Aegon N.V. (NYSE:AEG) Q3 2022 Earnings Call Transcript

Aegon N.V. (NYSE:AEG) Q3 2022 Earnings Call Transcript November 10, 2022

Aegon N.V. beats earnings expectations. Reported EPS is $0.25, expectations were $-0.29.

Jan Willem Weidema: Thank you for joining this conference call on Aegon’s Third Quarter 2022 Results. Before we start we would like to ask you to review our disclaimer on forward-looking statements which you can find at the back of the presentation. With me today are Aegon’s CEO, Lard Friese; CFO, Matt Rider; and Chief Transformation Officer, Duncan Russell who will take you through our 3Q results and the progress we are making in the transformation of Aegon. After that we will continue with our Q&A session. And on that note, I would like to give the floor to Lard Friese.

Lard Friese: Yes. Thanks Jan Willem and good morning everyone. We appreciate that you’re joining us on today’s call. It’s been a busy few months for us here at Aegon and I want to start by running you through our achievements on slide number two. In the past few months we have taken a number of important steps in the transformation of Aegon. We have made substantial progress on our operational improvement plan and taken additional actions to maximize the value of both our US variable annuity book and TLB, our high net worth insurance business. And of course, we recently announced the combination of Aegon the Netherlands with ASR. We also made solid progress on our ambition to grow our strategic assets, especially in our life and retirement businesses despite continued financial market volatility and political unrest.

Our operating results in the third quarter declined by 11% on a constant currency basis, reflecting adverse market conditions that more than offset an improvement in claims experience in the United States expense savings and the benefit from growth initiatives. Based on extensive analyses and the learnings from engagements with third-parties, we have concluded that the best option with respect to our US variable annuity portfolio is to continue to own and actively manage it at least in the near-term. Furthermore, we recently completed an internal reinsurance transaction between TLB and Transamerica that freed up $600 million of excess capital. This will in part be used to create a buffer to mitigate the impact of adverse equity markets which materially reduces the capital sensitivity of our US variable annuity book.

But we’re not done yet. We continue to see opportunities for growth and greater efficiency and we will remain focused on the execution of our strategic agenda. So, let’s turn to slide three. In October, we took a pivotal step in our transformation with the agreement to combine our Dutch activities with those of ASR to create a leading insurance company in The Netherlands. The transaction enables us to accelerate the return of capital to stockholders. It also propels our strategy of releasing capital from mature businesses and building advantaged businesses in our chosen markets where Aegon is well-positioned for growth. Additionally, the long-term asset management agreement that we have entered into with ASR strengthens our position as a provider of fiduciary services, retirement multi-asset solutions, fixed income, and responsible investing.

We are excited about the transaction and the opportunities it brings. After the closing, we will hold a strategic stake of almost 30% in ASR. And through this stake, we will benefit from the synergies that this in-market consolidation brings. The majority of the cash proceeds from the transaction will be used to return capital to shareholders. We expect the transaction, the synergies, and the capital deployment to result in accretion of the free cash flow per share over time. We have started the preparations to get approvals from the relevant stakeholders and we initiated a program to disentangle the Dutch business from the group to ensure a smooth transition to ASR. Slide number 4 highlights the good progress we continue to make with the execution of our operational improvement plan.

We have now implemented most of the more than 1,200 initiatives that are part of this plan. Just in the last three months, we completed another 100 initiatives and our efforts are bearing fruit. Expense initiatives resulted in a reduction of annual addressable expenses of €300 million in the trailing four quarters compared with the base year 2019. This is an increase of €50 million compared with last quarter. We have been able to absorb inflationary headwinds and further reduce our expense base towards the goal of €400 million expense savings by 2023. We are also increasingly seeing the benefits from our 260 growth initiatives that we have executed so far. Over the trailing four quarters, growth initiatives contributed €264 million to our operating results.

