F&G Annuities & Life, Inc. (NYSE:FG) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the F&G Annuities & Life First Quarter 2023 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Lisa Foxworthy-Parker, Senior Vice President, Investor and External Relations for F&G. Thank you. You may begin.

Lisa Foxworthy-Parker : Great. Thanks, operator, and welcome, everyone, to F&G’s First Quarter 2023 Earnings Call. Joining me today are Chris Blunt, Chief Executive Officer; and Wendy Young, Chief Financial Officer. We look forward to addressing your questions following our prepared remarks. Today’s earnings call may include forward-looking statements and projections under the Private Securities Litigation Reform Act, which do not guarantee future events or performance. We do not undertake any duty to revise or update such statements to reflect new information, subsequent events or changes in strategy. Please refer to our most recent SEC filings for a discussion of the factors that could cause actual results to differ materially from those expressed or implied.

This morning’s discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. Non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules within our earnings release, financial supplement and investor presentation, all of which are available on the company’s website. Today’s call is being recorded and will be available for webcast replay at fglife.com. It will also be available through telephone replay beginning today at 1:00 p.m. Eastern Time through May 11, 2023. And now I’ll turn the call over to our CEO, Chris Blunt.

Chris Blunt : Good morning, and thanks for joining us today. For F&G, 2023 is off to a solid start, as shown in our first quarter results. I’m proud of this result especially given the tumultuous nature of the first quarter macro environment, characterized by ongoing market volatility and inflationary pressures, stress on the banking system given the recent regional bank failures and concerns around credit and commercial real estate exposure with the prospect of a recession on the horizon. Although a difficult environment, it really highlights what makes F&G different, how our superior ecosystem operates and how F&G is well positioned to weather the storm. I’d like to share some of those insights with you. First, starting with the effects of market volatility and inflationary pressures.

Higher interest rates and extended periods of market volatility are known to spur fixed annuity sales as financial advisers and consumers seek resilience for their investment portfolios and retirement savings. Fixed annuities are increasingly viewed as an attractive solution offering relatively higher rates, guaranteed growth, principal protection, tax advantaged accumulation and annuitization options. Importantly, we’re an industry that makes good on promises and serves as a steward to meet long-term policy objectives. These factors drove record industry annuity sales in the fourth quarter of 2022, and the momentum continues, with LIMRA forecasting another record-breaking first quarter for 2023. Similarly, for F&G, these dynamics have contributed to record gross sales in the first quarter and are generating a level of profitable sales and issuance of new policies that substantially exceed policy maturities and other withdrawals.

We reported record total gross sales of $3.3 billion in the first quarter, a 27% increase over the prior year quarter and a 22% increase over the sequential fourth quarter. Our retail channels reported record gross annuity and life sales of $2.8 billion in the first quarter, an 87% increase over the prior year quarter and a 12% increase over the sequential quarter. We saw growth across all 3 retail channels, including agent, bank and broker-dealer channels as compared to the prior year. Institutional sales were $520 million in the first quarter, split evenly between pension risk transfer and funding agreements. We have also closed an additional pension risk transfer transaction of approximately $200 million in April, which was not reflected in first quarter sales.

F&G’s net sales retained were $2.2 billion in the first quarter, which reflects 67% of gross sales as compared to 70% for the sequential quarter and 92% for the prior year quarter. This trend reflects third-party flow reinsurance, which increased from 50% to 75% of MYGA sales in September of 2022. As a reminder, we utilize flow reinsurance, which provides a lower capital requirement on ceded new business while allocating capital to the highest returning retained business. From our perspective, this is a smart financial decision as it enhances cash flow, provides fee-based earnings and is accretive to F&G’s returns. Our ending assets under management grew to $45 billion as of March 31, an 18% increase due to positive net flows over the prior year driven by new business net of flow reinsurance, stable in-force retention and debt issuance net proceeds.

