2018 continues to track well against management's best estimate.
Our best estimate includes a morbidity improvement assumption of a 1.5% reduction in claims incidents per year for 15 years, and after year 15, we no longer assume an improvement in claims experience for morbidity. Thus our morbidity improvement assumption is only for incidents and not for severity.
It is very difficult to separate out and identify to what extent morbidity improvement contributes to our claims experience, and I think that's one of the reasons why there has been so much debate about it.
That said, if we were to remove the morbidity improvement assumption from our IFRS reserves, it will result in a one-time $700 million pretax earnings impact. Although we do not include an assumption for morbidity improvement for our statutory reserves, we do so for both cash flow and premium deficiency reserve testing.
For both testing methodologies, we project future cash flows using an assumption of a 1% reduction in claims incidents per year for 15 years. We currently have no plans to remove our morbidity improvement assumption from our IFRS or statutory reserve testing methodologies as we continue to expect morbidity improvement to occur in the future.
There are in fact studies that demonstrate evidence of morbidity improvements in the general population. However, it has been more challenging to get definitive evidence of it for the insured population.
The reason we believe morbidity improvement will occur in the future is because we continue to see advancements made during clinical drug trials for Alzheimer's and dementia.
We expect that morbidity improvement related to long-term care will occur in a step change fashion rather than gradually over time, similar to what we saw with the AIDS epidemic in the 90s when medical treatment advanced so rapidly.
If the morbidity improvement assumption were removed, we would expect to see a reduction in the reserve sufficiency for both methodologies. We do not, however, expect that we would need additional reserves for cash flow testing because the total legal entity would continue to remain sufficient.
However, with regard to premium deficiency reserve testing, we would need to establish a separate premium deficiency reserve of approximately $700 million if the assumption for morbidity improvement were to be removed. However, and this is very important, even if we were to remove the morbidity improvement assumption, we would still expect the U.S.
to continue normal remittances to the group, while keeping capital in the top half of its target range, this despite anticipated changes to RBC factors as a consequence of tax reform and changes to variable annuity reserving rules.
We would expect to achieve this as, one, we are not currently remitting the full capital generation of the unit, and two, we would expect to implement additional management actions to strengthen the capital position of the U.S. That brings me to our strong capital position, which I would like to walk you through on Slide 15.
As you can see, our Solvency II ratio has increased significantly by 14 percentage points to 215% in the first half of 2018. This increase was the result of own funds growing by €1.5 billion, while the FCR increased slightly.
Our own funds increased during the quarter as strong capital generation net of new business strain more than offset for more than €200 million paid out for the 2017 final dividend. In addition, favorable market impacts of approximately €700 million were driven by both equity market movements in the U.S. and the U.K.
as well as favorable credit spread movements in the U.K, while the lowering of the ultimate forward rate by 15 basis points in the Netherlands impacted our own funds by just under €200 million. At the same time, the SCR has increased by approximately €100 million since the start of the year.
This increase has been primarily driven by the Netherlands, where market movements led to a strong increase in SCR, which was fully offset by higher own funds. These increases in own funds were supplemented by the benefit related to exiting the travel and stop loss business in the U.S.
and the completion of the sale of Aegon Ireland in the first half of 2018, which both led to a decrease in SCR. Now let's turn to Slide 16 and briefly examine the solvency ratios of each of our main operating units.
As you may recall from our webinar in June, local unit solvency ratios are one of the binding constraints for return on capital to shareholders. I'm therefore pleased that all our main operating units remain well within or above their target zones during the first half of 2018.
This allows us to absorb upcoming known regulatory changes in the U.S., the strain from the illiquid investments in the Netherlands and the BlackRock part 7 transfers in the U.K.
In United States, the risk-based capital ratio improved by 18 percentage points to 490%, which is well above our target zone of 350% to 450%, an improvement driven by favorable market impacts and product exits.
In Netherlands, the Solvency II ratio declined by 9 percentage points to 190% due to the previously mentioned lowering of the ultimate forward rate, the strain related to the illiquid investment strategy that we initiated last year to improve returns, and some model updates. The ratio nonetheless remains well within the top half of our target zone.