In light of the announced transaction with ASR, we will update our expense savings target and other targets in due course. And in the meantime, we will remain disciplined and focused on improving the operational performance across all our businesses. Slide number 5 zooms in on the progress of our US strategic assets. In individual solutions, we have the ambition to regain a top five position in selected life products over the coming years. And as you can see, commercial momentum remains strong in this segment. New life sales increased by 24% compared with the third quarter of last year. This was supported by the World Financial Group distribution channel where the number of licensed life agents grew another 10% compared with last year and now stands at nearly 60,000 agents.

In the retirement business, Transamerica aims to compete as a top five player in new middle market sales. Written sales were US$805 million this quarter, which is lower than the same period last year. Nevertheless, I’m satisfied with the results, considering the difficult circumstances with planned sponsors being hesitant to move retirement plans given the current volatile markets. Strong written sales in prior periods supported an increase in net deposits for the middle market to US$532 million. We will build upon Transamerica’s emerging commercial momentum and intend to invest capital to profitably grow our market share in selected product lines. We will share more details on our plans to profitably grow Transamerica as well as the UK our growth markets and our global asset manager at a Capital Markets Day in the second quarter of 2023.

Turning to slide 6, where we highlight the performance of our Dutch and UK strategic assets. I will start with the Netherlands, where we are a leading player in both mortgage origination and defined contribution pensions and continue to attract new customers. Mortgage sales decreased to €2 billion as the Dutch housing market is cooling down. Nevertheless, mortgages under administration continue to grow, partially due to lower client repayment activity that now amount to more than €62 billion. We also continue to consistently grow our workplace business, mainly driven by sustained strong demand for PPIs. Net deposits for defined contribution pension products increased by 35% to €245 million in the third quarter of 2022. Moving on to United Kingdom.

In the third quarter of 2022, the platform business across the retail and workplace channels generated net deposits of £83 million. Our workplace business delivered another quarter of positive net deposits. Outflows in retail reflects the impact of market volatility on customer confidence and their propensity to invest in line with what we have seen across our industry. Revenues for the overall UK business declined, as a result of the anticipated granular runoff of the traditional product portfolio. Despite the unfavorable impact of adverse markets under assets under administration, the efficiency of the platform deteriorated only slightly as a result of the steps we made to reduce expenses. Slide number 7 shows that our Asset Management business saw third-party net outflows in the global platforms, which reflect the challenging market conditions and the fact that customers freed up liquidity in a rising interest rate environment.

Third-party net deposits and strategic partnerships of €1.5 billion more than offset the €1 billion outflows in global platforms, leading in fact to positive net deposits for Asset Management overall. The operating margin of global platforms improved by around two percentage points to approximately 15% driven by lower expenses. This includes a reduction in accruals for variable compensation. The operating result from strategic partnerships decreased by 38%, as performance fees for our Chinese Asset Management joint venture reduced from last year’s elevated level due to adverse market conditions. In our growth markets, Aegon is investing in profitable growth. New life sales from these markets increased by 16% to €54 million and non-life sales grew by 17% to €25 million.

In summary, we remain focused on executing our strategic agenda and continue to maintain a high pace in transforming Aegon despite the challenging backdrop. Duncan will now provide you with more detailed information on the actions we have taken regarding TLB and the US variable annuities book. Duncan, over to you.

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Duncan Russell: Thank you, Lard. Let’s move to slide 9. At our Capital Markets Day, we laid out our strategy to focus on three core markets, three growth markets, and one global asset manager. We made clear that businesses outside the corporate amidst they will be managed with tight capital and a bias to exit. We made good progress on our portfolio rationalization, whether it’s through the divestment of Central and Eastern Europe, or our various actions to release capital by winding down or selling subscale ventures and businesses. TLB our high net worth business was the largest remaining operation outside the core perimeter. In the past two years, it has been managed with a focus on strict cost control and capital efficiency to increase its capital generation.

Over the past years, we have considered different strategic options for TLB, including a divestment. Following this review, we have decided to extend our internal reinsurance of TLB’s closed block to Transamerica. As of the fourth quarter of 2022, Transamerica will also reinsure the remaining 75% of TLB’s close block of universal life policies that have previously not been reinsured meaning that 100% will now be internally reinsured. Transamerica will hold additional reserves to cover the underlying risks, but it will also be allowed to recognize excess capital of TLB in its capital position. This frees up around $600 million of excess capital on a US level, which will increase Transamerica’s RBC ratio by approximately 30 percentage in the fourth quarter of 2022.