Next, turning to the topics of asset liability management, liquidity and risk management, which were brought to the forefront by the recent regional bank failures. I often say that insurance companies are a better form of a bank. In contrast to banks who borrow short and lend long, insurance companies borrow long and invest long. We are asset and liability-matched. And there are important characteristics of life insurance liabilities that ensure that they are not susceptible to runs like bank deposits, including a product design which mitigates disintermediation risk. In this regard, F&G is uniquely positioned with an in-force book of liabilities that are sticky and predictable and that do not contain problematic legacy blocks of business. Our liabilities are primarily spread-based and not tied to legacy economic assumptions.

When we sell a policy, the spread is essentially locked in. New business is priced for current economics. And for our in-force fixed indexed annuity and indexed universal life, we have the ability to reprice the current economics typically every year. This flexibility allows us to actively manage our in-force and new business to maintain pricing targets, and we have a long history of doing so regardless of volatility in the marketplace. Our liabilities are also relatively young given the robust levels of new business over the past 3 years. Our GAAP net reserves were approximately $43 billion at March 31, with 88% as either surrender protected or nonsurrenderable. Fixed annuities comprised 74% of total net reserves, of which 91% are surrender protected with an average remaining surrender charge roughly 7% of account value.

In addition, approximately 70% of these policies also have a market value adjustment protection. These policy features serve as a disincentive for policyholders to surrender early. Pension risk transfer, funding agreements and immediate annuities comprised 21% of total net reserves, all of which are essentially nonsurrenderable. Even with these protections, we monitor policyholder behavior regularly. Fixed deferred annuity surrenders were slightly elevated in the current quarter and during April, although in line with our long-term pricing expectations, and we experienced strong positive net inflows during the month. Our asset and liability cash flows are tightly matched within a year or less. Assets are generally held to maturity, and we have many sources of liquidity.

Our strong new business inflows are more than sufficient to meet outflows, as evidenced by our growth in assets under management. F&G does not expect to sell assets to meet a liability claim. As a further safeguard, we have ample sources of liquidity, including untapped capacity on our third-party credit facility, our parent revolver and FHLB borrowings. We also have $2.4 billion of cash and short-term investments on our balance sheet. And unlike many in the industry, we have a positive statutory interest maintenance reserve or IMR position of approximately $125 million, which protects statutory capital by serving as an offset to any realized loss on a portfolio asset sale. We are vigilant in our risk management approach, which includes counterparty reviews and regular stress testing of our assets and liabilities to meet internal, regulatory and rating agency requirements.

These various stress test results demonstrate the predictable nature of F&G’s liabilities given our product design and also highlight another key differentiator between insurance companies and banks. In a theoretical scenario where annuity surrenders are modeled with an unexpected spike, insurance companies like F&G would typically have a boost to earnings from the higher surrender charge fees and free up capital from the policy lapse. And next, turning to our investment portfolio. Our high-quality portfolio is diversified and well positioned to withstand uncertainty in the macro environment and well matched to our clean and stable liability profile. Our fixed income yield, excluding alternative investment volatility and variable investment income, has expanded to 4.33% for the first quarter as compared to 3.73% in the first quarter of 2022.

This primarily reflects upside from the 18% of our portfolio held in floating rate assets and higher yields on new investments. Our portfolio is allocated across 14 asset classes given our access to both public and private markets through Blackstone’s asset origination capabilities. The fixed income portfolio is 95% investment grade, and we have a modest average credit-related impairments of 5 basis points over the last 3 years, well below our pricing assumption. Credit-related impairments net of reinsurance were negligible at 2 basis points in the first quarter. Given broader market concerns around credit exposure in commercial real estate sector with a prospect of a recession, I’d like to walk through a few aspects of our portfolio, including alts, commercial real estate, CLOs and regional bank exposure.