Finally, in U.K., the Solvency II ratio increased by 21 percentage points to 197%, which puts the ratio well above the target zone for the first half of 2018.
This improvement in the ratio is driven by favorable market impacts and management actions, including the decision to de-risk the investment portfolio related to the remaining Annuity business, fund restructuring and the temporary benefit from changes in the equity hedging program.
Before turning to our excess cash position, let me first explain why our quality of capital has improved significantly on the following slide. The overall quality of capital for the group has further improved over the past six months, primarily driven by a strong increase in our own funds.
As I highlighted previously, our own funds increased by €1.5 billion in the first half of 2018, contributing to a 16 percentage point increase in unrestricted Tier 1 as a percentage of SCR. This improvement in unrestricted Tier 1 capital has reduced the overflow of Tier 1 capital into Tier 2.
In addition, we continue to actively manage our gross financial leverage to the low end of our 26% to 30% target range. While the leverage ratio increased slightly in the first half of 2018, this was primarily due to the timing of refinancing activities.
We expect to bring down the leverage by €700 billion in the second half of 2018, which is expected to reduce the gross financial leverage by approximately 200 basis points. Next, let me walk you through our holdings excess cash development for the first half of the year on the next Slide.
During the first half of 2018, holding excess cash increased by €569 million to well above the top end of our target range. This increase in excess cash was primarily driven by gross remittances to the holding of €593 million from our operating units.
This figure is made up of the normal remittances received from the United States together with contributions from the Netherlands and the U.K. These remittances were partly offset by capital injections to support the growth of business in India and to strengthen the capital position of Aegon's own business in Spain and its joint venture in Japan.
The holding also received €196 million following the completion of the sale of Ireland and has a temporary benefit of €200 million related to the timing difference for the debt redemption in the second half of 2018 that I mentioned earlier.
These benefits were partly offset by the cash portion of the 2017 final dividend of €167 million and normal holding and funding expenses of €164 million. Following the previously highlighted debt redemptions in the second half of the year, we expect the holding excess cash to return to the target zone.
On our final slide, I would like to turn to capital generation and capital return to shareholders. In terms of capital return, our strong capital generation enables us to pay a sustainable and growing dividend. As Alex said earlier, we are increasing our 2018 interim dividend to €0.14 per common share.
This growth is well covered by the remittances from our business units, while at the same time capital generation allows for significant investments that will help us meet our strategic priorities. During the first half of the year, our free cash flows increased by 47% to €594 million.
This just puts us well on track to achieve our free cash flow target of €1.2 billion for the full year, underscoring our commitment and ability to return €2.1 billion to shareholders over the period 2016 to 2018.
In summary, this was not only a strong start to the year from an earnings and capital perspective, it was also one in which we made a series of significant steps forward in the execution of our strategy and to further deliver on our commitments for 2018.
I'm confident that we can further improve our performance by continuing to successfully execute our expense savings program and grow our business. At the same time, we'll continue to transform and become a more fee and protection based company that is uniquely positioned to serve our customers throughout their lives.
Alex and I are happy now to take your questions..
[Operator Instructions] We will take the first question from Farooq Hanif from Credit Suisse..
I had some questions on U.S. capital first. So can you update us on your sort of latest view on what the tax reform and RBC changes will do to your RBC ratio? I know you've said before that it will remain well within target, but I wonder if you could quantify it.
Secondly, it sounds like you're not likely to take a premium deficiency reserve charge based on your long-term view. But if you did, how would that impact your capital position? So would it be an immediate hit or would it be something that's spread out over time? And lastly, just on your deleveraging.
So there are some obvious things that are happening that you've told us about in terms of debt reduction, but you mentioned in the past the potential need to de-lever further given changes to IFRS.
So could you give us a bit more of a guide to how you're thinking about that going forward in terms of capital management?.