As a consequence, we feel that we have landed on the optimal solution for TLB compared to the alternatives and therefore, we’ll classify the business going forward as a financial asset with a continued focus on improving cash flows and disciplined capital management. Next on Slide 10, let me update you on our variable annuity business. In recent months, we have engaged with third parties to explore the possibility for a reinsurance deal. These interactions gave us confidence in our actuarial assumption set for variable annuities. And we saw that these third parties aim to manage the liabilities economically just as we do. Put simply, we witnessed a management approach and philosophy around VA that was consistent with where we have taken the block in recent years.

Following these interactions, we have decided not to engage further on a variable annuity transaction at this point in time. There are three main reasons for this. First, a transaction will lead to significant counterparty exposure given the size of the variable annuity business we have. And we have concluded that doing a smaller deal and thus reducing potential counterparty exposure wouldn’t represent a good use of time and effort given the intensity of these processes. Second, we would need to deal with stranded costs as the variable annuity block supports a substantial amount of overhead expense. These costs will need to be addressed as a block shrink naturally over time in an orderly manner. Over time, as the variable annuity block runs off and we successfully grow our strategic assets, stranded costs and counterparty risk will become less of a consideration for us.

Thirdly, with respect to valuation, the block under our ownership benefits from two main items: Number one, Transamerica benefits from a lower cost of liquidity management, given its overall large and diversified balance sheet; number two, we believe there is value in the emergency fees on the base contracts, as these are asset management look in nature. Other parties tend to hedge the base fees due to the volatility in the capital position it creates in particular on a smaller balance sheet. For this reason, we concluded also that the value benefit of the transaction was unlikely to be compelling. Now our work on the block does not stop. In October, we have taken another management action on the variable annuity portfolio following on from the actions we’ve taken so far.

We have decided to set the voluntary reserves, which reduces the amount of base fees reflected in the capital position. Second, the reserve will reduce the RBC ratio by approximately 15 percentage points in the fourth quarter of 2022. But by setting up the reserve the recognition of base fees in our capital vision will be more closely aligned with when they are earned. As a result, the sensitivity of the RBC ratio to a 25% decline in equity markets will reduce by about 1/3. When taken in conjunction with previous actions we have put in place for example the dynamic hedging and the policy buyouts, this additional action brings further stability and quality to capital generation as the variable annuity block runs off. I would now like to hand over to Matt to address the financial performance slide in the third quarter.

Matt Rider: Aegon’s operating result decreased by 3%, but by 11% on a constant currency basis to €429 million. Lower fees due to adverse market movements and expected outflows in variable annuities more than offset the benefits from expense savings, growth initiatives and an improvement in claims experience. As Lard mentioned, addressable expense savings for the trailing four quarters increased by €50 million over the last quarter and now total á¹£€300 million compared with the full year 2019 expense base. Operating capital duration before holding, funding and operating expenses amounted to €399 million mainly reflecting strong performance from the US, driven by income from alternative investments and seasonality and reserve movements in the US.

Cash capital at the holding decreased to €1.4 billion, mainly as a result of €373 million of capital being returned to shareholders, which more than offset this quarter’s free cash flow of €67 million. Our gross financial leverage amounted to €5.8 billion, which is slightly higher than last quarter due to the strengthening of the US dollar. As mentioned in the press release, we issued on October 27, we intend to use up to €700 million of the cash proceeds from the transaction with ASR to reduce our leverage further. Our balance sheet remains strong with the capital positions of all three of our main units remaining above their respective operating levels. The group Solvency II ratio decreased by two percentage points over the third quarter to 212% mainly from market movements.