First, with regard to alternative limited partnerships in our financial supplement, the net asset value of our alts limited partnerships is about $2.6 billion or 6% of the total portfolio as of March 31. The majority of our alts are in private equity and real estate strategies with an underweighting to credit and real estate. In fact, only $54 million or 3% of the total alts portfolio is held in office and $5 million or less than 1% in retail. Our long-term targeted allocation to alternative assets remains approximately 5%, although there will be some quarterly variation based on the timing as new commitments fund an existing alts runoff. Given the book was mostly deployed in 2018 and 2019, our timing was good, and the alts are seasoned and have performed well as expected.

Since the FNF merger in June of 2020, F&G’s alternative investment portfolio has returned 11% on average, and returns have been less volatile than the S&P 500 index. Next, with regard to commercial real estate exposure. Looking at our CMBS, CML and alternatives portfolios combined, our exposure to office is $1 billion in aggregate or less than 3% of the total portfolio, while retail is $400 million or 1% of the total portfolio. Our CMBS and CML portfolios are of high quality and moderate leverage with diversified exposure across various geographic locations and property types, including residential, multifamily, industrial and logistics. F&G is well insulated and underweighted relative to peers and also benefits from the expertise and insights that Blackstone holds as one of the largest property owners in the world.

And next, with regard to collateralized loan obligations or CLOs. We hold $4.3 billion or 10% of the total portfolio fair value in CLOs as of March 31, which is well diversified across industry, issuer and manager, with 95% of our CLO portfolio investment grade and having ample structural protection with 19% par subordination. F&G has been a valuation-sensitive and opportunistic buyer of CLOs, with much of our position initiated in 2018. We have opportunistically reduced our CLO allocation over time and notably hold less than $18 million of CLO equity. Our seasoned portfolio has performed well, remains overcollateralized and is actively managed through Blackstone’s investment professionals and rigorous underwriting capabilities. We feel that CLOs, if properly underwritten, have a better risk profile than holding the underlying loans directly given the inherent structural protections.

In fact, historic data shows that CLOs hold a lower default rate relative to corporate credit and lower loss rate relative to its structured peers. Finally, with regard to regional bank exposure, we do not have any holdings in Silicon Valley Bank, Silvergate Bank or Signature Bank, and we reduced our modest year-end position in First Republic during the quarter with only a de minimis preferred stock holding remaining as of March 31. Overall, we have conviction that our portfolio is well positioned to withstand an economic downturn and is well matched to our liability cash flows. We take a dynamic approach to continually re-underwriting the portfolio, taking advantage of market dislocations to not only increase the credit quality and diversification of the portfolio while also implementing targeted derisking programs to refine the portfolio on the margin over time as defensive positioning for potential macroeconomic conditions.

Our strategic investment management partnership with Blackstone remains a differentiated competitive advantage for F&G. We benefit from Blackstone’s extensive origination capabilities, depth and breadth of expertise in having over 300 investment professionals and are in continual real-time communications as we assess the portfolio relative to anticipated market conditions. Looking ahead, our prospects are bright. We see many opportunities to expand our profitability in addition to growing our assets under management. Our first quarter results demonstrate the underlying earnings power of the F&G business model where profitable asset growth drives earnings and we benefit from the higher rate environment. We compete and win in some of the industry’s highest-growth product segments, including fixed and fixed indexed annuities and pension risk transfer.

And we expect to launch our new registered index-linked annuity or RILA product later this year. We are also pursuing a strategy to expand our owned life insurance distribution while boosting our presence in underserved multicultural and middle-market segments. We have taken minority equity interests in 2 of our top life distribution groups, SYNCIS in early 2023 and FEG in 2021, and expect to expand with additional investments over time. We value the power of capital-light earnings streams from these owned distribution stakes, which are accretive to ROE and tend to trade at 2 to 3x the price earnings multiple of traditional life insurers. We also expect to build on our partnerships for accessing flow reinsurance, which provides cash generation, fee-based earnings diversification and is also accretive to ROE.