Good morning, Farooq. Maybe I take your first and second questions a little bit together because they are a little bit related. So let's begin with where we stand with the U.S. RBC ratio at the half year mark. So we're sitting at 490% RBC ratio.
We expect that tax reform changes relative to the RBC ratio will take place in 2018 and we're estimating that that impact could be, let's say, 50 to 60 percentage points on the RBC ratio. So let's just call the number 55 percentage points. So that brings you down to about 435%.
Now one thing that we have telegraphed before was that we expected the NAIC to increased risk-based capital charges for lower rated credit quality assets, but we learned recently that this is likely not going to take place until 2020. So let's disregard that one for one moment.
So when we do the -- and you are absolutely correct, we don't have a plan to, let's say, increase reserves for -- premium deficiency reserves for removing morbidity improvement. But let's say we were to do that, let's say we were to do that. That would be worth about 30 percentage point in the RBC ratio.
So the idea that even without management actions and even without retained capital generation, that gets you to about 405% RBC ratio, which is a little above the mid-point of the target range. So that's a bit how we tend to think about this..
And you still feel neutralish about the VA changes?.
Yes, that will be a neutral things, plus or minus 2 percentage point, something like that. It's quite immaterial.
Now with respect to the deleveraging, I think what I've referred to in the past is that in the -- so we have $700 million that we're going to do in the second half of the year, so that reduces excess cash and it puts us about 200 basis points lower than where we sit now at the 29.8%.
So this ends up -- that's effectively why we need to keep this in the low end of the target range. And also deleveraging -- we are going to retain earnings over time, so we would expect the gross financial leverage ratio to come down. But if we were to do additional deleveraging, probably it won't be in the near term.
I hope that answers your question..
The next question comes from Robin van den Broek from Mediobanca..
I was just wondering how we should look at the review that the NAIC and the Society of Actuaries is contemplating regarding this morbidity improvement.
The fact that you give sensitivities, which I appreciate very much by the way, does indicate that there could be risk that -- what should we expect from the publication in Q4? Could they in fact impose -- basically force you to remove that assumption or can you still stick to your own views there? And secondly, I also appreciate the math you just gave to question of Farooq, saying it's roughly 30 percentage point of impact.
I was just wondering if there any other moving parts that could potentially offset when you do the PDR, maybe, for example, the experience on rate increases..
So the -- maybe just to update everybody. Somewhere in the fourth quarter it looks like the NAIC and the -- it's actually the American Academy of Actuaries, will do a study on -- reflecting morbidity improvement in, let's say, provisioning.
We would expect that whatever they come up with, whatever that conclusion is, that it would sort of flow through all the various testing elements that you would do. So whatever they decide would be allowable with regard to morbidity improvement would likely be reflected in cash flow testing and premium deficiency reserve.
However, it's unlikely that that would be impactful in 2018. It would be more of a 2019 event that would happen. That's why I'm trying to be very clear about the fact that if it were to happen, which it would not happen in 2018, I give you an estimate about 30 percentage points on that one.
And then with respect to, does it change anything else that you do or there any offsets? I did mention that there are some management actions that we can take that would allow us to increase capital. But I would also reiterate the fact that we do retain capital generation in the U.S.
So I actually think we're in pretty good shape here even if the NAIC and the American Academy of Actuaries were to take a decision to disallow or reduce the amount of morbidity improvement used in these various tests..
Maybe one follow-up.
The 30 percentage point you mentioned, that is probably assuming no start in sufficiency? So that's the full $700 million basically plus tax on your required capital in the U.S.?.
Correct..
The next question comes from Nick Holmes from Societe Generale..
Two question please. With the 10% ROE target, just wondered how confident are you that you really can achieve this by the end of the year. I mean, you've had the benefit of the lower U.S. tax rate, but I can't really see where the rest of the uplift is going to come from? And then second point is -- the second question is update on variable annuities.
Wondered if you could tell us a bit more about the products. I'm thinking you're targeting fee-based rather than commission.
And what's your appetite for guarantees?.