Furthermore, eligible owned funds reduced due to tiering restrictions on the amount of deferred tax assets that we are allowed to recognize as capital. Turning to Slide 13. We saw the third quarter operating result come in at €429 million. Adverse markets have impacted our results in particular in Asset Management and in the United States. The operating result in the US decreased by 4% or 19% on a constant currency basis to €156 million. The primary driver of this was a lower result from variable annuities where fee income was negatively impacted by adverse markets and expected outflows. This was partially offset by an improvement in net claims experience in life and health. Mortality claims experience was €30 million unfavorable in the quarter of which €12 million related to deaths directly attributable to COVID-19 with the remainder due to a higher than average claim size.

Morbidity experience for the quarter was in line with expectations. In the Netherlands the operating result from our bank Knab and from Workplace Solutions increased supported by business growth. This was more than offset by a decrease in operating results from life and mortgages from lower investment income and lower mortgage prepayment compensations. In the UK, fee revenues declined as a result of unfavorable market developments and the runoff of the traditional product portfolio. This was more than offset by lower addressable expenses driven by the operational improvement plan. Once again, Aegon international performed well delivering growth across all businesses and showing improved claims experience compared to the same period last year.

Finally, the operating result from Asset Management decreased by 25%, mainly driven by lower performance fees in the Chinese asset management joint venture, which were negatively impacted by poor equity markets. While market movements negatively impacted revenues and global platforms, the operating result actually showed improvement over the year-ago quarter due to lower addressable expenses. Let us go now to slide 14, where we show that the net loss for the quarter amounted to €206 million. Nonoperating items totaled a loss of €622 million, mainly driven by an accounting mismatch related to the interest rate hedges for our legacy US variable annuities. This program hedges the economic liability. However, under IFRS, we carry the hedge assets at market value, while the liabilities for guaranteed minimum debt benefits and guaranteed minimum income benefits are calculated using locked-in discount rates.

The increase in interest rates during the quarter therefore drove a fair value loss as a consequence of this accounting mismatch. Realized losses amounted to €127 million from the sale of sovereign and corporate bonds in a rising interest rate environment, consistent with Aegon’s strict liquidity framework. Other charges amounted to €107 million, reflecting €79 million of onetime investments related to the operational improvement plan. On slide 15, I want to go through the capital positions of our main units, all of which ended the quarter above their respective operating levels. The US RBC ratio decreased 12 percentage points over the quarter to 404%. The RBC ratio was negatively impacted by unfavorable market movements. Benefit from the operating capital generation was offset by US$200 million of dividends to the US intermediate holding company.

These remittances from the operating companies were made in order to prefund the majority of the remittance to the holding, anticipated to occur in the fourth quarter of this year. Please note that the net 15 percentage point positive impact from the reinsurance transaction with the TLB and the setup of the voluntary reserve and variable annuities that Duncan mentioned will be reflected in the RBC ratio in the fourth quarter. The Solvency II ratio of the Dutch Life unit increased to 207%, particularly from a tightening of mortgage spreads and a flattening of the interest rate curve. The solvency ratio of Scottish Equitable, our main legal entity in the UK increased by one percentage point to 179%. On slide 16, you can see that the cash capital at the holding came down to €1.4 billion during the quarter, which is close to the top end of the operating range.

This quarter, we returned €373 million of capital to shareholders through dividends and the second tranche of the share buyback program announced in March. We still have one tranche of €100 million from the share buyback program to go, which is expected to be completed during the fourth quarter of 2022. Slide 17, summarizes the great strides we have made in recent months in maximizing the value of our financial assets. In the third quarter, we continued our track record of successfully hedging the targeted risks embedded in our variable annuity guarantees. We achieved 97% hedge effectiveness, despite significant volatility in financial markets. This is another example of how we are stabilizing the capital generation from this block of business.

In long-term care, I am pleased that we obtained regulatory approvals for additional rate increases worth US$59 million. The total value of approvals achieved since the start of the program now stands at $450 million. This means that we have achieved our target for this program, which we upgraded a year ago from the $300 million target that we had set ourselves at the Capital Markets Day back in 2020. We will continue to work with state regulators to get pending and future actuarially justified rate increases approved. The Dutch Life business again paid its remittance of €50 million, which was well-covered by the €63 million operating capital generation for the quarter. And as just explained by Duncan, TLB will also be managed as a financial asset going forward.