To recap, we have strong momentum as we head into the second quarter with many opportunities ahead of us to further expand our business, which will ultimately drive margin expansion and improved returns. We continue on positive ratings outlook with both A.M. Best and Moody’s, which reflects our proven track record, balance sheet strength, financial transparency and commitment to achieving upgrades over time. And we remain focused on delivering long-term value to our shareholders. Let me now turn the call over to Wendy Young to provide further details on F&G’s first quarter financial highlights.

Wendy Young : Thanks, Chris. Today, I’ll provide more details about our financial results and key performance metrics and capital liquidity and leverage position. Overall, F&G’s financial performance in the first quarter was strong and builds on our proven track record. We continue to have strong capitalization and financial flexibility to successfully execute our growth strategy. Starting with adjusted net earnings. We have adopted the new accounting standard, targeted improvements to the accounting for long-duration contracts or LDTI using the full retrospective transition method effective January 1, 2023, with changes applied as of January 1, 2021, also referred to as the transition date. As a reminder, LDTI is a U.S. GAAP accounting standard only with no impact to statutory results, insurance company cash flows or regulatory capital.

The most significant effects of the new accounting standard on F&G’s adjusted net earnings are, first, the adoption of constant-level amortization of actuarial intangibles, which will now show a more predictable trend and grow with the in-force book over time; and second, the new market risk benefit or MRB reserve change, which replaces the prior SOP 03-1 reserve change for the guaranteed minimum withdrawal or death benefits. We expect future quarterly fluctuations in market risk benefit actual experience that differs from expectations and with less amortization offset. Our 2021 and 2022 financials have been adjusted for the retrospective update, as shown in our earnings release and quarterly financial supplement. For full year 2022, we reported adjusted net earnings of $328 million or $2.85 per share as recast for the new accounting standard as compared to the previously reported results of $345 million or $3 per share.

For full year 2021, we reported adjusted net earnings of $656 million or $6.25 per share as recast for the new accounting standard as compared to previously reported results of $551 million or $5.25 per share. After excluding significant income and expense items and normalizing for short-term alternative investment volatility, our underlying earnings are 5% higher for both full years 2021 and 2022 under the new accounting standard. This reflects timing differences when sources of actual earnings emerged, although from an economic perspective, the underlying product profitability is unchanged. For the first quarter of 2023, we reported adjusted net earnings of $49 million or $0.39 per share. This included $99 million of investment income from alternative investments, offset by $37 million tax valuation allowance expense.

Alternative investments investment income based on management’s long-term expectation return of approximately 10% was $132 million. I’ll note that on a net income basis, we had $195 million loss in the quarter prior to non-GAAP adjustments largely driven by the mark-to-market movements. Going forward, we expect additional volatility in our quarterly adjusted net earnings trend due to timing differences from both the alternatives investment portfolio short-term mark-to-market movement that differs from long-term return expectations as well as MRB reserve changes for actual to expected experience variances, which were previously partially offset by intangible amortization. Again, underlying economics have not changed. And under the new accounting standard, our adjusted return on assets continues to trend over time above our return on assets target of 100 basis points.

Further details are provided in our earnings release and quarterly financial supplements as well as our investor presentation available on our website. Our 10-Q will also include expanded disclosures pursuant to new LDTI accounting standard. Turning to our balance sheet. Our capital, liquidity and leverage position is strong. Starting with our GAAP book value per share, our balance sheet for 2021 and 2022 have been adjusted for the retrospective LDTI update. As of December 31, 2022, we reported GAAP book value excluding AOCI of $5.2 billion or $41.45 per share as recast for the new accounting standard as compared to previously reported results of $4.6 billion or $36.66 per share. The approximately $600 million increase in equity reflects 3 primary updates to retained earnings, including approximately $500 million increase for changes in the MRB reserve and elimination of former SOP 03-1 reserve and $170 million increase for the migration to a constant actuarial intangible amortization methodology, partially offset by $60 million decrease for other items.