Well, on the 10%, I think what you're seeing here is we're on a trajectory where we have been improving our return on equity. You are right you point out that the tax reform in the U.S. has been helpful. But I also would like to point to cost savings programs that we are putting in place in first half of the year.
So we'll have a full effect at the end of the year and going forward. The investment in illiquids in the Netherlands, which is also something that we have been doing in the first half and continue to do in the second half, so you'll see more of the impact later in the year.
So the combination of these items combined with also the growth of our business make us believe that we are in pretty good shape to achieve that 10% ROE at the end of the year. In terms of VA product, we have been working hard on trying to adjust our offering in VA products.
And as you know, the most important one is how we have enhanced the Retirement Income Max product that we've done at the beginning of the year. We'll do further enhancements later this year. And in this specific product what we do here is to offer our customers the possibility to take a bigger part of the income in the earlier years of retirement.
So it's a whole idea that people that are just retiring would love to spend more, for example, for travel or whatsoever and need less later. So we try to adjust our products to what we see our customers are demanding. And I'm actually pleased to see that we are starting to see some good improvements, as I mentioned in my introduction.
Q1 was 8% higher than Q4 '17 actually and Q2 was 13% higher than Q1. So we've seen some sequential improvements in our products. We continue to believe that customers are looking for our products to provide them some form of security, and that means that we provide guarantees in the form of a living benefit.
So, that is part of our core offering and will continue to be part of our core offering. As you know, we've adjusted our....
Sorry, do continue..
Please go ahead..
No, no. Sorry, do finish, Alex..
No, I just -- just I want to say, and as you know -- actually, the point of the labor rules, now actually have been stopped in the sense that there is no more the DOL rules that will be applicable. However, what see is the SEC has actually taken that over and SEC is now working on rules that in a sense are somewhat similar.
But as you know, we said in all our previous calls that we are well prepared for this and that the offerings have been adjusted to a new reality where we are able to provide both commissions and fee products to our distributors..
Can I just have a very quick follow-up on the guarantees on variable annuities? Just wondered, Alex, well, what sort of level of guarantee are you now offering? And what is your feeling about the danger that the U.S.
stock market might be at a peak travel and if there is a downturn then these guarantees might be at risk?.
Well, a few things. First of all, the guarantees we provide, you know we hedge them at point of sale -- we hedge them at point of sale and base all our pricing on economic reality. So we're not assuming markets to continue to grow forever or interest rates to move in our hedging. And that's done at point of sale.
So that gives us protection and of course also our customers protection that we will be able to meet our commitments..
And the approximate level of guarantee, the range on the bulk -- I know this is difficult to quantify because it's different pricing for different guarantees, isn't it?.
Certainly, there's different pricing, but you need to look at it as a combination. So there's a financial guarantee in there that we hedge in the market. There is of course also the living benefit. So it is a combination in guarantees. But effectively the kind of guarantees level right now is around 5%..
We will now take the next question from David Motemaden from Evercore..
Just a question for Matt on -- following up on long-term care.
First question, just when was the last time you guys did a deep dive claims review or a comprehensive review on your claims? Because if I look at just the present value of your incurred claims development on form 3 of the stat experience exhibit, which is the best estimate of your claims experience, this has been consistently negative, including 70 million of negative experience in ' 17.
So just wondering what's going on there? Second, just on the morbidity improvement.
I guess do you see any morbidity improvement in your book of business? Do you see evidence of this including -- or occurring? And also just wondering on if you can provide any sensitivity to morbidity deterioration not only -- I know you guys gave it from removing it, but just wondering if you could provide I guess, for example, like a 1% deterioration in morbidity, what sort of impact that would have on your reserves? And then just lastly on -- CNO just completed a risk transfer deal in the U.S.
on their LTC business and just wondering what are your thoughts on doing something similar and if you see any opportunities out there?.
So your first question is a very good one, when was the last time we did a big deep dive on our claims experience. And the short answer is we routinely monitor this stuff. So the idea is that we look at our claims experience each and every year. In the past, we've done this at every third quarter. Now we do it for the first half year.