The reinsurance transaction that we announced today will free up capital and strengthen Transamerica’s capital position. And with that final note, I now pass it back to you Lard for the wrap-up.

Lard Friese: Yeah. Thanks Matt. Let’s go to slide 19. I’d like to reiterate that we are maintaining a high base in Aegon’s transformation. We are making good progress on the operational improvement plan, we are maximizing the value of our financial assets and we are investing in profitable growth. I’m, therefore, confident about delivering on our strategic and financial commitments. As a final note I want to share my appreciation for the hard work and dedication of all colleagues to support our customers’ needs in challenging times. Specifically our employees who are affected by the transaction with ASR and we continue to work tirelessly to improve our performance despite the uncertainty that the transaction brings for them personally.

It is thanks to the efforts of our employees that we are able to continue to improve our operational performance and accelerate our strategy. I would now like to open the call for your questions. Please be so kind to limit yourself to two questions per person. Operator, please open the Q&A session.

Q&A Session

Operator: Thank you. The first question from Andrew Baker from Citi.

Andrew Baker: Great. Thank you for taking my questions. So the first is on capital generation. Just wondering if you could provide some of the usual moving parts on the capital generation and what you’ve seen in the clean quarter run rate for both Q4 and then also 2023? And then the second one is on the variable annuity book. So, obviously, you’re retaining the book in the near-term but it feels like you’re not rolling out Q3 transactions just based on the growth of the underlying US business and when you can reduce that the impact of counterparty risk and the strategic costs. Just wondering based on your projections today, how long do you think it will be before those two constraints are small enough that you might be able to consider a transaction for that book? Thank you.

Lard Friese: Yeah. Thank you very much Andrew. I’m going to ask Matt to do the capital generation, and then thereafter Duncan on the VA. So first Matt over to you.

Matt Rider: Yeah. Thanks Andrew. So for the third quarter the operating capital generation from the business units that we reported was €399 million. We did have some what we would call unfavorable mortality and morbidity experience there in the amount of about €41 million. But we did get a benefit in two main items; one was in alternative investment income was higher than what we had expected in the amount of about €30 million. And then we had some favorable benefit from some seasonality in universal life reserving. And this was for an amount of about €35 million. So we also had about €25 million of good guys from international where we benefited from some lower required capital from just change in asset mix together with some favorable claims experience.

So if you net that all out, we end up with about a clean number for the quarter of about €350 million. So if you think about going forward for 2022 we have year-to-date reported €1,175 million of operating capital generation in the business units adding sort of a clean run rate of the €350 million for the fourth quarter and that gets you to something around €1.5 billion. So that’s an upgrade of the OCG guidance that we had given last quarter which was around €1.4 billion. Now we say it’s about €1.5 billion. So it looks like we’re on a good track to be able to achieve that. At this point in time we’re not giving any guidance on 2023 yet. We will do that in due course likely in the fourth quarter as we work through those ones.

Lard Friese: Thank you very much, Matt. So Duncan, the VA question?

Duncan Russell: Thanks, Andrew. Well you’re right to summarize that the two drivers — the two main considerations for us were the counterparty exposure given we don’t have a separate legal entity. So any deal we would do would be in reinsurance for. And the second one was the need to deal with stranded costs which of course would be possible. But some of those costs will be fixed. And as you know we are quite focused at this point in time in reinvigorating the growth engines within Transamerica. So that’s our focus right now. In terms of the question in terms of time line we’ll continue to evaluate things. Our work won’t stop on this block of business. We’ve derisked it materially and we have stabilized the capital generation coming out of it materially.

But we’re going to continue to look for incremental management actions as we have done in the past. Obviously, we’re not going to look to transact in the very near-term. But given that the policy count is running down between 8% and 10% per annum both the items I identified in the coming years should become less relevant for us. And therefore again we could be an opportunity for us to reevaluate in the coming years.

Andrew Baker: Great. Thanks, guys.