We ended the first quarter with a GAAP book value excluding AOCI of $5 billion or $39.94 per share with 126 million common shares outstanding as of March 31. There is a page in our investor presentation detailing the analysis of book value per share. F&G’s debt-to-capitalization ratio excluding AOCI was 24% as of March 31, in line with our long-term target. This reflects both the restatement of equity under the new accounting standard and $500 million of new senior notes issued during the quarter. We intend to use the net proceeds from the senior notes issuance to support the growth of the business and for future liquidity needs. Our annual interest expense is approximately $95 million or roughly 6% blended yield on the $1.6 billion total debt outstanding.

We target holding company cash and invested assets at 2x fixed charge coverage. Our strong capitalization supports growth and distributable cash. During the first quarter, we paid our first public company quarterly dividend in the amount of $0.20 per share of common stock or $25 million. Following yesterday’s announcement in the second quarter cash dividend of $0.20 per share, we view our current annual common dividend of approximately $100 million as sustainable. This translates into a dividend yield of approximately 4% based on F&G’s recent market capitalization of approximately $2.4 billion and demonstrates the underlying strength in our business as well as our commitment to creating value for our shareholders. The dividend is reviewed quarterly and expected to increase over time subject to cash flows and alternative uses of capital and market conditions.

Our Board of Directors has also authorized the initiation of a 3-year $25 million share repurchase program, as announced on March 21, to take advantage of our shares currently trading at a significantly discount to intrinsic value. As we have executed on our business plan to double assets under management and earnings per share by expanding our business into new channels of distribution well ahead of our original target time frame, the market has been slow to recognize the value that has been created, and we felt the repurchase program authorization was important to demonstrate our commitment to creating shareholder value. Finally, turning to our statutory capital position. We came into 2023 with a strong balance sheet, and we continue to target a company action level risk-based capital or RBC ratio of 400%.

Let me now turn the call over to Chris to provide further details on F&G’s reinsurance initiative.

Chris Blunt : Thanks, Wendy. We continue to execute on our planned reinsurance initiatives to support the ongoing growth of the business, including additional optimization through flow reinsurance. The ability of our new business platform to generate premiums is attractive to third-party asset managers, especially those who are not paired with an insurer as a means for them to take on asset growth and generate fees from the flow. To illustrate the economics for F&G, for every $1 billion of new business flow reinsurance, we free up approximately $75 million of capital to redeploy to the highest-returning retained business. This is meaningful. And to help put that amount in perspective, that is nearly 10% of the estimated $800 million of capital generation from our entire in-force block in 2023.

Importantly, we expect to grow gross sales at a double-digit clip while managing net sales retained to a level that continues to grow our AUM. We estimate that we could retain as little as $6 billion to $7 billion of gross sales and continue to grow the block. In this scenario, as long as sales are well in excess of outflows, we’re still growing with net inflows, albeit at a smaller spread but with less capital. This is highly accretive to ROE and also provides free cash flow from the ceding commission and expense allowances generated. We are well into our planning process, and I look forward to providing further details next quarter. So to wrap up, F&G is well positioned to fund its continued growth with positive and growing in-force capital generation, ample opportunity for future reinsurance programs and available debt capacity as our balance sheet delevers with book value growth over time.

And taken together, our common dividend and share repurchase programs demonstrate our commitment to creating shareholder value through a healthy return of capital to our shareholders. This concludes our prepared remarks. And let me now turn the call back to our operator for questions.

Q&A Session

Operator: [Operator Instructions] Our first question is from A.J. Hayes with Stephens Inc.

Operator: [Operator Instructions] Our next question is from Mark Hughes with Truist Securities.

Operator: Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Chris Blunt for closing remarks.

Chris Blunt : We’re pleased with our overall results, as you can tell. Despite the uncertainty and volatility in the current macro environment, we think F&G is poised to benefit in this higher rate environment. And we’re off to a strong start in our second quarter as a publicly traded company. As I said earlier, we expect to expand our business with a focus on further improving our profitability, which we believe over time will drive multiple expansion to deliver value to shareholders. Thanks for your time this morning. We appreciate your interest in F&G and look forward to updating you on our second quarter earnings call.

Operator: This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.