So we're looking at our claims experience actually quite carefully every time we do an assumption review. Your second question was with regard to the statutory books.
And I think that it's probably, at least for us, it's a little easier to look at this on an IFRS basis, because that represents our management best estimate view of mortality and morbidity. So the idea of statutory has some complexities that are not coming out well in the statutory blanks.
And I think one of the most important ones is that we are reflecting rate increases that we've done over time in the IFRS reserves and those are not reflected in the statutory reserves, although they are reflected in the....
Just to confirm there, Matt. Sorry, just to confirm. I'm looking at the claims reserve on a stat basis, which my understanding is that's a best estimate on a stat basis as well on IFRS. And that's where there's adverse....
You're looking at a disabled life reserve?.
Yes, the disabled life reserve experience..
[indiscernible]. Yes. We'll have to come back to you with more detail on that one. And then with respect to sensitivity to morbidity deterioration, I think that we took actually quite a big step to disclose what our -- the amount of morbidity benefit that we're taking in our reserving.
So we could potentially come with that kind of sensitivity, but I'm not going to give it right now. And on the CNO risk transfer deal, we would always be looking to potentially transfer risk, but in this case we don't see anything happening in the near term..
We'll now take the next question from Mark Cathcart from Jefferies. Please go ahead..
I would like to ask Matt. I noticed a slight change in the language that you used. You were very confident at the webinar, but now you're saying you're quite comfortable with the emphasis on "quite" in relation to your LTC reserves. And I'm just wondering if you're just gradually shifting to that position where you do take these.
So that's my first question. Second one is, in the UK you had a 3 million charge I think in June and you said that level of charging was going to continue until the situation completed.
So does that mean that on an annualized basis you're going to get £36 million of charges? Or is it going to be 10 million of charges we can expect for the full year? I'm just trying to work out how much of those charges are going to deplete the UK profit trajectory for 2018, possibly 2019 if that's the case? And then third, a lot of other companies tend to release their three year plans in December or November ahead of the three years in question I think.
And I just wanted to check. You're not going to release yours in December, but it will be in May. And also in connection with that, I wondered if you could talk about who would the most likely CEO be actually presenting those.
In other words, are we on the cusp of CEO change?.
You have detected some kind of a nuance in my language about my degree of comfort with our long-term care assumptions that I have completely missed. I think any change is likely coincidental. I've not changed my views since the June 9 seminar. Now with... .
You used the word "quite comfortable." That's all. So I really noticed it..
Yes. And it's -- yes. I didn't mean anything by it. Let's say that. Now in terms of -- let's say, in terms of integration expenses in the U.K., we have previously guided for about £20 million of integration expenses per half year. So we would expect that that would continue for the second half of this year.
However, we have seen that £ 3 million of additional charges come through in June and we would expect that one continue on top of the £ 20 million in this next half year until the integration of Nationwide is complete. So I hope that one answers the second one..
So in other words, it's going to be £ 3 million in each of the next -- well, for each of the 6 months of the second half of this year, but it peters out next year?.
Yes, until the Nationwide is completed. And I'll....
The £ 3 million run rate, yes..
Yes. And I'll let perhaps Alex to speak about the target setting and who will be presenting them..
Well, there's not much more that I can say, Matt. As you know, this is a decision for the Supervisory Board to be put forward for approval for the shareholdings. As soon as a decision on that is taken, we will share that with the market and of course also with you, Mark..
But you can confirm that the three-year plan will be outlined in May, not in December? Well, now in the next year, but it won't be as early as this year?.
February 19 is when we release our figures. That would be a logical time..
We will now take the next question from Kunal Zaveri from JP Morgan..
This is Ashik Musaddi, I'm just using Kunal's line. Just a couple of questions again on the U.S. capital. I mean, it looks like you're comfortably above your 350% to 450% capital at the U.S. level, so you'll be landing up at around 405% give or take. Can you just remind us as to how much capital you're generating every year in U.S.
and how much you're planning to pay out from U.S., just to get a sense as to how much you are accumulating every year on the RBC basis? That would be one, because I'm not sure if we need to be dependent on management actions. So that's first one. Second thing is, can you just remind us where we are on the dividend from Dutch and U.K.
given that your local solvency ratios have now stepped up in the U.K., especially like 199% or something, so it's pretty strong. So are we on track to start getting 100 million of cash from U.K. on a regular basis? And lastly is, it looks like you will be approaching around, say, 26%, 27% of leverage versus historically you have been around 30%.
So would you use that additional capacity again to do any M&A in Holland if need be? Or would you refrain from going towards that 30% mark again? I mean, it has taken you ages to come to this level.
So would you again go up to that level if the economics allow you or would you not?.
Thank you for your questions. So may be on the first one. I think you have the math pretty well right on the U.S. capital position. At this point, we would anticipate that they would generate capital on the order of $1.1 billion per year and that they would remit about 80% of it.
So that's where we stand regardless of what happens with morbidity improvements or those kind of things. I don't think we have to rely on management actions to be able to get to that level of remittance. So I think that that one is -- that's not a concern. On the other one on the -- so on the U.K.
business, you're right, we're sitting at 197% solvency ratio. We do have the BlackRock part 7 transfers that will come and bring that down about 10 percentage points. But right now -- the direct question you asked is, are they in a position to remit about £100 million per year on an ongoing basis.
And the answer to that is, yes, they have done and they have remitted the first £50 million in the first half of this year. So they are on track to do £100 million per year. On the gross financial leverage ratio, you're right, we're standing at the top of our target range now. You reduce leverage by $700 million in the second half of the year.
You get towards the bottom end of the range. That's actually a pretty comfortable place going into IFRS 17. So this is not something that we could do small things I think, but it's not like we would expand leverage dramatically in the near term at all to finance any kind of acquisition or whatsoever.
I like us to be in the low end of that target range..
But just a follow-up on that. I mean, you have mentioned in the past that if it ever comes into the market, you will look into it. And I'm not sure how much excess capital you have, I mean, apart from the debt capacity.
So if that ever comes into the market, would you -- I mean, are you still in the view that you will look into it and you have financial flexibility to do that? Because the leverage will be -- I mean, kind of debt leverage will be part of the financing structure I hope..
Yes. Well, what we've done -- I mean, we've said that this is going to come to market and we are going to take a look at it because it is in our backyard. But I think it is far too early to talk about financing options or whatever we might do. We're only in the beginning stages. It has not come to market yet. We're doing our own research at this point.
So I think it's a bit preliminary at this point..
The next question comes from Farquhar Murray from Autonomous..
Just 2 questions if I may. Firstly, on Aegon Sony Life. Could you just provide some magnetite around that, perhaps like net equity earnings or perhaps the SCR just so we can frame a sense of scale around that business and a possible exit there? And then secondly, just a point of detail on LTC. And thanks again for addressing the morbidity discussion.
Those disclosures are actually very helpful. And my question there is, the IFRS impact of 700 million relates to the closed book only? Would the impact be larger for the entire book? I suspect probably not materially, but just wouldn't mind confirming that.
And what was the rationale for doing the IFRS impact on a slightly different scope from the stat basis?.
On the first one on Aegon Sony Life, let's say it has got about $100 million of equity and it is slightly loss making. So yes, I think that answers the first one. Your second question I want you to clarify for me. You said we did it on a slightly different basis on stat. Help me to understand that one better. Because what we....
I think if we look at the slide there, you'll see on the footnote you've kind of mentioned that the actual IFRS basis assumption change -- well, when you're doing that kind of change to removing the morbidity assumption, you've done it on the closed book for the IFRS number, that 700 million pretax.
And for the 700 million on the capital, you've actually done it for the entire LTC basis. And I'm just -- one, wouldn't mind understanding what the rationale for having a slight different stat [Indiscernible]....
Yes, there is a little bit of nuance there..
Anything material if we....
Yes, there is....
And anything material if we change it?.
Yes, sorry. There's a bit of nuance there. So the 700 million is what we come to earnings on the closed block LTC book. There is an additional a $150 million benefit that we're taking on the open book. But that would not be a reduced earnings impact. It would effectively be a reduction in the loss adequacy testing sufficiency.
So it's not a -- it would not be an earnings impact. And the 700 million, we just wanted to do this for completeness sake. 700 million on a statutory basis is for the whole thing..
Just to understand on the IFRS basis, you're saying that's actually -- essentially a positive on the other open book?.
Well, we're taking a €150 million benefit on the open book. But were that to be removed, it would not impact our actual IFRS results. It would be a reduction in what they call loss adequacy testing headroom, not an [Indiscernible] impact..
We will now take the next question from Johnny Vo from Goldman Sachs..
The first question, just in regards to the Netherlands, the solvency position has declined slightly.
Can you just give more color around how that moved? I know that your approach with the dynamic VA is potentially different to others, so if you can just give more color and the moving points of that? And the second question is just in regards to a previous question that was asked in relation to your leverage position coming down to the bottom end of the range.
You are reviewing some of your portfolios, so you are creating more liquidity in your holding company and things look good.
In the event that M&A doesn't happen for you, how should we think about capital returns going forward?.
Maybe on the first one, Johnny. For the NL solvency position really what you're looking at here is -- the major impacts are the reduction in the UFR by 15 basis points, which we knew of course was coming, and the additional illiquid assets that we invested in during the quarter. So that's increasing SCR. There is a technical thing that is happening.
So the EIOPA VA increased by 10 basis points and that worked a little bit differently with the dynamic VA. But on that one, it is a very technical discussion. So I am going to leave that with the IR if you can contact them. With regard to the leverage position, so we are managing it down to the bottom end of the range.
But to be clear, what we're looking at is we're looking at 1.9 billion excess cash in the holding, but then we're repaying 700 million of debt. So we're right in the middle of the range, the 1.2 billion. So it's not like we're flush with cash that can be used to do acquisitions and that sort of thing. We end up right in the middle of our target range.
So I would not expect this to drive any changes and what we think of as our normal cash generation and capital repatriation to shareholders policies..
We will now take the last question from Steven Haywood from HSBC..
A quick follow-up on the morbidity assumption in your U.S. long-term care. I wonder could you tell us how the assumptions compare to your peers in the U.S. and what the peers are doing with the upcoming sort of review as well. Also on your group tax rate, you mentioned that 29% is too high.
What do you expect the group tax rate to be going forward? And lastly, on the illiquid investment program in the Netherlands, can you tell me how is it progressing and what further uplift to earnings do you expect here? Do you expect another 32 million positive to come through in the second half of this year?.
So on the morbidity assumption, you're asking me about what competitors are doing and also in light of what's coming from the NAIC. I would not comment on that at all. I would just reiterate our position and will react to any new information that becomes available. The group tax rate is ultimately on a trajectory to get to about 20%.
And as you know, we were a little bit high in the first half of the year. We had a one-off tax item in the U.S. which drove that one. Then the uplift of the Netherlands earnings, actually that was a very good story for us for the quarter. The illiquid assets are of course contributing to that. We saw good expense savings.
There was some one-off -- one-time items that were positive in the first half of the year. Illiquid asset development in the first half was about 700 million. We've been a little purposefully slow in putting this stuff on our books. But that has increased the investment spread that we're getting.
And we would expect to see something along a similar amount of additional illiquid assets up on in the second half of the year. But I wouldn't comment on an earnings projection for the Netherlands, but just say that we're encouraged by what we're seeing on the earnings front there. Thank you..
If I can just quickly follow-up on the last question, the 700 million you've added and expecting to add again in the second half this year.
What is the total amount you're expecting to put on the books, just to remind me?.
About 3.4 billion over a period of a year..
That will conclude today's question-and-answer session. I would now like to hand the call back over to your host for any additional or closing remarks. Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect..